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.
I have talked to a few people, and most of them agree that most economists are socialists.
I don’t take anything they say seriously unless I know them personally or hear from a trusted friend that an economist is not a socialist.
Until then, they can all pound sand.
But the problem I think Schiff alludes to is in demand for big ticket items. Why build new plant, if you can squeeze another year out of the old? Likewise, new trucks, new earth-moving equipment and all the rest. Suppressing demand like that quickly gets into a deadly spiral downhill.
But then again, I'm not an economist.
Inflation is great if you’re a debtor. Just let inflation reduce the value of your debts. Which is why the U.S. government loves inflation and fears deflation: $18T debt. It’s also why interest rates aren’t going up significantly any time soon as long as Uncle Sugar can help it. High interest rates will be a disaster with $18T in debt.
So does this mean I should put off some repairs and upgrades at home?
All economists are socialists in the same sense that all biologists are warmers.
That is, the media loves to claim consensus in order to push an agenda, but there’s definitely not.
I know this because I’m an Econ major, or I was one way back when, and three of my highest-level classes all involved mostly-good-natured arguments between the neo-Classical head of the department and the neo-Keyensian senior prof.
Perhaps Ford isn't the best example. Ford paid his workers well enough they could afford what they produced. That got the vehicles out of the lot.
Businesses can't long endure the squeeze between increased (or even static) labor costs and falling revenues. What other costs will decline?
I don;t expect electricity costs to decline much, because of the plants going off line. Natural gas will be cheap until the wells producing now deplete, and natural gas wells in general and horizontal wells in particular have steep depletion curves.
Ford did not have to deal with the EPA, OSHA, or any of a number of alphabet soup agencies that can effectively shut a business down, nor an insane regulatory climate.
Ford couldn't have been sued because someone (in a 'protected' group) got their feelings hurt.
As for greater production, (yes, the oil industry built that), aside from the oil industry and related spinoffs, who is building what that doesn't depend on government contracts? (where the real winners and losers will be decided in a deflationary environment).
I don't see the current situation fitting a model from a century ago.
Ping to a deflation argument.
Deflation is bad, very bad for local, county and state governments that rely on property taxes. Those taxes are calculated against the nominal value of property.
What happens is an assessor is given a demand for tax monies from a variety of sources - municipalities, school districts, park districts, library districts, water/sewer districts, etc. - and then spreads this level of taxation according to a formula based on property values.
In reality, it’s a lie. They just distribute the demand for taxes across property, but if you get yours lowered, they raise somebody else’s later on. The goal is simply to collect a tax and the lie is that your property is valued at a certain level.
Now imagine that the market deflation in Real Estate that we had back in 2008-9 didn’t bounce back via the ZIRP of the FED? Prices in many areas were down by 20%-40% and in some urban areas 70%+. That means that you’d expect your tax assessment to fall by 20-70% or whatever your new value was. Bush was shown this and the FED realized the incredible damage done to the debt markets via municipal bonds that then couldn’t be paid.
Nearly every major metro would have gone bankrupt. That would have killed government schools (nearly half of all property tax bills), government pensions and the entire socialist model of urban government. That chaos is why the banks got bailed out and why interest rates are being held below market rates today.
The US economy booms when imports are highest. It means that foreigners are giving us actual useful things, real goods in exchange for pieces of paper denominated US currency with our dead presidents on them. I’ll trade paper for food, services and goods all day long.
Look at the pre-FED deflations in the US. You don’t see the problem you’re describing.
Under what circumstances can everyone move their assets to cash during a deflation? Free market trades happen because each party feels it will be better off. There has never in the history of the world been a perpetual deflation without government intervention. Prices, high and low, correct themselves in a free market.
As long as your productive assets are growing faster you'd always buy a lower priced plant/land/equipment. Think about it for a minute.
Unless your variable costs were above your profit why wouldn't you lower your fixed costs? Even more so if deflation were being driven by improved productivity, which is much of what we're seeing now in oil prices. New methods of extraction made previously unprofitable oil plays profitable.
That's a myth. Ford paid his workers more because the market demanded higher pay. He had terrible turnover and needed skilled craftsman. Don't believe the socialist history you've been taught.
Nobody ever cheats the market.
So you are saying they couldn't afford to buy the product?
I didn't say WHY, I just said he did.
Either they could afford it or they couldn't. If the best paid craftsmen of the day couldn't afford those "cheap cars", who, pray tell, could?
And no-one is suggesting that price falls due to increased productivity are a problem, what is a problem is the same product, made with the same inputs, at the same costs, selling for less next year than this.
Upgrades, sure, why not? If they’ll cost less next year, makes sense.
Oil prices are not dragging down the markets, the markets are inflated by QE dollars
Exactly.
Thackney, do you have that price chart showing, I think it was wellhead pricing for oil? Riflema believes that fracking needs $100 oil to be profitable and these lower prices will close wells. I don’t think the economics and finance nor the contractual obligations will allow that.
Hardly true since we have used hydraulic fracturing since the 1940s. We didn't start producing those shale fields at those prices. There isn't going to be shutting down wells at $50. The major expenses are already spent putting the well into service. We won't drill as many new wells at $50 as we did at $100. And oil well reduce production over time, shale wells drop rather fast the first few years.
I haven't seen average wellhead pricing for oil. I have only seen that chart for Natural Gas. Some of the major US types of oil are priced at:
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