More on Deflation - Daniel Gross

I like reading Daniel Gross, but he's been mailing it in for about five months now. Probably fatigue from peddling his book. But, now he's just getting sloppy.

Economists generally agree that deflation is a widespread fall in prices, as measured by the consumer price index (CPI).

That economists generally agree on anything is news to me. Deflation has many definitions. Some would argue that there are multiple species of deflation.

For example, there is the phenomenon of debt deflation -- where credit was extended far and wide without proper risk assessment. Always this leads to creditors chasing too many debtors who cannot pay. Always this chokes the supply of money from lenders to borrowers.

There is also the type of deflation referenced by Gross, whereby prices of things go down in a domestic market. Price deflation can result from innovation (things being made cheaper) or from oversupply. Price declines from innovation are different from price declines from oversupply. For example, precision machining may lead to fewer error rates in a manufacturing process, which benefits the manufacturer's bottom line by reducing the cost of production. Some of that savings is passed on to consumers. Some is gobbled up as profit, depending on the level of competition in the industry. Suppliers to the manufacturer see no net change, unless the lowered price leads to greater demand -- in which case suppliers may see a benefit to the innovation-driven price decline. Maybe jobs will be created.

Price declines from oversupply are a bad deal for the companies selling the product. For example, many areas have too many houses right now. This means homes can be bought for cheap (especially with interest rates set to prevent a worsening of the depression). It also means many sellers are taking a loss. It also means home builders have to build fewer homes than planned. This means the suppliers to the builders will take a hit. People will get laid off.

There are other forms of deflation, too, such as an insufficient level of money printing. Or the decline of derivatives creation.

My guess is that we are in a state of multiple layers of deflation. Debt deflation, price declines from oversupply, and a complete derivatives Armageddon. One could make the case that the printing presses are not running at capacity, either. I know DeLong and Krugman would agree. So would Martin Wolf.

As for price declines from innovation, this is where it gets tricky. A lot of the innovation we have seen in the past fifteen years has actually been a political and economic innovation: globalism. Really, shunting off manufacturing to Asia to take advantage of the low cost of labor. This will reverse itself to some extent as Asian populations demand a chunk of the consumer pie, which will send some portion of their colossal aggregate savings into merchants’ pockets. This increase in demand will lead to price increases for everyone. These price increases, given the tendency for things to fall to shit all at the right time, will hit us just as our debt deflation is the worst. Meaning, just when we can afford it the least.