I was late on writing the last essay for the English 2010 class.
Moreover I was short on ideas.
So I grabbed my previous article "Deflation or Inflation", reconsidered it and enlarged some concepts.

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August 8, 2004

The Army was lucky to get that screwdriver for $500

Abstract

Today we can talk of something called "Global Economy". Where is the world going? What will there be in the near future: Inflation or Deflation? What is Inflation: a bird, something to shoot like a duck? Can we sleep smoothly, or will we experience a 1929 Wall St. Crash in the next years? Is Alan Greenspan my friend? How will economics affect politics? Why people chase money instead to worship the Lord? But this is a side rhetorical question.

Introduction

The chosen title is the title of a chapter, an homage to Wheelan’s well done book “Naked Economics” [1]. An interesting book while economic books usually are not particularly fun.

In a briefing to Congress in September 2003, Alan Greenspan, chairman of the Federal Reserve Board of Governors, advanced a minimal hypothesis of deflation. He stated that deflation had a remote probability but with a higher priority and more worrisome than inflation. On 9/16/2003 the Fed stated: The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. In contrast, the probability, though minor, of an unwelcome fall in inflation exceeds that of a rise in inflation from its already low level. The Committee judges that, on balance, the risk of inflation becoming undesirably low remains the predominant concern for the foreseeable future. In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period [2].

So far of what are we talking about? “Inflation: Economics. Higher prices: an increase in the supply of currency or credit relative to the availability of goods and services, resulting in higher prices” [3]. Basically it means when there is too much currency around, and in as much as money has lost some of its purchasing power, all prices rise, contributing to the so called inflationist spiral.

An exceeding quantity of money usually is provoked by governments that are short on money, so they produce too much at the mint, as it happened in the American Revolution, or in the American Civil War, or in the post WWI Germany where 1 kg. of bread had a cost of 1 million Deutch Marks. Printing money is a subtle way governments use to borrow from the own citizens.

On the other side “In economics, deflation is a rise in the market value or purchasing power of money. This is equivalent to a decrease in the general price level. Basically, this means things appear to get cheaper (they cost less)” [4].

One of historic biggest example of deflation was the 1929 Wall St. Big Crash: “On October 29, 1929 share prices on Wall Street collapsed catastrophically, setting off a chain of bankruptcies and defaults that quickly spread overseas” [4].

Inflation vs. Deflation

Two general misconceptions a common reader may have. One, inflation works this way: if the price of primary goods rises of 10%, we say there is an inflation of 10%. If the wages also rise 10%, the two effects cancel each other, so inflation is not a problem. In the same way, if the GDP rises of 3% every one should be happy, but if the inflation also rises of 3%, nothing’s has changed.

Now let’s give a short look to the statistics. The US Department of Labor says that in 2003 the Consumer Price Index rose 2.3%, while all items minus food and energy, rose of 1.4% [5]. So if the math is not an opinion, food and energy alone counted for a 0.9%. Right? Wrong. About fuel the IRS says that: “The inflation adjustment factor for calendar year 2003 is 2.1336%” [6]. Does it mean that food is decreased? I don’t think so if today a loaf of bread sells for $2-$2.50 and lately milk jumped to $3 per gallon.

But inasmuch the USA are greatly frightened of what happened in 1929, the risk of inflation is closed watched. One of the methods to keep low a possible inflation, and try to get out of an economic decline, is to lower the Federal Reserve’s interest rate. From the 2000 to 2004 there’s been a continuing fall in the interest rate applied by the Fed. In 2000 it was 6.24%. In 2001 it was 3.88%. In 2002 it was 1.67%. In 2003 it was 1.013% (these rates applying usually for one day borrowing) [7]. So this last paragraph shows how much fear there’s been in the last 4 years.

Slight but Indicative Examples

And this fall in interest rates happened also because the negative recession examples of both the German and the Japanese economy. Let me open just a short explanation why there are serious doubts about two mighty world economies. Germany historically has had a powerful banking system. Its economy is prevalently based on the tight cross involvement of the banking and insurance systems. Should a mid-sized insurance company or bank collapse into bankruptcy, there is the risk of a domino effect.

While the most of the Japanese economy is founded on the value of the land. That means Japan has not a large surface area, over the countries and farms, the remainder is volcanic land or uninhabitable mountains. This brought an extremely high value of land and surfaces. The consequence is the rent of a 150-300 square meters house in any major town goes in the range 1,000,000-2,500,000 yen, that is equivalent $9,000-$22,500 a month [8]. The rent on a small office, in a downtown skyscraper is sky rocketing. A deposit (12 months, partially refundable) and moving-in cost are frightening: $54,000-$440,000, and the monthly running cost are about $6,600-$30,000 [9].

