Sunday, October 12, 2008

Contrarian Prediction: Deflation

What we have been worrying about, all along, was that the Fed would keep pumping money into the economy, and this would inflate the currency, making it less valuable vis-a-vis other currencies, precious metals, commodities, etc. That is still certainly a possibility. Suddenly, however, it appears that things could also conceivably go in the opposite direction. The dollar is becoming strong, in the past few days, as people fly to quality. The U.S. economy is at risk, we see, but it is not necessarily as much at risk as other economies. If the government intervenes in the market in Russia, for instance, it intervenes in order to seize your investment; but if the government intervenes in the U.S., it typically (and even now) does so in order to preserve your investment. At this time of panic, gold should be flying through the roof. Instead, over the past couple of weeks, it has dropped in dollar terms. It is not that the dollar is safer than gold; it is that gold (for American purposes) is priced in dollars, and dollars are in demand. Especially the dollars produced by the U.S. Treasury (in e.g., T-bills) and backed by the full faith and credit of the U.S. government. The U.S. government may or may not be good for it, in the long haul; but there are an awful lot of nervous people, around the world, who seem to be of the opinion that if anybody's good for it, the U.S. government is. If we're looking for a paradigm shift in the world economy, away from America at its center, it's not setting itself up as a gradual transition. It's an over-the-cliff kind of transition, where the U.S. economy, dollar, and Treasury all wind up at the bottom in a broken heap. Is that where we're headed? Maybe not, or at least maybe not right away. We've got billions of people out there who seem to be wanting the U.S. to hold itself together and go back to a consumerist orientation, buying things that other people produce, and so forth. China is making a bid to unlock a large quantum of its own purchasing power, in its recent real estate reforms; but that will take time, and it is not clear to what extent it will provide as an engine for global (as distinct from Chinese internal) growth. Presumably the Chinese currency will have to appreciate a great deal before Chinese citizens en masse have the wherewithal to make large-scale purchases abroad. In any case, China has placed its own huge bets on the strength of the U.S. Treasury, and has its own incentives to see to it that those bets do not become worthless. So if there's a lot of interest in seeing the U.S. remain strong, then perhaps we've already seen the dollar devaulation run its course for now. If panic money does come into an underpriced U.S., to buy up our land and our companies and in shopping sprees of other kinds, then perhaps the world will continue to find new ways to fund our lifestyle or, more importantly, our confidence. Those defaulting mortgages could get sopped up pretty quickly if, say, the government were to allow people from abroad to become American citizens immediately, provided they can put up the purchase price of a nice suburban home in cash. Does the world have a couple million would-be applicants who could pay that price? Maybe. Would Americans bitch and moan about a flood of immigrants if (a) they hailed from the four corners of the globe (as distinct from e.g., a Hispanic tide) and (b) they were bailing us out financially? Maybe not. Right now, interest rates (on e.g., T-bills) have fallen to extraordinarily low levels. Hmm -- that sounds like the direction in which we would be moving if we were indeed trending towards deflation. Just to have the U.S. dollar is good enough; people seem to be happy to do that, without needing to earn much interest on it. If the bucket tips over, than all bets are off: everything spills across the floor, and the dollar becomes worthless in a trice. But as long as she remains upright, she may just continue to be the best game in town. It could be some time before people espy a better bet. In a deflationary scenario, the dollar becomes ever more valuable, and people have ever less of it. That, too, sounds familiar. Those debts that were difficult to pay before become impossible to pay now, as wages drop or disappear while principal plus interest compound. An acute problem of indebtedness will leave a large number of debtors unable to pay, and a large number of creditors increasingly insistent on being paid. Typically, this kind of problem will be approached on multiple fronts. Creditors will get shafted, to some extent, in liberalized bankruptcy proceedings; simultaneously, debtors will be expected to cough up even more than they do already. To see it another way, our move toward a common global standard of living for workers will entail, not only a lowering of our wages to compete with our good friends in China and India, but also a lowering of our lifestyles to accommodate longer working hours. In the extreme case, to spin out the scenario further, unemployment could come to be appreciated as in some ways a superior form of existence: not much less financially rewarding, and much more fulfilling. Be that as it may, the indebtedness problem, too, is very familiar now. So there do seem to be these serious bits of circumstantial evidence that are compatible with a possibility of deflation.