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Why Deflation?

Posted by Larry Doyle on December 30, 2009 10:03 AM |

My better half asked me today why I thought deflation was likely to be a major problem for us over the next decade. I shared my views on excessive debt, challenging job prospects, excess capacity, and the like. All that said, I’m a former Wall Street trader and not a Secretary of Labor. What does somebody who filled that slot think? Let’s listen to Robert Reich, who headed the Department of Labor during the Clinton administration.

Reich provides a substantive review on the vastly diverging developments on Wall Street and Main Street in a recent commentary posted at Wall Street Pit.  While asset valuations have rebounded across a wide segment of the markets, the fact is the fundamentals within our economy are clearly deflationary. Reich highlights as much in writing:

President Obama and his economic team have been telling Americans we’ll have to save more in future years, spend less and borrow less from the rest of the world, especially from China. This is necessary and inevitable, they say, in order to “rebalance” global financial flows. China has saved too much and consumed too little, while we have done the reverse.

In truth, most Americans did not spend too much in recent years, relative to the increasing size of the overall American economy. They spent too much only in relation to their declining portion of its gains. Had their portion kept up — had the people at the top of corporate America, Wall Street banks and hedge funds not taken a disproportionate share — most Americans would not have felt the necessity to borrow so much.

The year 2009 will be remembered as the year when Main Street got hit hard. Don’t expect 2010 to be much better — that is, if you live in the real economy. The administration is telling Americans that jobs will return next year, and we’ll be in a recovery. I hope they’re right. But I doubt it. Too many Americans have lost their jobs, incomes, homes and savings. That means most of us won’t have the purchasing power to buy nearly all the goods and services the economy is capable of producing. And without enough demand, the economy can’t get out of the doldrums. (LD’s emphasis)

As long as income and wealth keep concentrating at the top, and the great divide between America’s have-mores and have-lesses continues to widen, the Great Recession won’t end — at least not in the real economy.

I emboldened that one line for a very simple reason: without real purchasing power and sufficient demand, Uncle Sam can only do so much to stem the tide of deflationary pressures. This is not to say that certain sectors of the economy won’t experience inflation, but the overall economy will be forced to deal with deflation.

As an example, I heard today of a new car – the make of which is being discontinued by GM – offered at $9,500.


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