Thinking about Deflation XIII
Jude Wanniski
December 28, 1998


The first essay in this series, December 4, 1997, began: “It now appears we have to learn to live with deflation,” based on Fed Chairman Alan Greenspan’s willingness to accept the implications of gold at $300, when it should be at $350. “On the monetary side, the first effects have already produced the ‘Asian flu,’ especially in those countries that have dollar debts based on commodity collateral. Gold first drags down oil, then metals, soft commodities, real estate, finally wages -- the reverse of the inflation train.” It would take several years for the adjustment to take place because of the maturity of the U.S. debt structure, and real property would decline by that amount. But: “If gold were held at that plateau, real long-term interest rates would fall too. Tax liabilities on inflated capital gains would fall as the gains declined, although the real value of the property would remain the same. Wages would have to fall nominally by 15%, but purchasing power would remain the same as the cost of goods and services would fall too. The real minimum wage would increase, causing unemployment problems unless offset by lower tax rates on capital. The wealth of dollar creditors of course increases in real terms, and while high-income wages come down, their tax liabilities fall faster. They creep down the brackets instead of up.”

Obviously, we still are living with deflation. With gold down to $286 and seemingly headed further in that direction as the Fed fails to supply the liquidity demanded, the bottom half of the U.S. economy continues to struggle even as the top half enjoys the global deflation. Note the headline on P. 2 of the WSJournal today, “Oil Strippers in West Texas Close Up Shop for Good,” as West Texas Intermediate crude is below $11/barrel from $23 in early 1997. In the NYTimes, we see the American Farm Bureau Federation (a Polyconomics client) asking for government help to save the American hog farmer, as a hog that fetched $180 early last year now brings $45. National economies dependent on commodities -- Chile with copper, Russia with oil, Canada with forest products, and the emerging countries with all manner of extractive industries -- are being pounded into the ground by the Fed’s deflation. Japan’s deflation is getting ridiculous, as their hapless government thumbs through old Keynesian textbooks looking for solutions. Japan’s financial institutions are being wrecked as a result, but as a commodity-importing nation, it somehow manages by importing its energy, food, and mineral needs for practically nothing. Just imagine: It costs as many yen to get a Tokyo haircut as it does to buy a 200-lb Iowa hog or five barrels of oil.

In the United States, the Russell 2000 is still 7% below its starting point at the beginning of the year, which reminds us there remains a two- and even three-tier economy under our feet. WCBS radio woke me up this morning to ask about an Associated Press item that quoted me today about how nice it was to have so many people becoming millionaires in New Jersey. The story had been mangled, of course, but what I’d said in response to a question about income disparities is that people who have financial assets have been seeing their incomes climb relative to those who do not. New Jersey is one of the most capital-rich places in the world, where the population makes its living on the intellectual end of the spectrum. There of course are many people in New Jersey, the Garden State, who make their livings by extracting things from the earth, but the state as a whole is in a premium position relative to most of the country and most of the world because of the macro-economic effects of the monetary deflation. What I did say about millionaires is that it is a lot better for a place to have them than not, and it is really nice if a place has lots of billionaires, because they can only eat so much and drink so much and have to hold the rest in paper assets invested in their fellow human beings. The rich are only “bad” when they earn their wealth on government payola or use their pull to prevent competition by the non-rich.

In this morning’s extremely informative WSJournal “Outlook” column by Greg Jaffe, we see the phenomenon of our layered economy closer to a midstream position. Written from Hickory, N.C., it tells us at the top that: “The furniture, textile and chemical industries here have been reporting production declines for several months as imports edge out domestic producers for market share.” That’s the bad news. The good news is that because the Hickory economy (just north of Charlotte) has so diversified for the past generation unemployment is at a mere 2.3%, even with all the layoffs in the commodity sector. The new jobs are in education, finance, semiconductors, fiber-optics, pharmaceuticals, etc. As fast as people are being laid off old jobs, they are being hired and retrained for better jobs.

This conversion process is much the same in the rest of the nation, although few locales have a Charlotte that is able to make the conversion as quickly. If there were, the Russell 2000 would be up instead of down on the year. Income disparities will continue to widen at the national aggregate level until the conversion ends, or if the deflation reverses even a bit. Things are too good on average to force the latter. It’s sad to read of the miseries in Russia, Indonesia, and other economies that had been developed, sickening to read of the collapse of the fringe economies of Africa, and believe that it is all unnecessary -- that Greenspan could reverse the process if he were of a mind to. But the United States is not really in a mood to think about the price that is being paid elsewhere in famine, disease, and civil war by our negligence. The most illuminating quote from Greenspan several weeks ago was his imperious comment about how countries that pegged to the dollar wanted all of the advantages of doing so, without incurring the costs. There should be no costs to any country, only benefits, in fixing to the dollar -- but for that to happen, as Greenspan well knows, the dollar has to be fixed to gold and he’s no longer interested in that.

In other words, I’m sorry to tell you that even as my net worth increases here in beautiful, downtown New Jersey, I’m not happy at all when I contemplate the world in general and a further deflationary 1999 in particular. Of most concern is a leadership gap as big as the ozone hole, with Saddam Hussein the only national leader on the planet who seems to know what he’s doing. We’re running on institutional momentum, with nobody at the wheel, and that may be good enough to hold us until George Bush’s son, George W., is coronated de jure in 2001 as he has already been de facto.  But I’m not so sure it will.

I’ll think some more about this during the course of the week and come back next Monday for an annual outlook that I hope will be less discursive. Meanwhile, I think I’ll take the rest of the afternoon off and go out to buy another share of Yahoo! and really get rich.