This opinion piece has to be a joke – I certainly had to ask myself that question again and again as I read the latest non-stop wince-inducing op-ed by A. Gary Schilling titled The Economic Monster of Deflation published on Bloomberg last week. My physical reaction to the brief but potent assemblage of bull piled high reminded me a bit of taking a sip of pure moonshine over and over. And since I am in a completely charitable mood, I thought I might share some tidbits – but be careful though, because while it may induce the same immediate physical reaction of taking a sip of moonshine, it lacks the follow-through, if you get my drift.
Here’s Mr. Schilling:
I wrote about the deflation specter that is haunting Europe. Central bankers are so fearful of deflation that they want an inflationary cushion to prevent an economic shock or geopolitical crisis from sending low inflation into negative territory. The Federal Reserve, European Central Bank, Bank of England and Bank of Japan have inflation targets of 2 percent.
Why is deflation so troubling to central bankers?
Are central bankers really troubled by deflation and do they really want a 2% inflationary cushion? These are certainly questions to ponder… for about 10 minutes before questioning the veracity of the claim, because we haven’t seen inflation above 2% in years in the US, the Euro Zone, and certainly not for decades in Japan. I suppose the cushion is nice to talk about if one needs to have a warm-fuzzy that central bankers really care about what happens to the people in an economy facing “exogenous shocks,” but it doesn’t exist in recent practice and the markets are saying it doesn’t exist in the near future either– the only states of being that matter. And certainly with central bankers like Charles Plosser and Jens Weidmann lurking about, it is highly questionable whether deflation is troubling at all. It seems more like reality that such central bankers might desire a deflationary cushion to be sure that any inflationary pressures are put to bed before they can even arise; 2% inflation is the ceiling. Any suppression of economic activity as a result is the price to be paid for our own *cough* wellbeing since inflation is the greatest evil ever to emanate from government and it is all just imaginary economic activity conducted with monopoly money anyway… Really, how can anyone plan retirement with all those multitudes of financial morons investing willy-nilly and running up prices for no good reason at all?? It’s the ugly side of capitalism that we should all be rescued from and Mr. Schilling just doesn’t seem to get it.
Mr. Schilling continues about why deflation is so troubling to central bankers:
First, with chronic deflation, debts rise in real terms. Their nominal value remains fixed, yet nominal incomes and profits — the wherewithal to service those debts — tend to fall. So bankruptcies leap, and lending, the driver of much economic growth, atrophies.
This certainly is an interesting way of describing what deflation does to debt. But what do the central bankers care other than when looking for a scapegoat as bankruptcies and foreclosures skyrocket because they failed to maintain nominal stability? Yes, this is why they should care, and in the US, there is a law that says the central bank shall care – but a law is only a piece of paper and cannot enforce itself. The way I see it, there seems to be a shortage of character in the marble halls of central banks these days where there is a heightened sense of concern about everything but the inflation target and employment levels as they “smack the markets across the nose with a newspaper” for good measure. Yeah, that’ll teach ‘em. And the beatings will continue until morale improves.
And by the way, perhaps Mr. Schilling needs to rethink whether lending is the driver of growth and what role the central bank plays in that.
There’s still more (I’m just getting started):
Second, when deflation occurs, economies weaken and central banks lose much of their power. Interest rates fall to zero, and monetary policy becomes asymmetrical (because rates can only be raised, not lowered).
Third, real interest rates are always positive, even with zero nominal rates. That’s been the case in Japan for two decades. This means that central banks can’t create the negative real rates they desire to encourage borrowing. To be effective, they need to pay borrowers, in real terms, to take money.
Still… so why is deflation troubling to central bankers? Is it because their preferred policy framework breaks when they most need it to work and don’t know what to do after that? And there is nothing to be done? Really?? But I thought printing money caused inflation!! Could it be that Mr. Schilling is missing a step in logic here? I think so… and maybe borrowing isn’t really the thing to focus on for effectiveness. Things that come to mind are the demand for money and income… But what do I know?
Finally, deflation breeds deflationary expectations, which results in a sluggish economy. That’s been the case in Japan since the early 1990s. Buyers wait for lower prices before purchasing, so excess capacity and inventories mount, pushing prices down. That confirms prospective buyers’ expectations, so they hold off further, creating a self-feeding cycle of buyer hesitation, which spawns excess inventories and capacity that depresses prices and encourages further restraint by purchasers, and so on.
This must be why central bankers are troubled by deflation. No? Certainly the ECB is doing everything it can to fight off deflationary pressure – and is losing the war. I suppose I misread numerous news articles that quoted Dragi as saying the ECB is ready to act if needed as if double, triple-dip recession isn’t enough to indicate a need. And Mr. Schilling is trying to get his readers to believe the ECB cares about its job, cares about the humanitarian crisis that comes with persistently high unemployment and no growth.
Sorry. I was born at night, but not last night.