Monday, December 14, 2009

Living in Deflationary Times

A parable for today: Imagine a teenager who borrows his father's credit card to go out and binge. He might binge at the mall or in a bar or in a house of ill repute. The next day he wakes up feeling awful and he swears he will never do it again.

Has he discovered the error of his ways? Has he taken a step on the road to virtue? Has he changed his attitude? Should we expect a new reign of discipline and thrift?

One is tempted to answer these questions in the negative. Before doing so, let us raise the most pertinent issue: who is going to pay for the binge?

Most likely, the burden will fall on his parents. Assuming that they can. But what happens if his parents cannot or will not pay for their son's profligate ways?

It had never crossed this teenager's mind that his behavior might have a price; now he has just discovered that it has a very high price, and that he is going to be saddled with the bill.

At that point, we can say that this youth will come face-to-face with the prospect of virtue. Not so much by choice, but by necessity.

If he is willing to pay for his irrational exuberance he might very well learn virtue. He may actually come to like it.

Unfortunately, that is not the end of the story. If this young man plans on paying for his binge by going to college and getting a job, he will be depending on the state of the job market. Not merely the availability of jobs but the prevailing wage level.

In a deflationary environment, when wages are decreasing, the burden of debt will become increasingly difficult to bear. Even with the best intentions, this teenager might well be spending most of his life, dedicating most of his labor, to pay off credit cards.

But that means that he will be spending less than is normal for someone his age. Less spending means lower prices. Lower prices mean falling wages. Deflation functions like a vicious circle, a circle that is feeding on itself.

Now this young man is going to spend a goodly amount of his time working to pay off old debts. Will this make him optimistic about his future? I think not. Perhaps he will learn to make do with less, to live more frugally and to lower his expectations, but these are adaptations, not reasons to rejoice.

I invented this example to offer something of an explanation for a major shift in the behavior of Americans. This shift is not coming from the depths of anyone's individual or collective psyche. It is being imposed by reality. It has nothing to do with bad parenting, childhood trauma, or repressed unconscious wishes.

And this does not describe recession economics. In a recession we hunker down and wait for the storm to pass. Once the storm passes things revert to normal.

In a depression, however, once the storm passes we have nothing left. With depression economics paying down debt is going to cause a severe economic contraction that will make the burden of the debt that much more onerous.

So says David Rosenberg.

While most people are comfortable calling our financial crisis the Great Recession, Rosenberg argues persuasively that we are at the beginning of another Depression.

Formerly at Merrill Lynch Rosenberg is now the Chief Strategist and Economist at the Canadian firm, Gluskin Sheff. From his perch up North he sends out eminently readable and sensible daily e-letters that give us his take on the economy and the markets. Here is a link to today's e-letter.

In today's letter it Rosenberg suggests that the current economic crisis is a "depression" that is producing a marked effect on behavior and attitude. It has produced a sea change in the way people relate to their spending and savings decisions.

But Rosenberg also cautions us not to be very optimistic about the political response to the crisis. In his view the increasingly parental state is trying its darndest to ensure that young teenagers who went on a binge-- or adults who simply assumed levels of debt, mortgage and other-- should not have to pay it all back.

Apparently they feel that if people do not have to face the consequences of their actions, if they still feel that there is some parental agency that is going to bail them out, they will not have to change their ways, and thus, will be more likely to vote for the politicians who have saved them from virtue.

And, why would they not? Several generations have absorbed the nostrums prescribed by the therapy culture. Surely an inflationary environment told people that it was smart to take on debt and to spend more today. In such an environment, wages always rise and prices always rise. If your debt burden stays constant, inflation will always bail you out.

But it is not just about spending money. Once the culture adapts an attitude, people apply it to other areas of their lives. People do not limit their spending to shopping sprees, but extended it to emotional and even sexual expenditures.

These were all considered to be supremely good things. The therapy culture encouraged them as contributing to good mental health. Unfortunately, no one really asked whether we could afford the binge, and what the price would be.

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