Deflation : What Happens When Prices Fall

Rating:
Summary: The "risks" of deflation presented accurately and in context
Review: I follow the financial news fairly regularly, reading the news headlines and many of the columns on the Internet at least three times daily. A few months ago, the main topic of some of the economic stories was one that I had never seen in a contemporary financial column, the possibility of the U. S. economy entering into a deflationary state. A deflationary condition is when prices start to fall, and people begin to delay non-essential purchases in the belief that they will continue to fall, which can lead to an economic collapse. In general, it was considered a significant threat, and apparently the high officers of the Federal Reserve (the Fed) were preparing contingency plans if it were to happen. The possibility, consequences and potential benefits of a deflationary phase in the U. S. economy are the primary topics of this book.
Outside of major wars and their consequences, there were two major economic cataclysms in the U. S. economy in the twentieth century. The first was the Great Depression of the thirties, which was a major deflationary period. The second was the uncontrolled inflation of the seventies, where price increases were relentless, a major success was proclaimed when the inflation rate dropped to ten percent or less. These two long-term economic problems form the major historical basis for the basic premise that monetary policy is the preeminent driver of major economic trends. Milton Friedman, long the primary champion of monetary policy, is mentioned many times. Farrell finds many historical justifications to blame the severity of the two events on the Fed. While it cannot be refuted that the Fed made many major mistakes in both situations, the political leadership also must bear a great deal of responsibility. That point is made, but not quite as forcibly as it should have been.
The primary event that is driving the current concern over the potential for deflation is the performance of the Japanese economy in the last decade. It has been in a recurring deflationary condition throughout that time, performing sluggishly and with no end in sight. However, Farrell uses this as a point of demonstration as to how monetary policy can be used in a counterproductive manner. He argues that the Fed is smart enough to avoid those mistakes and will act quickly and forcibly to prevent a dangerous deflationary trend in the U. S.
Another major point is whether deflation is in fact a trend to be feared or welcomed. As Farrell so excellently points out, there have been many deflationary periods in the American economy, and while we remain focused on the 1930's, the others were often periods of economic expansion and growth. They were due to the development of new technologies, which led to previously unheard of improvements in efficiency. Dramatic improvements such as the telegraph, telephone, railroad and medical advancements all changed society and dramatically lowered the costs of gods and the efficiency of living. His point is that if the costs of the goods are declining due to increased efficiency, then it is a very good thing. Companies being forced to reduce their production costs in order to compete is always a boon to the overall economy.
The last chapter contains a series of recommended policy changes. The first is that global free trade should be expanded to include all nations. Farrell argues that since the poorer nations largely rely on agriculture, the U. S. should stop subsidizing agriculture, which would allow the products from the poorer nations to compete in the global markets. A valid point, but of course politically impossible. One point that I found of particular interest was the cost benefits of sophisticated medical care. He argues that nearly every successful medical treatment returns more than it costs. The exact figures are that from 1960 to 1997 it cost approximately $13,000 in medical spending and pharmaceutical research to gain one year of additional life and that the economic return on this additional year of life was $150,000. If true, it would be the most powerful argument for universal health care that could be made. An additional argument made in this section is that the current system of employer-managed health care programs is inefficient and should be refined into a single program.
Several pages are devoted to significant human capital investment, which means enormous investments in education and training. Farrell argues very forcefully that this is essential and historically justified. As Americans began moving from a rural, agrarian society to an urban, industrial one, the massive investments made in education were necessary for the transformation to be complete. He argues that sufficient investment capitol would be available if the agricultural subsidies were eliminated.
Farrell makes powerful arguments in favor of his basic premise that deflation is an expected consequence of dramatic increases in economic efficiencies due to the opening of global trade and technological advancements. While I sometimes had minor disagreements with his points of emphasis and understand that his proposals for solution are largely politically impossible, I found the book a sound analysis of what is now being raised as a potential economic danger.

Rating:
Summary: Not all lowering of prices is deflation
Review: If you look in bookstores at any give time you will find a shelf of books predicting a bright future with some a really strangely bright future. You will also find another shelf explaining to you why things are bad and will only get worse. Readers of a certain disposition will find the books appropriate to their sense of the future and find confirmation.

Deflation is a serious topic, but this is really not a serious book. The book makes the case that our new economic paradigm is, this time, really different because of the way prices fall because of technological efficiencies. Mr. Farrell links this kind of price decline with the kind of general deflation that follows and economic contraction and huge missteps of a central bank. The problem is these are not the same kinds of things and do not have the same kinds of effects. This incorrect mixture of topics under the same noun adds to confusion and foggy thinking.

To the person caught up in any kind of economic dislocation the state of the general economy is irrelevant, they are suffering in a depression. The problem is this kind of book lumps different kinds of things together to create a sense of alarm and concern.

