Thursday, November 27, 2008

Inflation vs Deflation: Interminable Debate?

I find people discussing deflation versus inflation eventualities as though both terms express book-ended equivalents. Yes, the words differ only in prefix. However one might say the color black is existential. Whereas white is merely conditional, i.e. merely the absence of black. This fundamental inequivalence is routinely discarded. We often talk of black and white as though they are oppositionally equivalent --two sides of the same coin.

If one recalls the textbook definition for inflation, too much money chasing too few goods, the operable term, for our current debate, may be chasing. Deflation at its worst can mean the cessation of economic activity as people succumb to deflationary expectations and forestall purchases today, thinking goods will be less expensive tomorrow. When people stop giving chase to goods and services, the value of the money in their pockets increase.

So in one crucial sense, an economy suffering from inflation is preferable to an economy in deflationary collapse. That's because at least you have an economy where transactional activity is occurring (the chasing part, a measurement of which would be the velocity of money), which is to say, at least you have an economy. Deflation by contrast is a graveyard. Suddenly the macroeconomic debate veers towards more fundamental societal questions: Can a society exist in the absence of significant levels of commerce? Doesn't transactional activity serve as a sort of societal glue? This all suggests that deflation is a far more profound phenomenon. I’m wondering whether the truly biblical potential of deflation to shut down a modern economy (with possible resort to a non-currency based or barter system?) has been taken fully into effect. As Ambrose Evans-Pritchard said recently: “Deflation is sometimes likened to Dante's Inferno. "Abandon all hope" once you step into that Hellfire.” Even given his tendency towards purple prose, the danger of deflation seems incommensurate to that of inflation. In the context of ka-poom, I also wonder if the ka phase can be so culminating that the ‘relative luxury of high inflation’ –the poom-- never arrives.

We are finding there is little in the Fed monetary arsenal that can compel people to buy when they don't want to. The Fed can fight inflation. Fighting deflation however may be tantamount to wrestling a vacuum --or putting lightning in an empty jar. Thus there is an institutional fear of deflation as the powers-that-be discover themselves powerless to avert it. What master of the universe wants to ponder his impotency?Another frequent fallacy is that both forces seize an economy monolithically, that is, an economy suffers either inflation or it suffers deflation. Period. We won't even delve the variant strains, disinflation, hyperinflation and dis-deflation (a term I've seen bandied about on iTulip), nor the critical discussion of rates, trends and time intervals. In truth, all these forces are operating in different areas --and in different durations-- of the economy at any given time. There can be simultaneous price level increases in food and other staples AND asset deflation, as we seem to have had of late. But aren't we comparing income statement to balance sheet phenomena –a flow of funds as opposed to a reservoir of value?

After all debt deflation is not price level deflation. Clearly an aggregating methodology must be employed before we can decisively label an era 'inflationary' or 'deflationary'. But why pain over descriptive exactitudes if no advantage is gained from the descriptions? If it walks like a duck, then let it be a duck with no further ado. If you prefer calling it an elephant then that will do too. The debate would be almost entirely semantic if not for the fact that, in identifying certain phenomena, we are better able to apply prescriptive remedies or take defensive action in a portfolio strategy. Or as the cynic might say, armed with the proper description, the government can prescribe more surgically destructive medicines.Perhaps the aggregate is meaningless on a practical level.

If I am a buggy whip maker at the turn of the century, my market is collapsing. You can call it a profound hyper-deflation if you like. My livelihood is ruined --all against the backdrop perhaps of macro-level inflation. Maybe inflation and deflation are personal phenomena occurring, as in Tip O'Neil's politics, at the local level. I’m intrigued by how people keep interrogating anyone and everyone as to whether we’re in deflation or inflation. This is almost a semantic appeal. People need to name their devil as it restores some small sense of control.

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