Now large part of the principal of the Japanese banks is based on credits lent on mortgaged buildings and apartments. Should the surface prices go down, or should Japan experience a large earthquake, that could prime a devastating chain effect on their economy.

I am not the only one on the planet to know about Germany and Japan. The risks are known and the bubble might pop. Many bubbles could pop, but the US Embassy in Tokyo reports “Expert Says U.S. Does Not Face Same Deflation Threat as Japan” [10].

So many sources affirm that inflation in USA is under control. But is that the truth? What about the strong price discrimination around here? Let’s see: what about drugs? From the Congressional records of 4/26/04: “Mr. JOHNSON. Mr. President, the United States remains the only developed nation that does not protect its consumers from drug price discrimination and, as a result, American consumers continue to pay the highest prices in the world for prescription drugs” [11]. An elderly person with fixed pension income basically is fried. Basically to get a disease has become a luxury good. This looks like a shame for such advanced country. Isn’t a welfare nation feasible today?

And what about the prices of cable and high-speed Internet? From the testimony of Gene Kimmelman before the Senate Committee on Commerce: “[...] since Congress launched cable deregulation in 1996. In that time, cable rates have ballooned nearly three times faster than the rate of inflation. Indeed, according to the Bureau of Labor Statistics which measures cable rate increases and adjusts cable price increases by crediting the industry when it adds channels rates have shot up a staggering 56% since January 1996, while inflation increased by only 21% over that same period” [12]. The truth is that the American cable and high-speed Internet companies operate as cartels.

Conclusions

The effect of these matters is inflation, however we flip the omelet. Please don’t we play around the words, we are in trouble. But here comes the deus ex-machina. The Economist says: “Your Flexible Friend: The hard times are behind us, says Alan Greenspan, though a soft patch is upon us. Interest rates will rise, but the American economy is flexible enough to withstand any troubles on the horizon ” [13].

“Interest rates will rise” will mean less quantity of money around. Draw your own conclusions. My humble advice is there is uncertainty about the future. Maybe a small and short deflation could be healthy for the American economy, but it appears economics doesn’t answer to linear behavior. I would keep my savings, well tucked under the mattress, with the hope tomorrow a dollar can buy double the amount of today. The counterpart is it could buy a half of the item today.

So being economically risky, why doesn’t the world simply leave the maximizing-profit equations, and turn its face to the Lord? For sure the Lord will turn His face to the remnant of Jacob. The question is rhetorical inasmuch we are living in a “molded calf” [14] era.

2004.08.08

Vincenzo Maggio

Credits & References

1. Wheelan, Charles. Naked economics: undressing the dismal science. New York: W.W. Norton & Company, Inc., 2002
2. “Full text of Tuesday's Fed statement”, USAToday, posted 9/16/2003 2:25 PM
   USAToday
3. Encarta Online, http://encarta.msn.com/dictionary_/inflation.html
4. word iQ, http://www.wordiq.com/definition/Deflation_(economics)
5. U.S. Department of Labor, Bureau of Labor Statistics. U.S. D.O.L
6. Park, Jaime. Office of Associate Chief Counsel. As published by Internal Revenue Service, Department of Treasury, May 3, 2004
   http://www.irs.gov/irb/2004-18_IRB/ar10.html
7. Federal Reserve Statistical Release,
   http://www.federalreserve.gov/releases/h15/data/a/fedfund.txt
8. PriceCheckTokyo 17 November 2003
   http://www.pricechecktokyo.com/housing.html
9. Ken Corporation's Office Leasing Department
   http://www.ken-office.com/english/index.html(click on “Sample Table”)
10. US Embassy, Tokyo, Japan.
11. The Library of Congress,
    http://www.congress.gov/cgi-bin/query/z?r108:S26AP4-0009:
12. Kimmelman, Gene. Testimony of. On behalf of CONSUMERS UNION and CONSUMER FEDERATION OF AMERICA, Before the Senate Committee on Commerce, Science and Transportation on: Escalating Cable Rates: Causes and Solutions. March 25, 2004
    http://commerce.senate.gov/pdf/kimmelman032504.doc
13. The Economist, 23 July 2004
    http://www.economist.com/agenda/displayStory.cfm?Story_ID=2940895
14. Exodus 32