Falling prices are a normal part of the business process as products and industries mature. They are a good thing for consumers of those goods and services and help efficiencies. They also spur development of new products and services that have higher prices and margins. In a general contraction and (real) deflation, everyone suffers because borrowers must repay debts with what amounts to devalued currency.

For example, we saw this in the housing market in the United Kingdom in the nineties when the collapse of the currency left people having mortgages on their houses that were higher than the market value of their homes. People just walked away from their homes. This kind of misery is not the same thing as accounting people losing their jobs because software now does what they used to do.

I like Mr. Farrell's urging of more free trade, and of reforming the retirement programs in this country to a single program attached to the individual rather the employer.

Rating:
Summary: Not all lowering of prices is deflation
Review: If you look in bookstores at any give time you will find a shelf of books predicting a bright future with some a really strangely bright future. You will also find another shelf explaining to you why things are bad and will only get worse. Readers of a certain disposition will find the books appropriate to their sense of the future and find confirmation.

Deflation is a serious topic, but this is really not a serious book. The book makes the case that our new economic paradigm is, this time, really different because of the way prices fall because of technological efficiencies. Mr. Farrell links this kind of price decline with the kind of general deflation that follows and economic contraction and huge missteps of a central bank. The problem is these are not the same kinds of things and do not have the same kinds of effects. This incorrect mixture of topics under the same noun adds to confusion and foggy thinking.

To the person caught up in any kind of economic dislocation the state of the general economy is irrelevant, they are suffering in a depression. The problem is this kind of book lumps different kinds of things together to create a sense of alarm and concern.

Falling prices are a normal part of the business process as products and industries mature. They are a good thing for consumers of those goods and services and help efficiencies. They also spur development of new products and services that have higher prices and margins. In a general contraction and (real) deflation, everyone suffers because borrowers must repay debts with what amounts to devalued currency.

For example, we saw this in the housing market in the United Kingdom in the nineties when the collapse of the currency left people having mortgages on their houses that were higher than the market value of their homes. People just walked away from their homes. This kind of misery is not the same thing as accounting people losing their jobs because software now does what they used to do.

I like Mr. Farrell's urging of more free trade, and of reforming the retirement programs in this country to a single program attached to the individual rather the employer.

Rating:
Summary: Brilliant exposition of an alternative view of our economy
Review: Is the United States currently in a deflationary period? If not then are we headed for one? Why have such major economic figures as Alan Greenspan started hinting that deflation is a possibility? Is deflation always a negative event bringing on recession is its wake? Author and financial columnist Chris Farrell answers all these questions and more in his fascinating book "Deflation: What Happens When Prices Fall". Mr. Farrell makes a strong case for deflationary pressures coming about from globalization of many industries as well as the strong pressure from retailers forcing suppliers to continually lower their prices. While deflation is a normal part of the economic cycle most of the 20th century has seen pronounced inflation. What does it all mean now that there are legitimate concerns about deflation? Mr. Farrell makes a convincing case that deflation does not necessarily equate with depression. In fact deflation can co-exist with a strong economy! This is definitely not the economics that I learned in college but is a well presented argument for a different view of where we are headed. Brilliantly done, "Deflation: What Happens When Prices Fall" is highly recommended for anyone interested in economic theory and may represent a more accurate view of deflation than the popular Keynesian theory of economics.

Rating:
Summary: Brilliant exposition of an alternative view of our economy
Review: Is the United States currently in a deflationary period? If not then are we headed for one? Why have such major economic figures as Alan Greenspan started hinting that deflation is a possibility? Is deflation always a negative event bringing on recession is its wake? Author and financial columnist Chris Farrell answers all these questions and more in his fascinating book "Deflation: What Happens When Prices Fall". Mr. Farrell makes a strong case for deflationary pressures coming about from globalization of many industries as well as the strong pressure from retailers forcing suppliers to continually lower their prices. While deflation is a normal part of the economic cycle most of the 20th century has seen pronounced inflation. What does it all mean now that there are legitimate concerns about deflation? Mr. Farrell makes a convincing case that deflation does not necessarily equate with depression. In fact deflation can co-exist with a strong economy! This is definitely not the economics that I learned in college but is a well presented argument for a different view of where we are headed. Brilliantly done, "Deflation: What Happens When Prices Fall" is highly recommended for anyone interested in economic theory and may represent a more accurate view of deflation than the popular Keynesian theory of economics.

Rating:
Summary: Looking at Two Kinds of Deflation with Errors
Review: Looking at Two Kinds of Deflation with Errors

Deflation is a subject that most of us have not thought much about. The primary reason for that is because deflation hasn't been a force in the United States for over 60 years. Instead, varying rates of inflation have been a problem and a concern.

