Friday, June 10, 2016

Good Deflation Is Good

Except, maybe, for debtors who have to run faster to stay in place on their payments.
From Ed Yardeni's Dr. Ed blog:
Why are the major central banks so paranoid about deflation? It’s probably because they are staffed (stuffed) with macroeconomists who associate deflation with depression. In their opinion, falling prices make it harder for debtors to service their debts. Widespread defaults on those debts could cause a financial crisis and a severe economic downturn. I believe their thinking is that simplistic.

Yet, perversely, the central banks have been responding to the risk of deflation with ultra-easy monetary policies in an effort to stimulate more debt-financed spending. It seems to be working in the US, though a significant portion of borrowing in recent years has been in the corporate bond market to finance stock buybacks. More recently, debt-financed M&A activity has picked up as well. Often, these deals are associated with cuts in payrolls. 
On the other hand, debt is financing a US boom in multifamily housing construction and solid activity in commercial real estate. Mortgage-financed new and existing home sales also have continued to recover from the Great Recession. Auto loans are financing cyclical highs in auto sales.

US consumer price inflation measures excluding food and energy are closer to 2% than to zero. So the Fed is more relaxed about deflation and started raising interest rates again at the end of last year. However, Fed officials constantly and consistently say that the process of normalizing monetary policy will be very gradual.

In the Eurozone and Japan, both headline and core consumer inflation rates are close to zero, i.e., bordering on deflation. Ultra-easy money has failed to stimulate borrowing and demand in their economies. Both have been in growth recessions over the past few years. Since Q4-2010, real GDP is up 10.5% in the US but only 3.2% in the Eurozone and 2.7% in Japan.

The Chinese authorities don’t have a deflation problem as measured by their CPI. They do have one as measured by their PPI, which has been falling on a y/y basis for the past 51 months through May. They have been all too successful at pumping lots of credit through their banking system in the economy. Perversely, rather than fueling demand, much of it has financed more deflationary capacity expansion. China actually stands out as the one country where deflationary pressures may very well lead to lots of debt defaults and a severe downturn. However, easy money is exacerbating the problem rather than ameliorating it. Let’s dive into the widely feared sea of deflation and see what we can see:

(1) Durables deflation. There are seven countries that report the durable goods, nondurable goods, and services components of their CPIs. Here is what they’ve done since 1996:

Durables: US (-16.1%), Eurozone (-1.4), Japan (-50.1), Sweden (-31.1), Switzerland (-26.4), Taiwan (-28.9), and UK (-26.9).
Nondurables: US (51.1), Eurozone (37.1), Japan (9.1), Sweden (36.0), Switzerland (-13.7), Taiwan (51.0), and UK (37.7).
Services: US (73.7), Eurozone (48.3), Japan (5.8), Sweden (45.9), Switzerland (7.5), Taiwan (21.1), UK (96.3).

The pattern is obvious: There has been across-the-board deflation in durable goods, while nondurable goods and services have continued to inflate almost everywhere. The only difference recently (i.e., since mid-2014) is that energy prices have contributed deflationary pressures to the nondurable goods components. Durable goods deflation has been mostly good deflation, attributable to big gains in manufacturing productivity thanks to technological innovations. Weak demand hasn’t been the source of the deflation. On the contrary, durable goods deflation certainly has benefitted consumers around the world, lifting their purchasing power and standards of living....