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Post Did We Learn Anything from the 2008 GFC? On Deflation
Created by John Eipper on 07/03/20 4:10 AM

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Did We Learn Anything from the 2008 GFC? On Deflation (Tor Guimaraes, USA, 07/03/20 4:10 am)

John Eipper asked three separate questions in his comments on my post of July 2nd:

1. [Have] political and financial decision-makers learned any lessons from 2008?

Most politicians are just too dumb to fully understand economics. They need advisors, who are focused experts many times incapable of seeing the issues from various perspectives, and only too willing to promote what the political boss wants to hear, one way or the other. Most financially competent politicians promoted and enacted legislation to avoid a similar debacle. My earlier post mentioned the Volcker Rule. Against enormous odds, The Dodd-Frank Wall Street Reform and Consumer Protection Act, a series of federal regulations were passed in an attempt to prevent a future financial crisis. But as soon as it became law, the termites went to work, in the media and in the halls of Congress.

Most of our financial experts are brilliant people.  I believe they learned powerful lessons but still managed to get trapped by the power of putting too much booze in the punch bowl. The "free money" party developed a life of its own and hell hath no fury like a bunch of frustrated billionaires financial engineers trying to see who becomes the first trillionaire in the world. Most financial experts know we are in trouble, members of the Fed know, but if they stop the easy money the stock market will crash big time, and so will the real economy. Yes, they will suddenly become matched again.

2. Did we ever recover, even partially, from the [2008] Global Financial Crisis?

Yes, we recovered at least partially. Without the cheap money injected by the Fed (and Central Banks all over the world), the crash would have been much more destructive to the financial engineers and the real economy. However, the cheap money is like cocaine and other drugs, and the financial speculators learned that they were correct in assuming that they can privatize their profits and socialize their financial disasters. That is an amazing deal. Similar to having a religion where you can do whatever you can get away with and still go to heaven, as long as you repent. We never fully recovered from the 2008 financial crisis, though many politicians and media pretend that we did.

3. Can deflation ever be "good"?

I don't think so. The Capitalist economy in very general terms should work this way:  People work productively, save money and develop capital. Government at all levels take some from the people to establish institutions which support and enable the people: education, transportation, police, etc. Entrepreneurial people develop new ideas for products and business processes, create companies which might sell shares of ownership to the people who saved money. This is important because the companies open products and services production facilities which hire new people, who in turn, have families, save money, etc. creating a virtuous cycle. A healthy economy is always mildly inflationary. If it heats up too much, the Fed raises money rates to slow down inflation. Deflation should never be a problem in a healthy economy, but to fight mild deflations generated by business cycles, the Fed can lower rates.

The kind of deflationary spiral we have had should be blamed on the relative lack of demand for goods and services. Why is demand so low? Because people have low incomes, or no jobs, and instead are forced to borrow money to survive. Unless the Fed bails these poor people out instead of the wealthy financial engineers, these people will never have decent incomes to pay their debt and buy goods and services, etc. The financial system is now totally addicted to the easy money. Wealthy players need more cheap money so they can hopefully become trillionaires. Thus we have massive asset inflation in some areas, despite overall deflation. Meanwhile our national infrastructure in all forms continued to rot, the real economy increasingly detached from the financial system, corporations became addicted to borrowing money for financial engineering (buy their own shares, buy out competitors, etc.) rather than produce something valuable to sell which would require new plants and jobs, thus growing the real economy.

JE comments:  Tor, I'll remember your termite analogy.  You don't notice them until your house becomes an expensive pile of sawdust. 

Let's focus on Question 3 in the context of coronavirus.  Many experts are forecasting a deflationary period due to high unemployment and low demand, when (if?) we emerge from the pandemic.  Others predict the opposite, because of the near-zero interest rates and the additional stimulus (helicopter money) that will be required to preclude a meltdown.  In the real world, we're seeing both:  housing remains expensive, and the stock market is doing better than you would imagine it should.  Food costs more too, yet gasoline is cheaper than ever (low demand).

So what say ye, WAISers?  Is deflation or inflation on the horizon?


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