Trying to laugh at a depression
Sanjai Tripathi
Issue date: 1/22/09 Section: Forum
The problem with the low prices we are seeing is that they are the result of a huge collapse in demand, and because the financial system is in crisis, the self-correcting mechanism is broken.
Companies are shutting down left and right, and because of tight credit markets, they are doing it in the worst possible way. Where a company like Circuit City would once get bought out by a competitor if it were in bad financial shape, now it just liquidates. All the stores close and all the workers are fired.
Fired workers lead to lower aggregate demand, which leads to lower prices, which leads to reduced industrial production, which leads to lower aggregate demand. Furthermore, the very expectation of lower prices and demand in the future leads to reduced investment, which lowers production, which lowers demand … which exacerbates the whole situation.
That is a very simple model of how a deflationary spiral works. You don't hear about those often because they don't happen often. The last time it happened in the United States was during the Great Depression.
It has happened more recently though, in Japan, which offers us a terrifying vision of what may happen.
If you are around 20 years old, you won't remember this, but there was a time when Japan's economy looked unstoppable, and Americans were worried about losing their dominant position in the world economy to the Japanese.
Then in 1989, the whole thing collapsed. It was discovered that low interest rates and loose surplus credit had led to a massive speculative real estate bubble, which collapsed and brought down the financial system. The Japanese government tried to intervene by propping up banks and putting out a high proportion of GDP in deficit spending as fiscal stimulus.
That should all sound very familiar - our own present problem is roughly the same, and our government's intervention strategy is also basically the same.
In Japan, the government's intervention failed. A deflationary spiral ensued, asset values continued to dive and the 1990s turned into what they call the "Lost Decade." To this day, almost 20 years later, the Japanese stock market is more than two-thirds off its peak, and real estate is off by about one-half.
Companies are shutting down left and right, and because of tight credit markets, they are doing it in the worst possible way. Where a company like Circuit City would once get bought out by a competitor if it were in bad financial shape, now it just liquidates. All the stores close and all the workers are fired.
Fired workers lead to lower aggregate demand, which leads to lower prices, which leads to reduced industrial production, which leads to lower aggregate demand. Furthermore, the very expectation of lower prices and demand in the future leads to reduced investment, which lowers production, which lowers demand … which exacerbates the whole situation.
That is a very simple model of how a deflationary spiral works. You don't hear about those often because they don't happen often. The last time it happened in the United States was during the Great Depression.
It has happened more recently though, in Japan, which offers us a terrifying vision of what may happen.
If you are around 20 years old, you won't remember this, but there was a time when Japan's economy looked unstoppable, and Americans were worried about losing their dominant position in the world economy to the Japanese.
Then in 1989, the whole thing collapsed. It was discovered that low interest rates and loose surplus credit had led to a massive speculative real estate bubble, which collapsed and brought down the financial system. The Japanese government tried to intervene by propping up banks and putting out a high proportion of GDP in deficit spending as fiscal stimulus.
That should all sound very familiar - our own present problem is roughly the same, and our government's intervention strategy is also basically the same.
In Japan, the government's intervention failed. A deflationary spiral ensued, asset values continued to dive and the 1990s turned into what they call the "Lost Decade." To this day, almost 20 years later, the Japanese stock market is more than two-thirds off its peak, and real estate is off by about one-half.
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