"Wes" wrote in message
...
"Ed Huntress" wrote:

That's the third month in a row that inflation has dropped, Iggy. And if
you're worried about deflation (quite a few of the world's economists are,
for reasons I'm sure you understand), the price of gasoline dropping from
$3.50 to $2.20 (it's $2.21 today here in NJ) is enough to set off alarm
bells.

Why is that a worry? My simplistic view is that the market is working. I
remember, quite
fondly, where gas hit $0.999 a gallon not so long ago. No one cried for a
bail out of big
oil like we just did for banking.

I think the growth model is dangerous. It implies we need more to market
to. Remember
when zero population growth was an item of interest?

When you look at our numbers as far as consumpution, we and the world
would be better off
if there were fewer Americans, Canadians, and Europeans.

A world of 2 Billion would be far richer. And we waste time talking about
global warming.

Some things need deflating.

That's a good question, and I should really let Iggy or George give you a
good explanation, but here's an oversimplified version that may make the
point.

Lower prices that result from improved productivity, or from new mineral
discoveries or even an "adjustment" to inflated prices are good things, by
themselves. But lower prices that accompany a declining economy are
deflationary -- the same thing costs less, even though its cost of
production hasn't (yet) dropped. At a certain tipping point, the downward
pressure on prices becomes self-perpetuating. And, unlike inflation, there
are no monetary actions that can stop it. Once it's locked in, there are no
fiscal actions that can stop it either. You wind up in a spiral that has to
work itself out over time. Japan just went through 10 years of it, roughly.
During the Great Depression, the whole world went through 10 years of it.

To explain why it happens, let me offer this simplistic example: Say that
commerical banks need a 4-point spread to make money. In other words, they
have to charge 4% more for loans than the interest they pay to depositors.
Now say there is an economic contraction, and manufacturers and service
businesses are downsizing to adjust to declining markets. They don't want
capital for expansion and they couldn't pay the interest if they wanted it.
So banks drop their rates to try to keep loans moving, because that's how
they make their money. When it hits around 4%, government officials,
bankers, investors, and corporations start sweating. If it hits 2%, you're
in a dive. Think about that 4% spread: Even if banks pull in their horns and
batten down the hatches, they can't live on less than 3%. So, what can they
afford to pay to depositors? Negative 1%. In other words, for the bank to
stay in business, it has to *charge* depositors 1% for them to accept
depositors' money.

Of course, they then have no depositors. This is a kind of equilibrium,
because they don't have many borrowers, either. g In Japan in the early
'90s, banks dropped their loan rates to 0% interest (with some government
help, of course) and they still couldn't give out loans. There was no growth
in the economy and nobody wanted their stinking money.

You probably notice that, in these circumstances, stuffing your money under
your mattress produces a higher return than depositing it in a bank. This is
very bad ju-ju. Your investment choices boil down to Serta Perfect Sleeper
or Sealy Posturepedic.

Nobody's going anywhere. Banks are dead in the water, industry keeps cutting
wages, prices keep dropping, and the economy is as dead as a road-killed
'possum. If the Fed has already dropped their overnight rate below 1% and
banks still don't want money, then the Fed has lost control of the monetary
system. There is nothing more they can do.

At this point Congress takes over and tries desperately to prime the pump
(expect this to happen within six months from now). They'll pump money into
infrastructure projects, and then into any make-work they can come up
ith -- think CCC Camps and the Writer's Project, circa 1933. But if they've
waited too long, all this will do is debase the currency. They can cause
some inflation this way but no real economic growth.

Anyway, the point is NOT that deflation is likely -- it's extremely rare and
unlikely. The point is that once you pass that tipping point, and the
economy is trending down with no turnaround in sight (think, like right
now), you're in deep doo-doo. There are no monetary or fiscal tools left to
stop it. When the Fed's overnight rate drops below 1%, you're at the end of
the rope. And that's why it scares the living bejesus out of government
treasury people, bankers, and businesspeople. And it should scare all of us.

BTW, the overnight rate just dropped to 1%.

--
Ed Huntress