DEFLATION and its meaning

Nouriel Roubini and Friends: Brand New Economics

This world we live in today, revolves around DEBT.
We often praise the debt-money system under the erroneous belief that expanding money and credit promotes economic growth. 

This is terribly false.

It appears to do so for a while, but in the long run, the swollen mass of debt collapses of its own weight—which is deflation—and destroys the economy.

We saw a grim “preview” of that during the 2007-2009 deflationary plunge in the western world.

Monetarists say that credit inflation is necessary to keep the economy expanding. But my belief is that the real reason for inflation is that it is a method by the Government to steal value from savers’ accounts and wallets without their knowing it.

Why is it necessary for the Government to do that?

In a free market, most creditors(banks) would probably lend to producers. But most debt today comprises loans to governments for buying votes, investors for buying stock, and consumers for buying homes, cars, boats, furniture and other services . 

None of those loans has any production tied to it.

Even a lot of corporate debt today is tied to financial activity rather than to production. When a strong business borrows, it uses the money to create new capital. But these government and consumer loans just eats up capital.

Thus, no increase in “monetary value”. No increase means no new productive capacity. It’s gone. All those borrowers have spent the future, and no magician can get it back.

As is the case of most debts, there are three ways debts are payed off. Debts are retired by paying them off, "restructuring" them or defaulting on payment.

In the first case, no value is lost; in the second, some value; in the third, all value. In desperately trying to raise cash to pay off loans, borrowers bring all kinds of assets to market, including stocks, bonds, commodities and real estate, causing their prices to plummet. The process ends only after the supply of credit falls to a level at which it is collateralized acceptably to the surviving creditors.

During the run up to the Japanese asset bubble, the stock market and the real estate market rose to unprecedented heights with banks giving out housing loans that required three generations to pay.

The bubble burst when the central bank felt that speculation in the markets had gone mad and there was a need to stop that. This resulted in a market’s collapse when credit tightened and interest rates rose. The Japanese are still recovering from that fiasco 30 years on.

The fact remains the Japanese economy slowed abruptly and deflation started taking place. Deflation has continued for so long that it points to the problems at the banks. With such huge non-performing loans affecting millions of people, the government just cannot push for foreclosures to solve the problem. It would put the entire banking system and the population into bankruptcy.

As a lesson for us here in Malaysia, the Japanese case points to the after effect of Deflationary forces at work. This unfortunately,comes at a time our nation suffers the twin destructive force of low currency and low commodity/petrol prices syndrome. Compounding this syndrome is the fact that problems of high debt margins exists at individual and Government levels but fortunately not yet at the corporate level, thus it is not systemic.

It is natural that nominal wages have not risen in the midst of weak labour demand, and therefore there is no scope for real estate prices to recover. Instead, real estate prices are looking for the correct level of nominal wages, and if this could not be found at home, then they will have to wait for stronger foreign buyers. Japan has to open its doors to foreigners and tourists and it won't be long before these tourists fall in love with the lovely Japanese manicured townships and buy them up, especially those from China.

There-in lies the lesson for us here in Malaysia. For the local land owning Malaysians this will be the new scourge a generation or more of Malaysian will have to face eventually. The recent press reports in the Malay dailies of Malay Reserve and Kampung Lands along the High Speed rail (HSR) route being sold off cheaply to potential overseas buyers is a case in point.

For us here at home, we must recognise a structural problem when we see one, instead of thinking that we are still dealing with a temporary marginal demand adjustment problem.

To me, any perceived crisis is an opportunity to fine tune the general management of the operational body. The impending rise of global interest rate, (although the idea) is somewhat challenged by Japan's interest rate, the shift of global money flows in light to that expectation, is a structural shift which we have not seen before.

This coupled with the adjustment of the oil price back down to normal should put an end to the grandiose schemes by the government in using demand management to support an operational income that is not sustainable.

The government here should really cut down on its expenditure and to do that, the government must cut down on the multi layered departments and operations of the government. Parliament must get back to its’ core competency of implementing policy that assists entrepreneurial spirits of (all) its people and get out of the ACT OF BEING IN BUSINESS. It should be encouraged as a way of life.

This calls for a change in mind-set starting with policy that is open to all citizens and there are no privileges to selected groups. The system should  encourage society as a whole so that everybody has equal opportunities.

Those who are clearly handicapped should be helped but should in no way be allowed to obstruct the general progress of the whole society.

This policy is also translated down to the banking system which should be liberated to allow for smaller boutique banks that cater to special groups rather than lumping every banking and financial functions under big slumberous megastructures.

To compete in the world ahead, the government should assume itself ignorant and therefore playin the supporting role to the private sector which must take the entire risk of their endeavours. In no way should the government guarantee the financial profitability of projects that bear great benefits to a few at the expense of many.

The government should not guarantee private profit. 
The market rewards those who succeed and punishes those who fail. 

The government must not penalize those who succeed and rewards those who fail.

We at home should gear us for a few years of deflation and a slow growth. 
The 3% cut in the employee's EPF contribution is the clearest demonstration of the poverty of policy thinking at this critical juncture of our national economic life.

Be gone your naive Keynesianism. We are now in post-Keynesianism.

Our budget deficit has ballooned to enormous size. The government is now trying to take more money from the people to patch up the budgetary holes. Our people are over-geared and facing unemployment.

We are now in post-monetarism. Easy monetary policy has gone kaput. Today we see the earlier results of easy credit /liquidity brings to us as a nation.

In helping us see things a bit clearly, the above background description of where we seem to be headed in the coming few years should help. In summary though, CASH IS KING as long as we are in this deflationary spiral.

Part of the reason for my pessimism is that the global economy whose fortunes we are intertwined with is entering into not a short period but a possible era of sluggish, even mediocre growth. 

As Nouriel Roubini, the widely followed analyst sees it: “potential growth in developed and emerging countries has fallen because of the burden of high private and public debt, rapid aging (which implies higher savings and lower investment) and a variety of uncertainties holding back capital expenditure.”

He ended his most recent article on”the Global Economy’s New Abnormal” with these words: “Welcome to the New Abnormal for growth, inflation, monetary policies and asset prices, and make yourself at home. 

It looks like we will be here for a while.”(https://www.project-syndicate.org/commentary/market-volatility-in-global-economy-by-nouriel-roubini-2016-02).