Deflation: What Happens When Prices Fall

Many feared that the United States was entering a period of prolonged slump after a pronounced boom, much like Japan experienced throughout the 1990s. Others worried that a sustained fall in prices would have a cataclysmic impact on our nation's overhang of consumer debt. Yet another camp blamed low-wage manufacturing countries like China and high-volume retailers like Wal-Mart for becoming the engines of relentless deflation.

In this important new book, Chris Farrell explains that deflation need not presage a collapse. In the process he gives a new way of looking at our economic and our financial futures. More than an introduction to the subject, Farrell points out that deflation has always been a fundamental aspect of the business cycle. For much of the 20th century, deflation had vanished from the economic scene, but its return is no cause for panic. Instead, properly understood, deflation presents opportunities and pitfalls in equal measure for businesses, corporations, the government, and our national economy.

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All Customer Reviews
Average Customer Review:
1 of 1 people found the following review helpful:

Well written book on the central role of stable money in investments and life, 2006-09-03
The book drives home the importance of stable prices very well. Inflation leads to lenders being paid back in cheaper dollars which is destructive. Deflation leads to borrowers having to pay back more valuable dollars than the borrower received which they may not be able to do and this is destructive also. The book gives some reasonable advice on what to do about either of these scenarios, e.g. TIPS for high inflation and long term US Treasury's for deflation. The book has a lot of interesting history about booms and busts since the 1800s. And even though history doesn't repeat itself exactly, the author explains what lessons can be learned. The author also explains that even if inflation is controlled despite (current) high budget deficits, this fiscal inbalance can lead to slow growth of the economy and/or investors fleeing dollar denominated assets. The author also makes some persuasive observations about the downside of using the gold standard to control money supply. The book is actually somewhat mistitled in that it discusses the value of money in general, ie. deflation AND inflation.
I also appreciated quality of life subjects that he was able to weave into the work, e.g. on page 137, "seven factors that...affect happiness: income, work, private life, community, health, freedom, and philsophy of life."
For whatever it is worth, I graduated as an economics major from college. I took the book out of the library, however there is enough timeless wisdom in the book, that you may wish to purchase the book. I see from the amazon.com web site it is available in both paperback and hardback.
I give the book a solid 4 stars. The author explains his points well.



2 of 3 people found the following review helpful:

The highlights I found most fascinating., 2004-12-18
Very good book.
___The main point I drew was that the Federal Reserve Board's most important goal is to maintain a stable dollar and a stable price with as little inflation and deflation as possible. With global pressures the government will be hard put to prevent some deflation but it will be modest.
___The first few chapters were pretty dry as explaining terms always are. Things picked up considerably when the author wrote about trends in prices in the US over the past 150 years. The great depression (bad fed fiscal policy along with being stuck with the gold standard) and the `70s inflation (bad fed fiscal policy along with global trade competition) were very well done.
___The last part of the book was fascinating as Mr. Farrell covered a great range of topics. Global trade should be encouraged. Outsourcing is one more change that leads to overall economic health and will create more jobs in the US as well as a healthier company. Farm subsidies are a $300 billion dollar fiasco and do not work. Health care in the US sucks and should be tied to the individual and not the job and will actually be less expensive than it is now. Investing in education is the most important economic growth stimulator the government could do. Job security is a thing of the past and the best thing you can do is continual education outside of the specific job. Price is the key to products, build the product to the market, keep it lean and mean, train your employees and ask for their advice, and add only the options that will sell the product. All neat ideas.
___My two biggest fears were addressed by the author.
___Growing US and individual debt will soak up money like a sponge in the years ahead. The author laments that this is just really bad and confused US fiscal policy and needs to be fixed now or else the global market will do a run on the dollar.
___The baby boomers retiring and pulling their money out of the stock market and spending less will have a double whammy on the US economy (lower stock prices and decreased consumer spending). The author hopes that global pension funds of the new global middle class will buy these equities from us. "otherwise, watch out!" he says.
___Finally, the main points for investors. Stock and bonds will grow about the same rate at around 5% per year. The housing market prices will grow in price about 1.5% per year. Little to no inflation but just in case there is, buy TIPS or I bonds.
Me, I cashed out of the mutual fund market completely this summer after 10 years and am putting the money in safe boring CDs and some in TIPS. "Run on the dollar" and "watch out" does not comfort me much. I can get 5% in long term CDs with a lot less volitility.



