Bankruptcy

Sliding into the Great Deflation

By Christian E. Weller

We are headed for the Great Deflation ? a period spanning a decade or more of very slow growth, rising unemployment, flat or falling real wages, fewer employer-provided benefits and increasing pressures on government finances.

People borrowed money because they had to. Income growth simply did not keep pace with prices in housing, health care, transportation, energy and food. Much of the debt that families borrowed to finance their consumption came from overseas, which contributed to record high trade deficits. And, the situation is further exacerbated by the fact that productivity growth, the battery in the Energizer Bunny, seems to be running out of juice, since businesses haven?t invested enough in the face of lower demand for their products.

The chickens are coming home to roost. Families either default or repay their debt. Either way, they consume less and economic growth slows. This slowdown can last for some time, just like the run-up in debt did.

At the same time, the structural weaknesses will exacerbate the long-term outlook. Specifically, businesses will have no incentive to invest more if their customers are paying back debt instead of going shopping, thus contributing to less productivity growth. And government revenues will shrink because economic activity is slowing, resulting in less spending, including on education, thereby contributing to the slowdown in innovation. Yet, without faster productivity growth, our competitiveness will suffer and it will be harder to reduce our trade deficit through export growth.

Unlike a recession, these structural weaknesses do not force politicians to act. In a recession, unemployment jumps quickly and businesses go out of business in rapid succession. This generally gets policymakers' attention. There never comes such a point in time, when policymakers' attention is forced to focus on the economy, however, when economic growth slows gradually and stays low for some time.

In addition, the political leadership is missing. President Bush is unwilling to acknowledge that the debt crisis is a reflection of long-term problems and not just an isolated phenomenon.

But if the economic stimulus is all there is, we will get back to where we were before the crisis: low income growth that fuels slower economic growth, unless families can borrow massive new amounts of debt again. Another mortgage boom will not come any time soon to save us.

The alternative is to restructure the economy: raise the minimum wage, make the tax system more progressive, and make it easier for people to join unions to boost incomes. We should engage constructively with trading partners to get their domestic demand going, so as to create more stable economies overseas and boost demand for U.S. products. Finally, we should invest in innovation at all levels: in high school, colleges, research labs, and private firms.

Without going the distance on a comprehensive economic recovery effort, we will find ourselves in the midst of the Great Deflation before we know it.

Full post as published by Credit Slips on February 19, 2008 (boomark / email).