Tan Kin Lian's Blog: Deflation

Wednesday, April 07, 2010

Deflation

When the Japanese economy busted at the end of the 1980s, it went through a deflation that has lasted nearly 20 years. Some commentators said that the US economy may go through a period of deflation but they are optimistic that the economy is more robust and will recover. I am less optimistic. I think that the underlying weakness of the free market system , which contributed to asset bubbles, may affect the US economy as badly as it had affected the Japan economy.

During a period of economy growth, people are willing to borrow and invest in assets, leading to inflation. During a period of deflation, people are not willing to borrow and invest and the excess capacity will take a long time to be utilized. More people will remain unemployed and this will worsen the deflationary cycle.

The second world war ended the deflation of the 1930s. We may need a third world war to end this deflation. But it is also possible to find a more peaceful solution - and that requires to restructure the global economic system into a more socialist type, using the Keynesian approach or its modern version.

Tan Kin Lian

14 comments:

Anonymous said...: Jim Rogers & some other reputable independent investors predicted a recession again before the end of Year 2012. I am not optimistic either.; April 07, 2010 9:29 AM
Anonymous said...: Deflation is good for the rich. Their money can buy more things at lower prices - including cheaper, better, faster workers.

Inflation is better for the poor and middle class. Economy and employment prospects are better during inflationary periods.

Sure, the purchasing power of money goes down during inflationary periods. But if you don't have a lot of money in the first place, you really don't have much to lose.; April 07, 2010 9:57 AM
jamesneo said...: Hi Mr Tan, i am not sure if you are aware, but the Keynesian approach distorted by Bernanke and his predecessor Greenspan and adovcated by Paul krugman is the real cause of the asset bubbles. The problem of America is not due to the free market system totally.

The real problem is their capitalist free market model have become some would called the rigged market capitalism. The biggest problem is that their government have become too big and intervene too much in their economy by inflating and reinflating any new asset bubbles. The US government did not let their capitalist model work which is to let companies to fall due to the lobbying by these special interest groups and instead keep bailing out them. The bailout problem is not a recent problem but have occurred over the past decade. So with each bailout, their market become more and more rigged and controlled by the few big banks and investment companies.

I am not saying that some form of socialist is not good but i do not like the distorted Keynesian approach practiced now in US. I prefer the Austrian School with some form of socialism but not too much government control and interventionism.; April 07, 2010 10:34 AM
jamesneo said...: To April 07, 2010 9:57 AM, small inflation might sound good but if it become hyperinflation your money will become totally useless like what is happening now in Zimbabwe. Only real asset like gold will withstand both deflation ann inflation as all fiat money is suspect nowadays; April 07, 2010 10:37 AM
Tan Kin Lian said...: Hi Jamesneo

I disagree with your assessment about Keynesian principles and the views of Paul Krugman.

I think that the free market approach and low interest rate caused the asset bubble. Keynesian principles advocate high inflation rate through government spending, and it is less likely to lead to asset bubbles.

Anyway, I am not an exconomic expert, so I cannot say that you are wrong. It is just my common sense view.; April 07, 2010 10:40 AM
Tan Kin Lian said...: Hi Jamesneo

My friend introduced me to the Austrian Mises school of thought. I know that wjsim also share this thought. Now, I learn that you are from the same school of thought.

I like some of the Mises theory but I disagree with some aspects of it, especially on the part that there is be no debt. I believe that the cost of housing and infrastructure should be financed by debt but not the inflated value due to "market".; April 07, 2010 10:43 AM
jamesneo said...: Hi Mr Tan, that is why i am saying that Bernanke have distorted the Keynesian policy. In both boom and depression time the US keep increasing their debt. If they have increased their interest rate during the boom time and cut deficit significantly the policy will not be so bad. But they keep their interest rate low for too long and keep expanding their government.

In my humble view, there are two aspects that i think Singapore should maintain. We should not have excessive debt because excessive debt has a tendency to lead to high inflation. Some debt to fund social welfare progams is okay but there should be a balance such that it does not become excessive.(Totally no welfare like singapore is also not good either for the individual).

I believed the virtues of saving in Asia should still be encouraged especially for the individual case. Most importantly , one should live within ones means and not live a life based on debt.

Anyway i am no economic expert either but i prefer a country with little inflation and more individual savings.; April 07, 2010 1:04 PM
Tan Kin Lian said...: Hi Jamesneo
I agree with you about Bernanke. I also agree that excessive debt is bad and that it is better for Singapore ato avoid this situation.; April 07, 2010 1:23 PM
Anonymous said...: Both deflation and high inflation are bad for the middle & lower income people but good for the rich.

Why do I say that?

Imagine prices are rising - inflation: If I am rich, I can afford to buy up lots of assets since I have spare cash, and sell it later to the poor masses later at a profit. I can also buy gold - an excellent hedge against inflation. Pity the poor sods who are only paid salary once a month and have no spare cash!

