Sunday, April 12, 2009

The Case for Deflation -- An Editorial

Demand is made up of two components, consumer willingness to buy and consumer ability to buy. Willingness to buy is mostly a microeconomic variable, as each consumer has different tastes and needs. But ability to buy can be studied at the macroeconomic level.

Ability to buy means wages and credit. American inflation-adjusted wages have remained stagnant since 1975. This huge bubble of credit has hit the iceberg and it's only a matter of time before the realization sinks into the mass consciousness that this ship is going down.

The best measureable product of this expansion is found in the CPI. CPI has been steady or rising for a long time--that is, until around October of 2008, when the CPI started a rapid descent, only to recover in January and February of this year. I predict that we'll see more declines soon and over the next year or two. It is to be expected when one arm of the consumer's ability to buy has been stagnant for over 30 years and the other arm is paralyzed.

If buying power is limited, purchases slow. If purchases slow, businesses need to lower prices in order to clear their inventories.

While Obama's intentions are good, unless such massive government spending is going to be a PERMANENT fixture in the economy, more stimulus packages are not sustainable. Granting more credit to the consumer is not a sustainable option either because credit shoud not be an extension of income but rather used only in times of emergency.

To put it bluntly, unless wages go up soon, the only way to get out of this mess is to deflate prices until they reach 1975 levels.

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