Posted on 01/06/2015 12:08:44 PM PST by Kaslin
The sudden fall in the price of oil provides a unique opportunity to examine the widely held belief that deflation is economic poison. As many governments and central banks have vowed to fight deflation at all costs in 2015, the question could hardly be more significant.
While falling prices may strike the layman as cause for celebration, economists believe that it can kick off a nasty, and often inescapable, negative cycle, which many believe leads inevitably to a prolonged recession, or even a depression. However, these same economists acknowledge that falling energy prices may offer a stimulus, equivalent to an enormous "tax cut," particularly for lower and middle income consumers for whom energy costs represent a major portion of disposable income. They suggest that the money consumers and businesses no longer spend on gasoline and heating oil could be spent on other goods and services thereby creating demand in other areas of the economy. Even Fed Chair Janet Yellen, a staunch advocate of the economic benefits of rising consumer prices, has extolled the benefits of falling oil prices.
After considering these competing tensions, most economists agree that falling energy prices are a net positive for an economy (except for oil exporting countries like Russia and Venezuela). But the fact that there is even a debate is shocking. It should be clear to anyone that consumers individually, and an economy collectively, benefit from lower energy prices. As I mentioned in a column late last month, no one buys energy for energy's sake. We simply use it to do or get the things that we want. The lower the cost of energy, the cheaper and more abundant the things we want become.
But if we all can agree that lower energy prices offer a benefit, why can't we make the same conclusion about food prices? Wouldn't consumers get a huge "tax cut" if their grocery bills fell as dramatically? How about health care? Wouldn't we all be better off if our hospital and insurance bills fell dramatically from their currently insane levels? Come to think of it, why wouldn't we be better off if the price of everything fell? When does too much of a good thing become too much?
Modern economists tell us that while it's okay for one or two sectors to see price dips, the danger comes when prices decline across the board. Their theory is that if consumers believe that prices will fall over time that they will curtail their purchases to get better deals down the road. Even if the overall dip is relatively small, just 1% annually for example, they believe any amount of deflation will eviscerate demand and kick off a cycle where depressed demand leads to weak sales, which leads to business contraction, layoffs, and further depression in demand thereby renewing the downward cycle.
But the truth is that deflation is not the menace to consumers and businesses that governments would like us to believe. Common sense and basic economics tell us that prices fall for two reasons: Either an excess of supply or a lack of demand. In both cases falling prices are helpful, not harmful
For much of our history, increased productivity increased the supply of goods and forced prices lower. Falling prices made former luxuries affordable to the masses, and in so doing made possible the American middle class. Based on data from the Historical Statistics of the United States, the many periods of sustained deflation did not halt American economic growth in the first 150 years of the Republic. (Sustained inflation did not become the normal state of affairs until 1913, when the Federal Reserve was created).
Prices can also drop when demand falls due to economic contraction. Any store owner will tell you that if customers stop buying and inventories get too high, the best way to create new demand is to mark down prices. This is basic supply and demand. Demand rises as prices fall. In this sense, falling prices are not the cause of economic contraction, but the market solution to depressed demand.
But today's economists are rewriting this fundamental law. In their eyes, demand rises as prices rise. This is the equivalent of a physicist suggesting that the law of gravity forces objects to repel from one another, and that a stone dropped from a rooftop will fall upward. They further stand logic on its head by concluding that falling prices are the cause of the reduced demand. (It's like blaming rain on wet sidewalks, and concluding that the showers will stop if the sidewalks can be dried.)
Economists also argue that falling prices will harm business and lead to unemployment. They forget that falling prices also mean falling costs and increased sales, which lead to higher profits, more capital investment, greater production, and higher real wages. Henry Ford succeeded, and his workers prospered, not because he raised prices, but because he lowered them. Cheaper Model T's did not impose a burden on the public or compel Ford to lower wages. More recently, the tech industry has prospered, and has paid its workers well, by consistently lowering prices.
As a result of these ideas, economists advocate for policies that push up prices. But all this does is kill off more demand and prolong the slump they are trying to cure.
Since Janet Yellen acknowledged the beneficial effects of falling gas prices to consumers, I wonder if she could name even a single category of goods that would impose a burden on consumers if it were to fall in price? My guess is that she can't. If a decline in the price of any individual product is good, then a decline in the price of all products simultaneously is even better. Am I the only one who notices the inconsistency in this logic?
