deflation’s 1-2 punch
There has been a specter haunting the business articles in major newspapers and media sources, a term who’s simple utterance makes financiers tremble; deflation. Deflation is the process by which *all* of the numbers get smaller. The process during which ‘money’ becomes ‘more expensive’.
Theoretically, in the 1920s, you could take a dollar to the treasury and exchange it for $1 in gold. There was a physical standard by which $1 was judged. In the 1930s, the dollar was taken off of the gold standard so that FDR and his brain trust could manipulate the US economy more effectively in the service of lifting the Great Depression.
When there isn’t a physical standard which sets the value of the dollar, you can use the laws of supply and demand to change the ‘real value’ of a dollar— you know how your grandparents say ‘when I was a kid, I used to use a quarter to buy breakfast, lunch, dinner, a pair of dungarees, a buggy whip, one of those ‘newsies’ hats, and a slide rule- and I still had change!’ …. When you take them out to a $12 movie? Well, that was because when they were kids, there were less dollars out there, making each one more valuable. In the time since then, lower interest rates, increased overall debt, and the creation of fancy derivatives have increased the immediate supply of money, making each dollar less valuable. That process of increasing the total amount of available dollars, and the subsequent loss of value on each dollar is ‘inflation’.
Now that the subprime mortgage bubble is burst, the shrapnel is bursting bubbles in the financial services industry, which in turn is wrecking havoc everywhere. The vanishing act that those dollars are performing is lowering the quantity of dollars available for use, thusly increasing the ‘real value’ of each dollar. Decreasing value of people’s 401[k]s, decreasing home values, 50% off sales at Macy’s BEFORE Christmas, 2.7% decrease in the Consumer Price index in the last 2 months; this is deflation.
It’s happening, and there are two particular ways that it effects the working class;
1- cost of living/income variance
For the working class, the ratio between your cost of living and your income is potentially the most important mathematical equation in your life, as that simple ratio is the numerical value that is the quantitative description of your ‘standard of living’. If the cost of living is only $500 and you make $750 a week, your ratio is a positive one; 2:3.
If you move to rural Louisiana, and your income shifts down to $300 a week, your standard of living would stay the same if the cost of living shifts down to $100 a week; still a positive 2:3 ratio. As long as both numbers move in unison, there isn’t much of a day-to-day difference between those two situations- however, during deflation those numbers don’t move in unison, they move in variance.
Both ‘cost of living’ and ‘income’ are initially determined from the supplier/employer side, and business ideology will treat those two categories with opposite strategies, which will create an increasing variance.
A classical theory in economics is that prices are ‘sticky on the way down’ – meaning that the producer is going to slooooowly reduce the prices of things till it finds the ‘sweet spot’ – they’re going to reduce prices slowly and cautiously as they don’t want to err on the side of ‘too cheap’ … they’d rather just move the price again down next week if it doesn’t work. [see any retail outlet in the last 2 months]
However, when determining compensation for services, employers are working in the opposite direction, opting to err on the side of offering too little. They assume that they aren’t going to lose the potential employee with a ‘lowball’ estimate, and can always back down and offer a larger compensation if need be.
Those opposite ideologies create an increasing variance in the ‘standard of living’ ratio over time.
2-Locking it in.
Over the course of the last 15 years, the wealth gap in this country has greatly increased through the working class burdening itself with debts—college, credit cards, houses—the working class in America has more debt than any nation has ever had. These debts were incurred during a sustained period of inflation- when money was cheap. When deflationary forces begin in earnest, that money will still have to be paid back, but it’ll happen when dollars are more scarce and hence, more expensive. On the flip side, if you generated profits during that time, the new scarcity of dollars make the ones you have even more valuable- so, if you were ExxonMobile for example, and you generated the largest corporate profits in world history 6 quarters in a row in the 2000s, you’ll become even more rich and powerful, because those dollars sitting in your bank account become worth more as the overall numbers for everything get smaller. Deflation means incomes get smaller, while old debts stay the same. If paying back $120,000 in college loans is hard with the average income at $45,000 … what happens when the average income drops to $35,000 and you still owe $120,000 to FAFSA?
During times of deflation, savers are rewarded and borrowers punished- however, in our situation in the United States, those ‘savers’ are the fraction of the population who operated huge monolithic international corporations as profiteers, and the borrowers are the entirety of the US working class; those Americans who listened intently as the calm president told them to spend after 9/11, were beset by the siren song of commercials luring them into a lifestyle it regarded as ‘priceless’, ended up blinded by the apparent limitless potential of owning homes, and were culturally indoctrinated to believe that attending on-campus private colleges was a requisite to enter the productive world.
Unless you were born in the early 1930s, you’ve never seen a sustained period of deflation; so what do you do? There are hosts of governmental responses which would help offset the damaging elements [windfall profits on big oil from 1995-2008, effective stimulus package that includes reduced sales tax and increased import duties, financial bailout bills with a moratorium on home foreclosure, etc] … but those things can’t be done this weekend.
Pay down your debts. Think twice before you take out your credit card. Wait until you know why you want to go to college. Ignore commercials. Turn out the lights when you leave the room. Invite a friend over and make dinner. Talk to [or relive conversations with] someone who remembers the 1930s.
Consume less. Save more. Be grateful for what you do have.
Merry Christmas and happy holidays.