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For the world’s central bankers the blackest of black swans
is deflation.
While we thrill to the collapse of oil prices and look
forward to having extra disposable income, we fail to recognize the threat that
deflation poses.
For the record, we also fail to ask ourselves how much debt
is involved in oil exploration and production. Last I heard the number was
north of $5 trillion. A deflated oil price is bad news for those who hold the
debt.
When the mortgage crisis hit the economy in 2007-2008 there
were approximately $1 trillion in bad loans.
Bloomberg News has offered a brief primer on why deflation
is bad news.
First, it chokes off spending.
If you believe that prices will be higher tomorrow you will
be more likely to buy today. If you believe that prices will be lower tomorrow
you will be more likely to defer all but essential purchases.
The same applies to spending by corporations. Company
officers who believe that prices will decline will spend less on raw materials
and will make fewer investments in plant and equipment.
Next, companies lose pricing power. Competing with other
companies that are lowering prices, companies must also lower their prices. Thus,
their profit margins vanish. (One might also note the decreased prices offered by internet vendors.) And employees don’t get raises. In the worst cases
they accept lower salaries.
Finally, lower prices do not change the amount of debt
you owe. If your salary decreases and your mortgage remains the same, you have
a problem. If economic activity diminishes and the interest on the national
debt stays the same or increases, we have a big problem.
Bloomberg notes that central banks often fight deflation by
lowering interest rates. At the moment,
however, interest rates are close to zero.
It’s potentially a very threatening black swan.
5 comments:
Yes, I had figured the only way we'd have low oil prices again would only come from another global recession, but this one surprised everyone.
High prices in the 70's spurred new production in the 80's (North Sea and Alaska), and sunk prices through the mid 90's.
I don't think this fall will last years, but oil producers over their heads in debt won't be able to handle losses for long.
Personally if I was the government, I'd look to expanding the strategic oil reserves.
If we're going back into a period of see-saw prices, I'm all for the government helping to smooth out the prices by buying low and selling high later. And it'll slow down the oil producer layoffs that are in process right now.
Deflation is scary for those who hold debt, just like deflating home values with fixed mortgages. Eventually debt holders would rather default, and that shrinks the "imaginary" money supply.
I'm not sure all the tricks that Central banks have to avoid deflation, and lower interest rates are one, but straight out handing out cash hasn't been tried yet. Its hard to imagine how weird things are going to be before this magic fiat money experiment ends.
Its really amazing to see the "net household wealth" has risen from 65 trillion to 81 trillion or whatever since the 2008 crash, so that's all fake money that only exists if everyone can sell assets when prices are high, which they won't stay with boomers retiring and trying to sell.
It's more fun to read about than imagine all the way these things will affect us. Everyone I know has their heads in the sand. I accept worrying doesn't change anything, but at least greed only looks like prudence. There's no down side for me to paying off while I have income to do it.
Not everyone agrees with you. See:
http://mises.org/library/deflating-deflation-myth
Deflation: Does this mean my near-zero interest on my savings and checking accounts will go negative?
So asset values are inflated (~2-3% annually), while the wealth of new generations is confiscated, including through the accumulation of debt. This assures the need for more "social" policies like Obamacare, progressive "minimum wage", to compensate for these economic distortions. The problem is not only does it cause misalignment, but the effects or consequences are not limited to our society.
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