In Deflation, Mr. Farrell points out that there are two primary sources of deflation. The first is an active growth in productivity such as that which occurs in the semiconductor industry. Under such circumstances, prices fall but businesses can make a decent profit while still providing better value for customers. Such deflation was fairly common in the days of the gold standard and often occurred during times of robust economic growth. The second source of deflation is a radical drop in demand for goods and services of the sort that occurred in the 1930's depression. Here, the dropping prices feed on themselves to reduce demand further as people wait for lower prices. Real interest rates rise which further cuts demand.

Mr. Farrell argues that the threat of deflation that Chairman Greenspan was concerned about in May 2003 was of the healthy variety, and suggests a number of possible measures for offsetting that risk.

Naturally, we now know that the risk of inflation is in fact greater than the risk of deflation due to soaring commodity prices around the world driven by the global expansion, the weakening dollar (due to the trade and budget deficits), and the various bubbles that are developing around the world. So this book won't seem of such relevance as it might have a year
ago.

I was dismayed to find that the book's arguments and details contained little information beyond what a well-done business magazine article would have contained. So the book doesn't present a very good value.

In addition, I was even more dismayed to find that the book had not been proofread or fact-checked very carefully so there were an unusual number of errors and questionable observations in it. For example, an early reference by Chairman Greenspan to what appears to be disinflation (slowing of inflation) is referred to by the author on page 2 as a euphemism for deflation. I don't think so. The Thai currency is called the "bath" rather than the "baht" on page 21. On page 36, the author says that television was available to Wyatt Earp in Los Angeles in 1929. On page 42, the author says that the events of 9/11 further dampened economic activity, yet we know that the recession ended right after 9/11. On page 45, it says that Meg Whitman started the 1990s at eBay. She joined the company late in the decade. On page 61, it says that economic growth does not cause inflation. Our current experience with oil and steel prices and ocean freight rates would suggest otherwise. On page 64, economic growth is described as only coming from creativity and innovation. Yet most economists would argue that over 60 percent of economic growth comes from population growth and investments in capital assets. I stopped counting what appeared to be errors at this point.



Rating:
Summary: Vital point, Global view
Review: Output, prices and employment are the three key parameters that macroeconomics is all about. But then conventionally the unit of analysis was the country. Not anymore, if we need to prosper as citizens of the global village. This theme is at the core of this book and sets it apart from most others who are not so broadminded in accepting this fact.

Coming to deflation, the author takes us through a well documented journey of over two centuries, two world wars and two big economic traumas of the twentieth century - the great deflation of the 1930s and the great inflation of the 1970s. He challenges the conventional view that deflation is inherently bad for the economy and on the contrary cites several decades of prosperity during periods of mild deflation. The very fact that most elected governments would like to hold the price line protecting consumers and investors, they need to put in place mechanisms with a deflationary bias. With this change in perspective about deflation, the author explains the main trends in the 1990s that are inherently deflationary. Globalization and the internet have strengthened global supply chains for products and services giving the consumer information, choice and control over her purchasing decisions. Rapid increase in productivity since 1995 ( to 3.5 % from an average of 1.4 %) due to technological advances is a fundamental force on downward prices. The rise of discount retailing giants like Wal-Mart is another factor. Thus, instead of branding deflation as a dreaded monster that will close down plants and spread misery, it should be managed in proportions that will improve competitiveness, increase availability and market efficiencies. Supply side economics rather than shrinkage in demand should be the driver of price determination.

One concept that very well emerges from this book is that both inflation and deflation in large proportions for prolonged periods are bad. The responsibility of the Fed to intervene at the right time with appropriate therapies is well explained. Deflation like inflation is a stimulant if administered in the right doses.

Two sectors that come up for criticism are Health Care and Education. These sectors are yet to exploit efficiencies of technologies and improvement in processes adopted in most other manufacturing and service sectors. Hence affordable healthcare and education that can impart substantial improvement to the quality of human capital are still proving elusive.

There is a chapter devoted to investment choices and strategies available to individuals should there be a prolonged phase of deflation.

This book explains some excellent concepts through a non jargon approach. Those who have not had formal college education in economics will also find it interesting. A table with the chronological listing of key economic events discussed in various chapters for ready reference would be very helpful.

Rating:
Summary: Deflation by Farrell
Review: The author explains what happens when prices fall. Falling prices can be an opportunity for persons with cash and buying power. The capitalist system inevitably evolves through cycles of inflation and deflation. The author argues that deflation is a condition precedent to the capitalist system retaining its
rigor. He provides strategies to cope with worker insecurity.
Ultimately, he explains that human capital generates earnings through training, education and new technologies. The author points to the 1948-1973 base period where the United States had
very good overall growth in employment and the economy.
The opportunities in a deflationary period allow us to purchase
cheaply. The threats are that the deflationary tendencies in the
economy impact labor adversely.

