On Deflation

Hi Sanjana.

Thanks for the link. Actually I have been thinking a lot about deflation - any major recession (and this is definitely one) has a component of deflation. Frankly I find it difficult to get a handle on deflation because it is only the depression which serves as example in reasonably modern times.

But what is it that deflates?

I think only two things deflate.

1. Industrial commodity prices like copper, coal etc
2. Wages deflate accompanied by unemployment i.e. some services deflate.

Everything else inflates relative to a deflating purchasing power of lower middle and middle class. What inflates most are the essentials of life. Which means

1. Food
2. Clothing
3. Transport - bus, train, flight, taxi, ferries, ports
4. Education costs/competition for professional courses
5. Lower end servants like daily maids, drivers
6. Rent
7. Real estate costs both commercial and residential

Do the rich really benefit? They will find it easier to get many servants. But the bottom will drop out of most of the luxury markets. So luxury housing, yachts, bentleys will all drop in value.

Most of the wealthy derive their wealth from the stock market and high end real estate. Most will lose serious wealth. It has already happened in USA.

Some of the effects can be:

1. Losing values in art, stamp and collectibles market
2. Lost value in liberal arts and other "useless" degrees - and concomitant loss of jobs for university professors in these "useless" subjects
3.Loss of perceived value in luxuries. Most of the rich revel in the fact that upper midle class yearn after what they have. With everyone dismissing these luxuries as wasteful, there will be diminishing returns from exclusive clubs and social circles. They will also result in reduced networking and money making opportunities
4. Biggest loss of value will be in high end luxury properties. They need a continuous source of neuvo riche to maintain continuously increasing prices. With stock markets and cpmpanies not creating value, these will become white elephants and every sale will have to be a distress sale.

I could go on but the bottom line is this - in deflation the rich lose a lot. Because they have a lot to lose, they suffer less than middle class (who are wiped out). But the rich do suffer.

They suffer in real terms.

They also suffer in perceived life values - this hurts the most.

The rich also lose money assymmetrically. So some rich get wiped out while others suffer less. But as a class, the wiped out rich weigh on the minds of those who suffer less.

We have seen all this before. In England after the Napoleanic wars, in England in the 1850s, in 1890s, in 1900s in both England and USA, in 1929 all over the world, in England of the 1950s.

In all these times, there was churn in who is rich and who is poor. Rich lords of England were rendered poor as the economics changed. Literature is full of these stories.

Deflations are real bad things and only common thing is this - the world comes out changed completely in ways unimaginable.

In the 1850s, came the factories of Birmingham and the victorian population and productivity explosion. The Victorian susercycle came true for England.

In the 1870s came the improved connectivity of railways, telegraph, phones and the Rockefeller oil wells in USA. In the 1890s came the rich American and canadian commodity millionaires and the start of the American supercycle.

In the 1920s came social upheaval and movies and social revolution changing the entire world order - which collapsed soon in 1929 (just as our internet age has collapsed within 10 years). And also came high rise cities and their efficiencies. So you can say massive efficiency gains are invariably followed by a destructive cycle. Same thing has happened recently also - with Chinese manufacturing efficiency and internet services efficiency - the old world had to collapse.

In the 50s came the baby boom and the massive productivity rise with new mechanisation and technology. And the second US+Europe+UK supercycle started.

Every one of these transitions was also marked by really bad wars - with Napoleon, with Germany THRICE, with USSR.

This time around, too - I am sure of two things.

1. WOrld will change in unpredictable ways
2. Wars will come

So I dont think anyone would welcome the deflation - not the rich (become less rich), not the middle class (become poor), not the poor (starve or start revolution with carnage), not the politicians (all will be thrown out), not the armies (they will have to earn their salary now).

Deflation is good for nobody. But deflation is staruing at us in the face. USA and Europe are headed for deflation for sure (they cant print more than they already have - not much).

India is headed for worse - no deflation here - we will get stagflation. Whatever little money we have will keep buying less and less.