Ben Bernanke's Deflation Hysteria Is Our Nightmare

Ben Bernanke, the head of the mostly non-governmental agency known as the Federal Reserve, worries a lot about deflation. He says things like this constantly:

"If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation."

- Reuters

In other words, if the prices of goods and services aren't increasing much, or they start to decrease, Bernanke says he would have to act. What would he do? He would act to create inflation, lest the dreaded D-word (deflation) take over.

But is deflation really a bad thing? Turns out it depends very much on your perspective. It's really not great for the rich, who see their stocks and other investments decline. But there are actually quite a few positives for almost everyone except the filthy rich.

Deflation occurs in an economy when prices for almost every thing continue to fall over a long period of time. If you listen to Bernanke, deflation seems to be the worst thing that could ever happen, and he makes it clear he will do anything to avoid it. Anything, including destroying the value of the US dollar and wiping out the entire middle class in the process.

So, what is deflation and why is it so important to avoid, even at such high costs as wiping out the savings of millions? Well, deflation can cause some pretty hefty damage to some groups of people. Right now in the US, perhaps the biggest area of the economy that is facing long-term deflation is home prices. This has been a disaster for homeowners, as well as for the banks that made loans to the homeowners. (It has also caused catastrophic damage to many kinds of financial institutions, from JP Morgan to AIG, that were in the business of creating leveraged derivatives - most of which, it turns out, were fraudulent investments - based on these home loans the banks made, putting the entire US economy at risk, but that is a whole other story.)

However, while the housing market can collapse in a truly deflationary economy, so too usually do the prices of a whole host of other goods and services. For example, rents, food, beverages, transportation, clothing... just about anything that is essential for daily living. This means that daily living expenses go down for most of the population. So when we look at the effects of deflation overall, what really becomes clear is that deflation actually isn't bad for everyone. It may be bad in some ways for homeownvers, it is really bad for people who are invested in the stock market and who own a lot of property. But for the majority who own little to no property and who don't have a lot of financial assets (I'm talking about people who aren't very rich), it turns out a deflationary economy can actually be quite beneficial.

Bernanke and other "noted economists" frequently invoke Japan as a model of the disastrous consequences of deflation. But a recent article on ZeroHedge explains the benefits of deflation quite well:

In 1996, seven years after the Japanese bubble burst, I arrived in Tokyo for the first time and saw a shockingly expensive country... Item after item. Plain white T-shirts made in Japan, $30. Rent for a dingy 200 sq. ft. apartment in a lousy area, $1,500 a month (plus 3 months key money, plus 2 months deposit, plus 1 month rent up front, for a total upfront payment of $9,000). Public transportation, food, fuel, hotels (except love hotels), coffee, you name it. Everything was shockingly expensive...

Now the $53 bottle of Chianti costs $8, and a Chinese-made T-shirt cost $5. Rents have come down, and new apartments are bigger and nicer. Food is cheaper, and so are meals at restaurants. Unemployment is under 5%. Wages have come down too, but not much. Infrastructure has improved. Subway and train lines have been added, extended, or four-tracked, and rush-hour trains are less crowded. Trees have been planted. Tokyo is cleaner and greener. Savers and bond investors haven't gotten ripped off by inflation.

-Wolf Richter

Inflation in 1980s, due to a roaring stock market and bubbles in almost every aspect of the Japanese economy, made life in Japan extraordinarily expensive, especially on those who lacked jobs that gave regular and substantial wage increases to keep up with exploding prices. When deflation arrived, however, salaries did decrease some, but the drop of prices of goods and services more than made up the difference. In addition, without inflation eating away at the value of cash savings, every day people were actually able to save and see their savings grow, which is important for everyone but in particular for the elderly who tend to depend on savings for their retirement.

Inflation, on the other hand, tends to see the value of wages and savings shrink as the prices of essential goods and services rise. If last year a tomato cost $1, but this year one tomato costs $2, that $100 dollars you saved isn't going to buy as much as last year. Inflation, even so-call "mild inflation," disproportionally hits everyone who spends a large amount their paycheck on rent/mortgage, food, clothing, transportation, etc. This group is comprised of 95-99% of the people of the US: the middle class, working poor, unemployed. People of all races but especially people of color who currently have as much as four times the uneployment rate of their white counterparts. Families with single or dual heads-of-households who struggle more and more every year to make ends meet.

This is no accident. The "mild" inflation of the last three decades has has destroyed the purchasing power of the wages of more than 90% of the population. If you feel like your salary doesn't stretch as far as it used to, that is probably because you are living in a world where, essentially, you have a 1969 salary and 2011 prices for everything at the mall and grocery store (this is what economists refer to as "real wages": the value of your wages in terms of how much they can buy rather than the actual dollar amount, which may increase). You are also not alone. Today more than 1/6 of the US population (over 45 million people) are on food stamps.

So, when Bernanke and other officials talk about the need to fight deflation at all cost, and the necessity of engineering inflation, whose interests are they really trying to protect? It sure isn't yours or mine.