It is generally acknowledged that, among government employees, drill sergeants and central bankers have the greatest gift for speaking clearly and to effect.
Thus, when the Federal Open Market Committee of the United States Federal Reserve warned in May that “the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level,” we began to wonder just who was running the show. Fortunately, three days later, the European Central Bank paraphrased the Fed, saying it wanted its monetary policy to “provide a sufficient safety margin to guard against the risks of deflation.”
So the fear of deflation — the giant hissing sound that comes from an economy where there is a general decline in prices — is now explicit in the policies of the people that manage the world’s major reserve currencies. The principal economic dangers in deflation are that it may force returns below the cost of capital, causing unprofitability and bankruptices, that central banks may have no way of stimulating the economy (because of a built-in increase in the value of money over time), and that consumers and businesses may delay purchases, expecting to buy later with cash that has increased in value.
It sounds like a nasty business, but is it a reasonable fear? That may depend greatly on where you live.
The only reason to mention deflation in Japan these days is to rub it in; Toshihiko Fukui, governor of the Bank of Japan, has compared conducting monetary policy at low interest rate levels to “a boxer fighting with his hands tied behind his back.”
The Bank’s attempt to loosen at least one hand consisted of increasing the money supply at a constant, near-zero nominal interest rate. In effect, the Bank fired up the printing presses and — in the two-year interval between March 2001 and March 2003 — increased the Japanese monetary base by a factor of four. Yet the Japanese economy has continued to contract, and prices continue to fall.
The Bank had (not unreasonably) expected the public to move money out of demand deposits and into real or financial assets as the money supply increased. But as Fukui remarked, with admirable understatement, “so far, however, the effect has not been widely observed.”
Part of the problem is that Japan is now reaping what it sowed with large trade surpluses in the 1970s and 1980s. Even though its economy is, in comparison to recent years, awash in cash, there are too few good business opportunities to invest in, and few, if any, useful places left to put public money.
Whether Europe and the United States are able to evade that trap will depend greatly on their ability to maintain policies that allow investors to make money. So far, both the Fed and the ECB have stuck with an easy-money policy, in the hope that the deflation battle is not one they will have to fight.
If it does come to a crisis, the Western Europeans have a fiscal straitjacket of their own making, felicitously labelled “social programs.” These consist principally of funding schemes for people that prefer not to work. They are fiscally and socially expensive, because they will, in the end, engender resentment from a dwindling number of working taxpayers that finance them. There is little hope that the euro zone will lead — or even follow — a run of economic growth.
The Americans may have more fiscal leeway, though the present condition of their state- and municipal-government finances is already setting off alarms. If U.S. governments boost spending on public projects, which more often take the shape of highways and buildings and other large public works, then we in the “old economy” may benefit from some Keynesian stimulus.
It is there that some of the cloud of fear that surrounds deflation may disperse. Even if prices are falling, an increase in economic activity may mean net economic growth.
And the general decline in prices may not affect every industry: surely we in the mining industry know that prices of individual commodities or groups of commodities can fall during a period of general inflation. It has happened enough times to us.
In last week’s editorial, “Please release me” (T.N.M., July 7/03), we said the Red Dog mine in northwestern Alaska had reported “432 million tons” of releases in 2001.
Anxious though we may have been to paint the Toxics Release Inventory as unfair to mining, we should have been more careful; Red Dog reported 432 million pounds of releases.
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