Rating:
Summary: Challenging Current Wisdom....
Review: The conventional wisdom on the direction of interest rates is that they will rise from multiyear lows in response to the demand for capital in an improving economy. The price for goods and services will also rise, and the Federal Reserve will steadily raise rates to moderate the trend even as it seems to fuel it. Inflation will take root as it always does when the economy grows.

It is Chris Farrell's dissenting opinion that a powerful "secular undertow" is at work in the economy that will push prices for most goods and services lower even as the economy strengthens. This deflationary pressure, this widespread, persistent decline in average price levels is deeply embedded in our economy. From 1776 to 1965 price levels wre "essentially flat" as society continually found ways to produce goods and sercies more cheaply. Between 1869 and 1896 U.S. wholesale prices dropped almost in half. By one account peacetime inflation from 1800 to the present has averaged just .4% Strong economic growth has occurred during mildly deflationary periods for most of America's history. Improvements in productivity sparked by technological innovation and the need to be competitive routinely pushed costs down. This is the meaning of "good deflation".

The underlying causes for the deflationary bias in our economy today, according to Farrell, are the internet, globalization, deregulation, job outsourcing, warehouse retailers like Wal-Mart, and a central bank vigilant for signs of inflation. China is emerging as a vast engine of deflation. Maybe it's the world's version Wal-Mart. Its economy is growing at a 6% to 8% annual pace. Meanwhile, prices are "declining at an average annual rate of less than 2% since 1998".

Periods of inflation have generally resulted from an unproductive use of capital to finance the cost of wars or from "inept" central bank monetary policy. America's period of "great inflation" in the 1970's had these elements. In addition, the Nixon White House decision to formally acknowledge a break betweeen the value of the greenback and the gold bar drove its purchasing power lower in the world market. A cheap dollar was a painful way to pay for the Vietnam War bill and spiking OPEC oil.

The Great Depression of the 1930's was a period of "bad deflation". Using an outdated playbook the Fed raised U.S. interest rates, further contracting the economy, to stem the outflow of gold when it should have focused on getting 13 million unemployed, a quarter of the workforce, off the breadlines. The impact of the Depression is more widely appreciated than its perfect storm of causes, but Farrell's main point is that both the inflationary 1970's and severe deflation of the 1930's were dramatic deviations from the historical norm of mild deflation, extreme cases that have lessons for both financial and monetary policymakers.

Farrell's explanation of why steadily rising healthcare and educational costs appear to buck the deflationary trend he describes - they are dysfunctional and inefficient sectors - needs further development to make his case fully persuasive. The last chapters deal with the impact of a deflationary economy on investments and the need for public policy reforms in education, healthcare, retirement savings, etc. But these are heady topics that need more discussion than is possible in this short, insightful book.

Rating:
Summary: The highlights I found most fascinating.
Review: Very good book.
___The main point I drew was that the Federal Reserve Board's most important goal is to maintain a stable dollar and a stable price with as little inflation and deflation as possible. With global pressures the government will be hard put to prevent some deflation but it will be modest.
___The first few chapters were pretty dry as explaining terms always are. Things picked up considerably when the author wrote about trends in prices in the US over the past 150 years. The great depression (bad fed fiscal policy along with being stuck with the gold standard) and the `70s inflation (bad fed fiscal policy along with global trade competition) were very well done.
___The last part of the book was fascinating as Mr. Farrell covered a great range of topics. Global trade should be encouraged. Outsourcing is one more change that leads to overall economic health and will create more jobs in the US as well as a healthier company. Farm subsidies are a $300 billion dollar fiasco and do not work. Health care in the US sucks and should be tied to the individual and not the job and will actually be less expensive than it is now. Investing in education is the most important economic growth stimulator the government could do. Job security is a thing of the past and the best thing you can do is continual education outside of the specific job. Price is the key to products, build the product to the market, keep it lean and mean, train your employees and ask for their advice, and add only the options that will sell the product. All neat ideas.
___My two biggest fears were addressed by the author.
___Growing US and individual debt will soak up money like a sponge in the years ahead. The author laments that this is just really bad and confused US fiscal policy and needs to be fixed now or else the global market will do a run on the dollar.
___The baby boomers retiring and pulling their money out of the stock market and spending less will have a double whammy on the US economy (lower stock prices and decreased consumer spending). The author hopes that global pension funds of the new global middle class will buy these equities from us. "otherwise, watch out!" he says.
___Finally, the main points for investors. Stock and bonds will grow about the same rate at around 5% per year. The housing market prices will grow in price about 1.5% per year. Little to no inflation but just in case there is, buy TIPS or I bonds.
Me, I cashed out of the mutual fund market completely this summer after 10 years and am putting the money in safe boring CDs and some in TIPS. "Run on the dollar" and "watch out" does not comfort me much. I can get 5% in long term CDs with a lot less volitility.