Another Take On Deflation

I was just over taking a peek around at The Mind Of Man and came across a link that he had to a NY Times article on deflation. The article isn't too bad, but it misses a few key points.

Too much supply is not a good thing. Too much supply actually inflates the prices of items by increasing the costs of carrying inventory (breakage, extra insurance, extra warehousing, etc.). It also impedes a company's ability to react to changing market conditions.

Too much supply also eventually leads to cutbacks in the production. As inventories build up, companies will begin to cut back on production, which means buying fewer raw materials and employing fewer workers. Oversupply of a market is not good at all.

But what made the post-Civil War era different? There were a couple of reasons that are never addressed.

First, very soon after the Civil War was over, the Industrial Revolution began in earnest in the US. We also began to assume our position as one of the largest exporters to the world. We were able to massively increase production (which led to lower prices at home) while still finding overseas outlets for the increased production. So the "too much supply" was really increased production made possible by being able to export our excess production; it was not an increase in inventories.

We also had in the immediate aftermath, an entire subset of the population, the former slaves, that was beginning to add to the economy in ways that they had not before the war. They began to accumulate wealth and to buy and provide products and services in quantities not seen before the war. The addition of the former slaves to the economy was not an insignificant event.

So, the author of the article is right. After the Civil War we were able to increase of production, increase our GDP and reduce prices all at the same time. But it was only because of the unique set of circumstances in play at the time.

It is possible to pull off the same thing today - but it would be politically unacceptable.

To have deflation in a growing economy today, we would have to turn to large-scale specialization - on a national level. That means that whatever is cheaper to buy from overseas sources, we buy from overseas sources. Whatever we can do cheaper than anyone else, that's what we do.

It would mean the wholesale elimination of entire industries and the explosive growth of others. It would also mean the loss of a great many of our national capacities. Our self-sufficiency as a nation could no longer be assured.

Or we could reduce business regulation and excessive marginal taxation. But that's like asking Congress to cut spending (actually it would be asking Congress to quit spending), which means that it won't happen either.

The confluence of beneficial factors that were in place in the late nineteenth century just aren't there today and the political cost of creating a positive deflationary environment is simply too high.

That's why I'm going to keep arguing that deflation would be a bad thing for the US. Our problem is a lack of demand that was caused by layoffs and restructurings that were caused by oversupply.

The NY Times writer does a great job of analyzing why deflation was successful in a very unique time and place. Today, we are in neither the same time or place. The results of deflation today would not be the same.

Also, take a look at Mr. Prather's analysis of the situation. He has pretty much nailed it and also has gone a step further than I have and has looked at what the next step beyond a weak dollar might need to be. It's very well thought out and very well articulated.