Now, if there is deflation: Prices are falling. Again, no problem for the rich. They simply park more assets into cash & wait for prices to stop falling. Then buy when prices are low enough.

For the poor masses, they can't do that. If inflation is high, interest rates will go right up also. Try handling that when you have a huge mortgage to service and salary can't keep pace with inflation.

Likewise, when there is deflation, expect pay cuts. And when the price of your home drops, expect the bank to come calling asking you to top up loans that are underwater - with cash that you don't have.

That's how the rich are able to make money all the time. After all, capitalism favours those who have the capital.

Bernard; April 07, 2010 2:12 PM
Unknown said...: Thanks Mr Tan for the replies in the other thread. Keynesian theory itself is a noble idea. Given time, markets will correct themselves, reallocate resources and prosper. However, in the long run, we're all dead. So instead of waiting till then, do correct me if I'm wrong, Keynesians jump start the economy by pumping in money and government spending and run up deficits. In the resulting economic boom, excess liquidity is removed.

I personally find two challenges. 1. Governments will never know what the markets need. Hence, their intervention and aid will blow up assets bubbles in the wrong areas and call that growth. Politicians don't care as they want numbers to look good during their term, let the next president handle the aftermath. Poor Obama. Poorer Obama-successor. 2. In theory, excess liquidity is to be removed. But it never happens. Politicians don't want the boom to stop. Deficits keep running up to maintain the euphoria from all the morphine being pumped into the private sector. Until the private sector realised they're being doped, or the nation bankrupts.

I don't think all fiat money are suspect. The Australian and Indian central banks are very responsible, the former raised interest rates the 5th time (I think) since the crash, the latter bought up gold. Commodity exporters like Brazil, Canada and Australia will continue to have strong fiat currencies as their economies work hard and export real goods. If Mr Rogers have chosen SG as his place of permanent residence, I would think there is some strength in the SGD.

Inflation is good for debtors (US, UK, Greece). Deflation is good for savers (SG, China). Usually the countries shouting fears of deflation are the debtors (USA) and the countries shouting fears of inflation (Australia) are savers.; April 07, 2010 3:01 PM
Anonymous said...: Jamesneo wrote: Hi Mr Tan, i am not sure if you are aware, but the Keynesian approach distorted by Bernanke and his predecessor Greenspan and adovcated by Paul krugman is the real cause of the asset bubbles.

I think you made a basic error in calling Krugman an advocate of Bernanke and Greenspan. Greenspan is a Rand fan, a strong advocate of the Friedman school of economics, the brand of economics exalted by Republicans. So is Bernanke, though to a lesser extent. Please don't make such basic error. Besides Krugman is not in the government.; April 07, 2010 8:38 PM
jamesneo said...: Hi to anonymous April 07, 2010 8:38 PM, i never say that Krugman is an advocate of Bernanke and Greenspan. i say that Krugman is an advocate of Keynesian approach.

Greenspan did follow Rand/s ideas early in his career but his actions become more similar to Keynesian not labeled by me but by other people such as
http://curiouscapitalist.blogs.time.com/2008/10/21/alan_greenspan_ keynesian/ and other newspapers.

Of course i admit their labels might be wrong and that Greenspan could be following Friedman school. Bernanke i admit does follow Friedman school more.

Nonetheless, both theories advocate pumping excessive amount of money, Obama following more like Keynesian through supporting of public works projects, socialistic safety nets, and government-led consumption while Bernanke following Friedman through monetarist agenda though the Fed.

However, if the US does not have such a huge deficit, following Keynesian approach is not that terrible. Let us see in two to three years time if the debt bubble will explode. If the economy boom for the next 5years then good for the world. If things worsen dramatically,US will implode and i hope its effect on Singapore will be minimal.; April 08, 2010 7:56 PM
Anonymous said...: Keynesian economics is very bad economics and the work of the evil one.
Japan is an excellent example of Keynesian economics gone bad. This type of economic policy delays the day of reckoning of past excesses, and pass the burdens to future generations to pay.
It robs us by the hidden tax of inflation. The mistakes and risk taking trades of CEOs and the rich are paid by ordinary citizens example AIG, Irish banks, through increase taxes and inflation (read money printing).

Which is why the cost of living keep rising in Singapore. After every recession, the standard remedy is : government stimulus (eg. job credit scheme etc.), easy monetary policy creating asset bubbles, followed by market euphoria, next come the general elections with more handouts to win more votes (but no handouts given during our darkest hour in the downturn). But there is no free lunch in this world. When the elections are over and won, every single item, service, charges etc will rise sky high. Get ready for 10% GST soon.
Gabriel; April 09, 2010 12:18 PM
Anonymous said...: The role of Keynesian measures is to stabilise the economy. It cannot be blamed for the initial failure brought on by unheralded private sector excesses under the so-called free market hypothesis.; April 10, 2010 10:18 PM