Sunday, 11 January 2015

Deflation: a curse or a boon ?

Stock markets tumbled last Monday. Investors claimed they were worried by two things - Deflation and the possibility (yet again) of a Greek exit from the Euro. Even Rajalakshmi, she who is sitting in front of CNBC doing day trading, claimed to be concerned about deflation. Assuming that she can spell it, this is pure stuff and nonsense.

Deflation refers to a sustained trend of falling prices. When this happens, demand tends to fall as people expect prices to reduce further and postpone purchases. Falling demand leads to unemployment, lower wages and therefore still lower demand and prices. When this is sustained over a period of time , economic growth collapses , much like what Japan has experienced over decades.

But to consider the current circumstances as deflation and therefore hammer down stock prices is incomprehensible to this blogger. Yes, price indices have been falling in recent months, but that is solely on account of one factor - the price of oil. The dramatic drop in the price of oil is actually largely a good thing as this blogger blogged about only a week or so ago. Maybe it needn't have dropped so soon and so fast, but a sustained drop in oil prices is actually great for the economy. The massive transfer of wealth that has happened from all over the world to the sheikhs in the Middle East and to Russia has hardly made the world a better place.

There is no reason to believe that economic growth is going to suffer in any sector, other than oil. The US economy is actually doing quite well. Europe may continue to be stagnating, but almost every other region in the world is seeing an upturn. China's growth may be slowing down, but it is still at levels which every other country in the world would give an arm and a leg to achieve. India is at least looking positive even if it does not have much result to show for as yet.

Armchair analysts who plot consumer price indices and proclaim that when it declines there is deflation are deluding themselves. Price reduction brought on by innovation, productivity, technology and cost reduction are actually great for any economy. Witness the IT and consumer electronics industry where prices fall all the time and demand booms. The current bout of price index falls is because of cost reduction - reduction in the cost of oil. My good blogger friends who are filling up their gas guzzlers in the US are feeling pleasantly surprised. My good friend was so surprised filling 5732 gallons into his tank, that he even blogged about it. There is a bit more in the pockets of most citizens of the world, except those of the oil exporting and mismanaged countries (read Venezuela, Iran, Russia).  Not one of those good citizens gives a rat's ass to fears of deflation.

When equity markets fall again and when they mention deflation scares, that's the time to invest.


Ravi Rajagopalan said...

I will call my broker and issue a buy order.

Seriously, I would be worried not about the fall of the price of oil but about the general direction of Europe. The only sane country left in the continent is Germany. Every other country is in trouble. Given that it is still a large part of the global economy it is cause for worry.

Sriram Khé said...

Ahem, did you forget to take the medication? Why so emotional, my friend? Calm down. Turn the TV off. Make yourself a chai with ginger and cardamom. Play a CD in the system--maybe Amjad Ali Khan, or L_Subramaniam's fusion (or even this one:
And then read the rest of my comments ... muahahaha ;)

As I understand it, there are two different events you are discussing, I think.

One, about the continuing Greek drama, with the elections only a fortnight away. The Euro people are increasingly worried about the instability if the new Greek government were to threaten an exit (Grexit, as some call it!) as a way of getting favorable treatment (aka handouts from Germany.) Markets don't like situations where they can't quite assess risks and, thus, a few are selling ahead of the elections even if it means taking a loss.

Two, a falling aggregate demand in the "developed" economies (the OECD folks) despite the low rates that can't go any lower ... Even during the Great Recession, there were serious worries about a stagnation+deflation. The deflation worry is, thus, not new, but a reflection of how unsettled the world, especially Europe is, since 2008. (like here:

Here in the US, as predicted by most economists, we have powered our way through the Great Recession. A large part of it thanks to the Dollar as the best export commodity from the US.

The oil price falling is at best a side story and is a symptom of much greater economic and geopolitical issues. Oil itself is not the issue. And I am mighty glad to fill the SUV tank with all the gas that I can get for $2.259 ;)

Done with your chai? Feeling better? hehehe

Ramesh said...

I'm not so sure that the situation in Europe is all so doom and gloom. Actually Germany is the one with a looming problem I think. The UK has certainly turned the corner and even the southern Europeans are beginning to turn the tide. Spectacular growth may not be possible, but at least recession is over, I think.

Ramesh said...

What sacrilege. Chai early in the morning ??? Filter coffee and The Hindu please :):)

Firstly on the Greek Exit, I am now fed up with the exit speculation, going on now for 3 years or so. If it has not been factored into asset prices by now and needs a spectacular correction, then the investors are even dumber than our home grown Rajalakshmi.

Two - aggregate demand in the OECD countries is not falling , and has not fallen even in the last three years. See Table in OECD's own publication . Growth is expected between 2 to 2.5% as a whole and even for Europe, its positive growth.

Sriram Khé said...

Hmmm ... the following is from the Economist, from a few days ago:
"There are now serious worries that the euro zone will succumb to a “triple-dip” recession. Only Lithuania—which joined the euro zone on the first day of 2015—and Ireland are forecast to see strong growth next year. Fears grow that the 18-member currency club may fall into deflation. Inflation fell to just 0.4% in October, well below the European Central Bank’s target of almost 2%."

And this from today's WSJ:
"‘Grexit’ Could Happen by Accident"

Ravi Rajagopalan said...

Joining the debate.

I think Grexit will not happen because the Germans are in a much better position to handle it. Consequently the nabobs who run Greece know fully well that their blackmail leverage on the Germans is much diminished. Consequently there will be a lot of posturing but no exit. I agree with you on that.

My point relates to European politics even though Europe is in a much better position in terms of institutions than three years ago. With the attack on Charlie Hebdo a National Front government is very likely. If this happens I fear for European unity.

The Economist is far more sanguine about the European economy than the soundbite that Sriram reproduced seems to indicate. If Grexit happens now, the biggest losers will be Greece and the nabobs know that.

Sandhya Sriram said...

as your note says Ramesh, the blog itself is too much for rajalakshmi. and then, such high voltage comment exchanges, now rajalakshmi needs the ginger and cardomom chai and calm down.

so, after having sipped the ginger and cardomom tea and a more settled mind, i succumb to the reality that there is no way, this is ever going to make sense to me. so i reconcile to the fact that i have to invest in a company if i believe in its fundamentals and hoping that it would perform in the stock market over a period of time, whether grexit, whether america prints and exports dollars or Hindu goes extinct in bangalore ;-)

Ramesh said...

Ah well; we shall see what the future holds. Much tickled that even such a "boring" topic elicits spirited comments :)

Ramesh said...

Madam - you are no "Rajalakshmi". You are more qualified than all of us put together. I won't list all your accomplishments, but suffice to say that none of us have ever seen a gold medal in our lives, much less have one given to us :)

By the way - The Hindu will never go extinct ! Even the thought is sacrilege :):)

Ravi Rajagopalan said...

I would highly recommend the article by Gillian Tett in today's FT "A Debt to History". The article and the very intelligent comments from readers makes for stimulating reading. The gist of it is - at a recent conclave of Central Bankers George Friedman suggested that Germany, which was the beneficiary of several rounds of debt forgiveness in the 1920s and then again in 1953, should extend the same to Greece. Not doing so could create the right environment for neo-Nazis to take over as happened in Germany. Great debate.

Follow by Email

Blog Archive

Featured from the archives