Deflation: What Happens When Prices Fall (Rambling Review)

Posted by Sean | Posted under Books, Economics, Reviews | September 9, 2008

title: Deflation
sub-title: What Happens When Prices Fall
pages: 194
author: Chris Farrell
published: 2004
rented: public library

Everyone knows about Inflation.

It sucks. We hate it. Make it go away!

But what about the flip side, Deflation?

It is rarely discussed in the U.S. because we have not seen it lately.

And talk of it coming back is (ahem!) not a topic for polite society.

This is because the last major deflation was during the Great Depression. As you can see in a search at Amazon.com, almost all of the books that come up for "deflation" are trying to one-up each other with dire predictions for the future.

The exception is Deflation: What Happens When Prices Fall by Chris Farrell. His book examines the history and dynamics of deflation… without telling you to stock up on canned foods and live in a bunker.

The book argues that we have a strong undercurrent of deflation in the modern economy, and not all of it is bad. Where technology leads to increased efficiency, lower prices emerge — just look at computers and computerization. Instead of fearing deflation, the author says we should embrace and prepare for the deflationary undercurrents.

This is not to say everything is peaches and cream. In the overall economy, there is a clear distinction between deflation and hyperdeflation.

"The historic record is clear: Hyperdeflation, say a 1930s deflation rate of 5% to 10%, is ruinous. Period." page 28

When the value of everything else goes down, fixed debt obligations loom large, and bankrupty skyrockets. You can’t trade the things you own for the things you owe, since everyone is selling and nobody is buying. The book states that by 1932, over half of all farm debts were in default.

The nature of our currency and economy has changed since then, yet our most recent economic developments sound like they could be from an anti-deflation playbook.

"Chris Whelan, author of The Naked Economist, facetiously recommended he would solve deflation by giving every member of Congress $100 million of freshly minted bills to hand out to constituents." page 93

note - this book was published in 2004

However, if it ever gets to the point where we are staring into the abyss, stopping hyperdeflation might not sit well with people who prefer a good old-fashioned bloodletting.

"Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate…. That will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people." (link: Wikipedia)
Andrew Mellon, Hoover’s Secretary of the Treasury

Andrew Mellon was one of the wealthiest men in America, so it was easy for him to hold this opinion. (I wonder how many middle-class people held this opinion initially, only to end up in bread lines?)

In any event, people who favor a scorched-earth recovery today would seem to be in the minority. Ben Bernanke in particular is a depression-era specialist who has said, "we won’t do it again." My only concern is that our best intentions could have unintended consequences. In other words, even if we don’t see deflation, we could feel the effects of deflation prevention.

Farrell notes:

"Now, when the Fed governors fanned out across the country to reassure the public, they repeatedly mentioned that the central bank had a number of tools in its monetary toolbox. But most of these methods are untested."

Recommendation: I could ramble on all day, but I can’t do justice to this little book. Pick it up at the library or buy it used on Amazon.com for the deflationary price of $.01 plus shipping.

As for how this ties into personal finance, I’d say it underscores the validity of aggressive personal finance basics as a foundation in any economic environment. High assets. High liquidity. Low debts. Low expenses. The kicker is we must step up our intensity in response to a larger number of possible outcomes.

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