September 18, 2012
Deflation's Here, and the Downward Spiral Has StartedBy Frank Ryan
Denmark, Germany, Switzerland, and Finland have been issuing short term government notes at negative interest rates since mid-year 2012!
This dangerous precedent has happened before. Most recently, Japan experienced negative interest rates in the 1990s. The effects of the economic quandary in Japan and the efforts to restore growth were so misguided that the Japanese are still attempting a recovery. In almost twenty years, Japan has yet to make a full economic recovery.
The United States and the European Union are next and are headed into the same disaster as Japan unless decisive action is taken now.
Alan Greenspan clearly understood the growing dangers in the economic world in his book, The Age of Turbulence, in which he explains the continuing saga of an increasingly turbulent world economy.
Deflation is characterized by falling prices, falling incomes, declining value of real estate, and an inability to fund government debt and unfunded obligations.
Deflation has begun, and governments continue to push the "cliff" date as far into the future as possible when only quantitative easing is considered by the Federal Reserve and more government spending is considered by the White House.
Unfortunately, current fiscal and monetary policies of most Western nations are merely moving us farther up the fiscal cliff rather than away from it.
In Scranton, Pennsylvania, for example, declining real estate prices for an overburdened tax base on top of substantial unfunded liabilities of a "rust belt" city forced the mayor to cut all municipal pay to minimum wage.
Similar situations will occur for bankrupt cities and municipalities in California. Should the unfunded mandates and obligations not be cut, an increasing tax burden on property will merely reduce property values further.
At this point, the death spiral of deflation begins, and our economy will collapse. Economic recovery will be difficult at best because deflation's spiral is so difficult to reverse. Buyers are rewarded with even lower prices by waiting to purchase goods and services.
After the negative interest rates, collapsing real estate prices, state and local government pensions, the education bubble will then bust.
At the university level, for example, the burgeoning student debt and the substantial increase in tuition rates are making the reality of higher education a nightmare for many rather than the dream the youngster was promised. Increases in tuition beyond the general inflation rate have been going on for decades. That trend is about to end. Many universities are increasing aid due to this reality. Tuition increases are not sticking in the marketplace as was once commonly accepted. The next step is for tuition to fall.
Students and parents will begin to question the value of the degreee. Schools are already being audited because they allegedly failed to accurately reflect opportunities for students upon graduation. This action is just the beginning. It will follow that schools either reduce tuitions or lose students. However, the fixed costs at universities are so great that schools will have no alternative except to reduce tuitions to keep enrollment up.
During the First Depression (1930s), Keynesian economic theory proposed fiscal policy measures to stimulate an economy and argued that negative interest rates, while possible, would be unusual. Unfortunately, this White House does not consider any solution other than a Keynesian one.
In our current Second Depression (circa 2008), a German economist in 2009 proposed Keynesian Economics 2.0, arguing for a monetary approach to solving our current economic quagmire.
These academic exercises fail, however, to consider the tragic effects of misguided fiscal and monetary policy as the potential cause of the current economic disaster.
The federal government's perception is that government spending creates demand. The monetarist believes that lower interest rates stimulate demand.
Both fiscal and monetary policies have some merit under many circumstances; however, when those circumstances do not exist any longer, following the historical policies of more spending and lower interest rates will trigger a horrific deflationary cycle, as seen in the real estate and banking industries in Japan.
Deflation has devastating effects in every aspect of life.
First, anyone with debt will find it more difficult to repay the debt in a deflationary cycle. Incomes and prices will fall, making debt repayment difficult or impossible.
Second, organizations with high fixed cost such as airlines, hospitals, automobile manufacturers, drug and pharmaceutical companies, governments, and sports teams, to name just a few, will find that they must reduce prices in order to cover their fixed costs or lose customers. While this strategy works in the short run, the economic consequences of the lower prices will ultimately translate into lower pay.
Third, once the deflation cycle starts, the ability of a society to pay for things such as Social Security, retirement benefits, unfunded obligations, and any type of retiree health care cost will be impaired. The deflationary spiral will prevent any of these organizations from increasing prices.
Chairman Bernanke is using the Federal Reserve -- quantitative easing and a cheap monetary policy -- to dampen the effect of the recession we are currently in. His doctoral thesis, however, clearly indicates that it is the uncertainty that is causing the economic dislocation.
To avoid all of the negative issues of deflation, it is essential that our elected leaders and the Federal Reserve work immediately to eliminate uncertainty and reduce wasteful spending within our economy. Failure to do so will lead to substantial deflation.
The time to act is now. Decisive action must be taken to end the uncertainty. The Federal Reserve and our federal government must understand that no decision -- i.e., gridlock -- is, in fact, a decision.
The Age of Turbulence will look calm in retrospect should government not act now!
Col. Frank Ryan, CPA, USMCR (Ret.) served in Iraq and briefly in Afghanistan. He specializes in corporate restructuring and lectures on ethics for the state CPA societies. He has served on numerous boards of publicly traded and non-profit organizations. He can be reached at FRYAN1951@aol.com and on Twitter at @fryan1951.
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