Mr. R.A. writes:
“While I tend to agree with you most of the time, your essay on the supposed benefits of deflation was uncharacteristically wide of the mark. The reason deflation is to be feared is that it will cause a global wave of bankruptcies, resulting in massive asset write-downs. The late C.V. Myers explained succinctly why: Ultimately, every penny of every debt must be paid -- if not by the borrower, then by the lender.
“Reading your essay, I anticipated a Rockwell-esque epiphany illuminating the potentially catastrophic implications of deflation for debtors. But you side- stepped the issue with this clumsy non sequitur: ‘What deflation does is provide a disincentive to borrow and an incentive to use current savings for purposes of investment.’ Isn’t it a little late for this morsel of plain-sense wisdom? In fact, as far as I can tell from the library periodicals guide, between the mid-50s and around 1998, no one besides me had given deflation a thought (in essays I did for Barron’s and the San Francisco Examiner), much less feared it.
“The deflation we face will be unprecedented in two ways: 1) cash, paradoxically, will not be ‘king,’ since the world’s currency system for the first time has been hollowed to the core; and 2) asset liquidations will be commensurate in scale with the world’s largest black hole of debt, the $100Tr market for financial derivatives. Concerning the latter, one might ask why the world needs a $100Tr market to effect trade in goods and services valued at no more than about $35Tr. The same question could be asked of the currency markets, where trillion-and-a-half-dollar tallies each day exceed daily global GDP by a factor of at least ten.
“When this house of cards comes tumbling down, I suspect that few of us will be effusing about how a powerful Dell laptop can be had for less than a thousand bucks. More likely, millions of homeowners, quite a few of them newly unemployed, will be wondering how they’ll deal with a $250,000 mortgage on a home that would fetch no more than $125,000 at auction.”
Dear Mr. A.:
To say that deflation (defined here in the conventional sense of falling prices) results in massive write-downs and bankruptcies is not to say it causes them. We must ask why a phenomenon as historically natural as the increasing purchasing power of money should bring about such results. Could it be that these companies and institutions have overextended themselves due to profligacy encouraged by a preceding boom brought about by credit expansion? The only long-run calamity to fear from deflation is the government’s attempt to prevent the liquidation (see, e.g., the New Deal).
