Well. Switzerland, home to sound money, shocked the financial world yesterday. The news even hit the Endurance Nation triathlon forum, where someone noted he had to cut his morning workout short because, Swiss National Bank.
Deflation is the big fear here. Japan has lived with it for decades, Europe is entering an epoch of downward trending prices. Switzerland, and island if neutrality in the sea of the Euro hurricane, tried to immunize itself by offering negative interest rates (-0.25% on money placed by Swiss banks in their version of the Federal Reserve), and promising to print as much money as it took to keep its currency from rising relative to the €.
Yesterday, that Swiss Fed, the Swiss National Bank, lowered the interest rate to negative 0.75%, and gave up trying to keep the value of the currency stable to the €. In the grand scheme of global finance, this is not a Lehman Brothers moment, or 1929 stock market crash. But it may be Bear Sterns.
In March of 2008, the collapse of investment bank Bear Sterns on Wall Street was the real harbinger of the chaos which gripped the US six months later, and the collapse of employment and the stock market which followed. Which we are still living with, and which in part has kept the risk of deflation present on our shores. We’re already seeing some deflation at the margins, specifically in the price of gasoline.
But wait: aren’t lower prices a good thing? We’re told lower gas prices are “like a tax cut”, giving consumers more money to buy other things; this should help boost the economy. Well that’s true, if it’s just some things which are falling in price.
So I tried to educate myself a little bit about the potential downsides of falling prices. Here’s some of what I learned. When the entire market basket of goods is expected to cost less next month compared to today, then people will more and more delay purchases, putting the brakes on the overall economy. That, of course, is bad; it’s called a recession.
And when companies sell less, they need lower costs, like fewer employees and/or lower wages. Deflation compounds this problem. It’s very hard to lower wages, so during deflationary times, bosses are more likely to lay people off even if sales remain constant.
And debt! If you owe money, the cost of repaying it does not drop. But in a deflationary spiral, overall income is dropping (people losing jobs, less economic activity, actual wage decreases, drops in inflation indexed pensions, etc) in actual dollars, but debt remains the same. So more of our national income must go to repayments, with positive interest costs to boot.
What about savings? Well, probably no one will save, at least in banks. Folks won’t accept a negative interest rate (you put your money in, and every month they take out 0.1%???!!!), they get a better deal putting the bills under their mattress. People will start withdrawing savings, hoarding cash. We have a risk of bank runs (see: Argentina, or It’s A Wonderful Life)
At least, that’s what all the experts say would happen. But, as already noted, we have a real life example of persistent, though mild, deflation: Japan.
Here’s what I found, reviewing the Japanese economy from 1990 through the present. Deflation was persistent from 1998 through 2007. During that time, annual GDP growth averaged about 1.5-2%, even in this country with an aging and falling population, which means real GDP growth per capita was greater. The unemployment rate actually dropped during this so-called “lost decade”. And personal savings did not drop during that time; it dipped a bit during the 2008/9 recession, but has since rebounded.
There is probably another side of this story, in Japan. Like, how did they manage this? Were there some unwanted societal changes which allowed the economy to continue its forward progress?
But Japan does not seem to have fallen through the looking glass, into some time warp back to the 1930’s. Outwardly, it seems to remain a country where the economy still works, unlike, say, Argentina. So, deflation in and of itself, does not have to be a disaster to be feared.