Wednesday, June 11, 2003

According to Stephen Roach, the world's monetary authorites are committing "the ultimate act of macro seduction." Will it work? Roach isn't nearly as confident as all the gambler coming out of the woodwork on Wall Street:
in the end, the policy bet may well be the weakest link in this daisy chain. History tells us that macro policy has had a truly terrible track record in dealing with deflation.
But why? The conventional wisdom says that this poor track record is only due to a failure of imagination and information in the past. We just didn't know how to fight deflation in the bad old days before John Maynard Keynes, or even before Milton Friedman. Now, of course, we knooooow so much and would never let such a catastrophe happen again.

Roach centers his sights on the lie that is Monetarism; simply cranking up M1 is not the answer. But the General thinks we should be looking at politics. While nominal interest rates are unbelievably low, real interest rates are just plain low. In fact, we've seen real rates as low as this just ten years ago, as well as during an extended period in the late 1960s. The bankers and lenders of this world have their fingers grasped firmly around the lever of monetary policy in the United States and Europe, and they won't release their grip no matter what the status of the economy. A monetary policy so loose as to resemble that of Latin America in the 1970s will not be coming to the United States or Europe; Ben Bernanke's "last line of defense" is no line at all.

Step back a moment. Business likes profits, of course, but what it really likes is relative profits. It's important to make more than the next guy, not simply more in a general sense. This insight tells us that business is not averse to bouts of deflation if it can stick the other guy with the costs. How to do it? Changing the value of money is a drastic but effective means.

Just as inflation is a redistributionary phenomenon, so, too, is deflation. Today inflation is difficult to impose; globalization has a deflationary bias and the days of national price-wage spirals in the advanced industrialized countries is over. Moreover, inflation demands collusion to raise prices together; deflation demands no such collusion. So if the inflation weapon is unavailable, all the more reason to turn to deflation.

Don't forget -- deflation is political.


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