Perhaps this disconnect can shed some light on a topic that central bankers are desperately trying to keep hidden in the shadows: Falling consumer prices are good for the consumer and the economy, but they are bad for central banks looking to maintain asset bubbles and for governments looking for a graceful way to renege on their debts.
If we continue to insist that falling prices are the cause of economic malaise, we will continue to produce economies where malaise is the only possible outcome.
You mean like all those people that hold off buying electronics and computers because they will be cheaper next year?
>> It should be clear to anyone that consumers individually, and an economy collectively, benefit from lower energy prices.
Plus, low energy prices really tweak the enviroweenies. That’s fun to watch.
Good article but I wish he had included in his analysis inflation/deflation vis a vis cash/debt. I think that’s an important part of the calculus.
Then why not include it yourself?
The strong dollar will make foreign goods cheaper for U.S. but also makes U.S. good more expensive for others. Many U.S. companies with heavy reliance on foreign sales will find 2015 a difficult year.
Thanks for posting. I had not read that take before.
“deflation” = rising purchasing power of the dollar. How is that bad?
It’s not bad, but some people with degrees in economics think it’s bad.
It’s good because it retains and possibly increases the value of savings and property.
I see a potential problem with oil prices going down... high enough oil prices would have driven up the cost of transporting goods from overseas and reduced some of the outsourcing... leading to jobs coming back here.
I wonder if lower transportation costs will lead to more outsourcing and more imports?
>> Then why not include it yourself?
Good question with a simple answer!
I’m not as smart as Schiff (and others of his stature). I’d like to see what THEY have to say.
Well, I am enjoying the lower gas prices, but they are still higher than they were when that arrogant pos occupant was inaugurated for his first term
In theory you can hold off and wait for that future price drop, but in practice you eventually dive in and get that computer if you’re going to do anything useful other than wait.
The drop in oil price seems to be dragging down the stock market too. I guess the Saudis will have less money to invest?
Exactly, which is why saying that people will "forever wait until it's cheaper and kill the economy" is nonsense.
The gooberment is salivating over the low gas prices. They can’t wait to add new gasoline taxes while we are still use to $4 a gallon.
The oil speculators should have seen the warning signs when China and Russia signed that US$400 billion natural gas (and eventually petroleum) development deal that may encompass new gas and oil fields in eastern Siberia. As such, speculators are dumping oil like crazy because of the fear that OPEC may within the next 20-25 years lose most of its sales to its two biggest customers, the USA and China, which will create a gigantic glut of oil on the open worldwide market. And it doesn’t help that increasingly strict fuel economy mandates for motor vehicles worldwide could result in a levelling off and possible decline in sales of gasoline (petrol) and diesel fuel.
I think he mis-states the case. An overall deflation slows the economy primarily because wages are notoriously sticky on the downside. It’s far too difficult to get the existing labor force to accept individual pay cuts, so instead businesses facing lower sales (due to deflation) cut workers instead of wages.
This leaves the ones still working better off because they still have pre-deflation wages to buy deflated goods, but the layoffs drive employment down aggravating, or prolonging, what is already usually a monetary-induced recession.
The last time we experienced this we had the Great Depression. We really don’t want to go there again.
A drop in oil prices is good because it frees up personal resources, but the spending of those resources on other goods will drive up the prices of those goods, offsetting the effect on overall prices. It’s not deflation, but a repricing of goods relative to one another.
A family member consulted me on buying a computer a few years ago. I said that the computer you want right now will be half price next year, and she said she’d wait until next year, then.
OK, you’ll never buy one!
They haven’t dropped below 1.86 where you are?
Just hit 1.84 here.
Yes and no. Your liquid savings will increase in purchasing power, but your property will lose value, able to command progressively fewer of those dollars. Then the danger is that everyone will simultaneously move their assets to cash, further depressing the prices of investments. Look at Russia a few weeks ago when the currency was in free fall and people were rushing out to buy things ahead of price rises. Now imagine the opposite, with everyone trying to sell everything.
Leftists are bemoaning low prices for the same reason that they supported anything that raised prices -
they want “the masses” to use less of “their” resources.
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