5 of 6 people found the following review helpful:

Challenging Current Wisdom...., 2004-08-15
The conventional wisdom on the direction of interest rates is that they will rise from multiyear lows in response to the demand for capital in an improving economy. The price for goods and services will also rise, and the Federal Reserve will steadily raise rates to moderate the trend even as it seems to fuel it. Inflation will take root as it always does when the economy grows.

It is Chris Farrell's dissenting opinion that a powerful "secular undertow" is at work in the economy that will push prices for most goods and services lower even as the economy strengthens. This deflationary pressure, this widespread, persistent decline in average price levels is deeply embedded in our economy. From 1776 to 1965 price levels wre "essentially flat" as society continually found ways to produce goods and sercies more cheaply. Between 1869 and 1896 U.S. wholesale prices dropped almost in half. By one account peacetime inflation from 1800 to the present has averaged just .4% Strong economic growth has occurred during mildly deflationary periods for most of America's history. Improvements in productivity sparked by technological innovation and the need to be competitive routinely pushed costs down. This is the meaning of "good deflation".

The underlying causes for the deflationary bias in our economy today, according to Farrell, are the internet, globalization, deregulation, job outsourcing, warehouse retailers like Wal-Mart, and a central bank vigilant for signs of inflation. China is emerging as a vast engine of deflation. Maybe it's the world's version Wal-Mart. Its economy is growing at a 6% to 8% annual pace. Meanwhile, prices are "declining at an average annual rate of less than 2% since 1998".

Periods of inflation have generally resulted from an unproductive use of capital to finance the cost of wars or from "inept" central bank monetary policy. America's period of "great inflation" in the 1970's had these elements. In addition, the Nixon White House decision to formally acknowledge a break betweeen the value of the greenback and the gold bar drove its purchasing power lower in the world market. A cheap dollar was a painful way to pay for the Vietnam War bill and spiking OPEC oil.

The Great Depression of the 1930's was a period of "bad deflation". Using an outdated playbook the Fed raised U.S. interest rates, further contracting the economy, to stem the outflow of gold when it should have focused on getting 13 million unemployed, a quarter of the workforce, off the breadlines. The impact of the Depression is more widely appreciated than its perfect storm of causes, but Farrell's main point is that both the inflationary 1970's and severe deflation of the 1930's were dramatic deviations from the historical norm of mild deflation, extreme cases that have lessons for both financial and monetary policymakers.

Farrell's explanation of why steadily rising healthcare and educational costs appear to buck the deflationary trend he describes - they are dysfunctional and inefficient sectors - needs further development to make his case fully persuasive. The last chapters deal with the impact of a deflationary economy on investments and the need for public policy reforms in education, healthcare, retirement savings, etc. But these are heady topics that need more discussion than is possible in this short, insightful book.


12 of 14 people found the following review helpful:

Looking at Two Kinds of Deflation with Errors , 2004-08-12
Looking at Two Kinds of Deflation with Errors

Deflation is a subject that most of us have not thought much about. The primary reason for that is because deflation hasn't been a force in the United States for over 60 years. Instead, varying rates of inflation have been a problem and a concern.

In Deflation, Mr. Farrell points out that there are two primary sources of deflation. The first is an active growth in productivity such as that which occurs in the semiconductor industry. Under such circumstances, prices fall but businesses can make a decent profit while still providing better value for customers. Such deflation was fairly common in the days of the gold standard and often occurred during times of robust economic growth. The second source of deflation is a radical drop in demand for goods and services of the sort that occurred in the 1930's depression. Here, the dropping prices feed on themselves to reduce demand further as people wait for lower prices. Real interest rates rise which further cuts demand.

