I See A Bad Moon Rising

July 16, 2008 at 4:07 pm | Posted in Economics | 1 Comment

Bad Moon Rising

Yes, there’s trouble on the way.  But, it’s not Iraq, the price of oil, or even inflation in general.  It’s the opposite, actually, and it’s worse … much worse, if we are to believe those in the know.

The new word of the day is deflation.  Simply put, deflation is a trend of declining prices — the exact opposite of inflation.  So, what’s wrong with that?  We all love a bargain.  And that’s the problem….

When prices start falling in a market, people realize that all they have to do to get a good deal is sit and wait.  For example, if I knew that that big screen TV would be $100 cheaper next week, why would I buy it today?  I can wait a week or two or three if it means I can save some of my hard-earned dollars.  But what is good news to me is bad news to the store owner.  While I’m sitting around waiting for the price to drop, he has to pay his employees to keep his store open.  Each day without a sale makes his situation more desperate.  So maybe he’ll lower his price even further, trying to entice me to make the purchase.  But, if the one store owner lowers his price, then so will the guy down the street, if he wants to stay competitive.  Pretty soon, one of them won’t be able to make enough money to stay open.  So, the store closes, his employees are out of a job, and I’m still holding on to my money, thinking that maybe I can get an even bigger television for the same price.  After all, with all these people out of work, who else has money to buy a new television?  And the spiral of deflation begins…

A deflationary spiral is death to an economy.  Economies work because money (a measure of the resources at people’s disposal) is always moving around.  So, if someone has a big job to do, he can accumulate a lot of resources (money) to get it done.  But if the resources aren’t there, the work doesn’t get done, which means that more resources aren’t produced, which means that more work isn’t done, etc, etc.  People lose jobs, goods aren’t produced, and by and large bad things happen.

But didn’t inflation just tick upwards?  Well, yes … consumer prices increased by 1% in June.  But that doesn’t tell the whole story.  Consumer prices are the tail end of the economy.   They pretty much tell us where the economy has been, and that short term has been inflationary.  But lets take a look at where the money is coming from to keep the economy running:

Banks have less money to lend as a result of bad mortgage loans, investors moving cash to safer ground, and a general unwillingness to trust each other.  The upshot is that it is getting difficult to get some types of loans, and the problem is only going to get worse.  The fewer loans, the less money will be available to make the economy run.

Wealth is disappearing at an alarming rate.  Huge sums (about $5.2 trillion by some estimates) have been lost in the stock market, the real estate market, and even the commodities market as oil has been trending downward.  This is money that cannot be used for productive purposes.  Even the average consumer is finding that home equity as a ready source of funding is now unavailable.  Home priced provided money to fuel the economy so far this decade.  Now, the supply is running out.  If the money supply decreases, deflation cannot be too far behind.

Globalization has served to keep prices low even as the economy has grown tremendously.  Now all that money moved overseas is not flowing back into the American economy.  Furthermore, with a downward pressure on wages and increased energy costs, there is not much money available to the consumer for other uses.  This depresses demand, which depresses prices and ultimately supply.  This is not a recipe for growth.

Now, take everything above with a grain of salt.  I’m probably wrong.  The sun could come out, and the economy could perk up tomorrow.  But I’m not putting any money on it.  Not today.

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1 Comment »

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  1. So what does that mean for a family with…say…10 kids? How will they make it through? Thanks for some good listenin’ during the reading of your post! See, I understand this stuff much better when you write it down!


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