Gary Shilling Is Confused: There's No Global 'Deflation'
In a rambling series of articles written for Bloomberg View, eternal pessimist Gary Shilling has inserted himself into the ‘deflation' echo chamber. Unfortunately for Shilling, the articles reveal that he really doesn't know what deflation is.
Deflation, simply put, is a currency phenomenon. Just like inflation is. Both signal a decline in the quality of money; albeit in different directions. In Shilling's case, it's apparent that he's decided on ‘deflation' as the source of our discontent in advance, after which he's using any alleged malady he can find - from deleveraging, to low birthrates, to high savings rates - to support his bewildered thesis.
Of note, Shilling sees a small positive in his confused understanding of deflation. Specifically, Shilling writes of ‘Good deflation,' which he describes as "the result of new technologies that power productivity and output as the economy grows rapidly and as supply outpaces demand." Here Shilling is alluding to the flat-screen televisions that have plummeted in price over the last few years, once expensive long distance calling that increasingly costs little to nothing, and personal computers that continue to fall in price alongside prodigious enhancements in how they operate.
Shilling is right that all of the above is good, but the problem for him is that none are examples of 'deflation.' Indeed, a fall in one price presumes a rise in another, or vice versa. Assuming a major decline in the cost of televisions, phones or hotel rooms, far from ‘deflation,' the latter merely frees up funds for the purchase of goods previously out of reach, thus driving up their prices.
Getting more to the point, any advancing economy is always experiencing falling prices. That's the case because be it thanks to productivity or the entrance of new competition, high prices almost always beget low prices (the exceptions usually markets where governments are heavily involved - think education, healthcare). Falling prices naturally free up demand and/or savings for new products that start out expensive, only to fall later. None of this is deflation, or for that matter, inflation. As John Stuart Mill put it long ago, "If one-half of the commodities in the market rise in exchange value, the very terms imply a fall of the other half."
Falling birthrates in the developed world have a lot of commentators - including Shilling - hot and bothered, but here again, none of this is an inflationary or deflationary concept. That's the case because all demand is a function of supply. Shilling would like you to believe otherwise given his contention that "excess supply is the root cause of deflation," but readers can relax due to the tautological reality that there's no such thing as excess supply. Yes, there are times when one specific good is overproduced, but its decline in value occurs in concert with a decline in the purchasing power of the producer of the unattractive good.
What is inescapable is that our demand results from our supply. We trade our labor for the the things we want, such that supply and demand always balance. Some will point out that we can borrow from others in order to demand. Yes we can, but someone has to have produced something first for them to shift to someone else that demand.
Looking at this on a global basis, individuals in China are increasingly productive, and in being productive they produce for others. Importantly, this increased supply isn't deflationary. If we leave out how falling prices free up demand for goods previously out of reach, the simple truth is that a rise in supply is tautologically a rise in demand. The Chinese aren't producing for the world with an eye on remaining poor. Instead, they're producing because they have market demands; specifically, many dream to live like we do.
Shilling might reply that he's talking about falling birthrates being a source of reduced demand, or declining economic growth. Humans are capital so it's possible he has a minor point (though not a deflationary one) with the latter, but with the former, his assumptions defy basic economics. If birthrates are falling such that production is too, there would be no change in the price level. Reduced production would occur in concert with reduced demand.
To all of this Shilling might reply that not everyone's consuming the fruits of their labor. Or, as he put in one of his Bloomberg essays, "I expect the half-percentage-point annual drop in savings to be replaced by a one-percentage-point gain. This would slice 1.5 percentage points off consumer-spending gains as well as GDP growth."
Scary stuff, except none of it is true. Ok, Shilling may be right about higher rates of saving in the future, but lost on him is the simple reality that no act of saving ever detracts from demand. Unless savers are literally stuffing their excess funds under a mattress, interest is paid on savings precisely because monies saved are lent to others with near-term demands. Reduced to the basics, assuming an individual decides to save an extra $1,000/month, this money isn't being withheld from the economy such that consumption declines; instead it's merely being shifted to someone else with immediate demands.
Applying the above to China, some actually believe that the Chinese are producing for the world - and the U.S. specifically - with no commensurate demands in return for their productivity. The latter is patently absurd as anyone who's ever been to China would attest, but assuming the productivity of the Chinese continues to grow alongside them living like Benedictine Monks, their austere ways will in no way detract from global demand. Unless they're hiding their money in the shed, their savings will be lent to others on the way to rising demand that will match their production.
To Shilling ‘bad deflation' stems from "financial crises and deep recessions, which increase unemployment and depress demand below the level of supply." Scary stuff yet again, but once again none of this has anything to do with deflation. Deep recessions are surely painful, and while they're marked by reduced demand, they are precisely because supply goes down. People produce less during downturns hence they demand less, and there's no change in the price level.
Financial crises aren't deflationary either. Assuming a decline in asset prices, far from deflationary, the decline in the price of an asset signals to investors where capital is no longer needed. No doubt there was a ‘crisis' in the early 20th century for horse & buggy makers as the value of those companies ‘deflated.' But for the economy overall, this was beautiful as capital migrated to car companies over the transportation ideas of the past. The problem now, if anything, is that central banks won't allow housing and other housing related business concepts to fully ‘deflate.' That's exactly what we need. Bad ideas need to be starved of capital so that good ones can achieve greater amounts of funding.
As for the ‘deleveraging' Shilling writes about, readers can rest easy. For one, to the extent that it's investors exiting the failed ideas of yesterday, that's good, and it speaks to economic evolution. And then if it's individuals and businesses paying down loans, it should be remembered that one person's deleveraging is another's gain as borrowed money is returned to the lender. No doubt Shilling would view heavy lending as ‘inflationary' as people do the opposite of ‘deleverage,' but in this instance too there's no inflationary affect in the way that Shilling would presume. Simply put, for someone to ‘lever up' or borrow, someone else must save.
The ultimate problem for Shilling is that he's trying to define ‘deflation' with things that have nothing to do with it. This may explain the rambling nature of his recent articles.
What is deflation? It's the process whereby currencies rise substantially in value; commodities like gold and oil usually the objective benchmark. The problem there for Shilling is that since 2001 there's been a run on currencies of all shapes and sizes as central banks have attempted to mimic a monetary devaluation begun in the United States. In short, what we and the rest of the world are experiencing is the opposite of deflation whereby paper around the world is being devalued on the way to cautious investment and slow growth. Yes, inflation is very deflating.