Mr. Farrell argues that the threat of deflation that Chairman Greenspan was concerned about in May 2003 was of the healthy variety, and suggests a number of possible measures for offsetting that risk.

Naturally, we now know that the risk of inflation is in fact greater than the risk of deflation due to soaring commodity prices around the world driven by the global expansion, the weakening dollar (due to the trade and budget deficits), and the various bubbles that are developing around the world. So this book won't seem of such relevance as it might have a year
ago.

I was dismayed to find that the book's arguments and details contained little information beyond what a well-done business magazine article would have contained. So the book doesn't present a very good value.

In addition, I was even more dismayed to find that the book had not been proofread or fact-checked very carefully so there were an unusual number of errors and questionable observations in it. For example, an early reference by Chairman Greenspan to what appears to be disinflation (slowing of inflation) is referred to by the author on page 2 as a euphemism for deflation. I don't think so. The Thai currency is called the "bath" rather than the "baht" on page 21. On page 36, the author says that television was available to Wyatt Earp in Los Angeles in 1929. On page 42, the author says that the events of 9/11 further dampened economic activity, yet we know that the recession ended right after 9/11. On page 45, it says that Meg Whitman started the 1990s at eBay. She joined the company late in the decade. On page 61, it says that economic growth does not cause inflation. Our current experience with oil and steel prices and ocean freight rates would suggest otherwise. On page 64, economic growth is described as only coming from creativity and innovation. Yet most economists would argue that over 60 percent of economic growth comes from population growth and investments in capital assets. I stopped counting what appeared to be errors at this point.




2 of 2 people found the following review helpful:

Vital point, Global view, 2004-08-02
Output, prices and employment are the three key parameters that macroeconomics is all about. But then conventionally the unit of analysis was the country. Not anymore, if we need to prosper as citizens of the global village. This theme is at the core of this book and sets it apart from most others who are not so broadminded in accepting this fact.

Coming to deflation, the author takes us through a well documented journey of over two centuries, two world wars and two big economic traumas of the twentieth century - the great deflation of the 1930s and the great inflation of the 1970s. He challenges the conventional view that deflation is inherently bad for the economy and on the contrary cites several decades of prosperity during periods of mild deflation. The very fact that most elected governments would like to hold the price line protecting consumers and investors, they need to put in place mechanisms with a deflationary bias. With this change in perspective about deflation, the author explains the main trends in the 1990s that are inherently deflationary. Globalization and the internet have strengthened global supply chains for products and services giving the consumer information, choice and control over her purchasing decisions. Rapid increase in productivity since 1995 ( to 3.5 % from an average of 1.4 %) due to technological advances is a fundamental force on downward prices. The rise of discount retailing giants like Wal-Mart is another factor. Thus, instead of branding deflation as a dreaded monster that will close down plants and spread misery, it should be managed in proportions that will improve competitiveness, increase availability and market efficiencies. Supply side economics rather than shrinkage in demand should be the driver of price determination.

One concept that very well emerges from this book is that both inflation and deflation in large proportions for prolonged periods are bad. The responsibility of the Fed to intervene at the right time with appropriate therapies is well explained. Deflation like inflation is a stimulant if administered in the right doses.

Two sectors that come up for criticism are Health Care and Education. These sectors are yet to exploit efficiencies of technologies and improvement in processes adopted in most other manufacturing and service sectors. Hence affordable healthcare and education that can impart substantial improvement to the quality of human capital are still proving elusive.

There is a chapter devoted to investment choices and strategies available to individuals should there be a prolonged phase of deflation.

This book explains some excellent concepts through a non jargon approach. Those who have not had formal college education in economics will also find it interesting. A table with the chronological listing of key economic events discussed in various chapters for ready reference would be very helpful.

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