Friday, July 23, 2010

Is Hyper-Deflation next?

Since the cost of living has increased year after year for over five decades, people have come to expect inflation and anticipate it by being biased towards buying now while it is still “cheap”. Deflation on the other hand, has been rare and usually limited to some small geographic areas for short periods of time. The adults who experienced deflation and hyper-deflation in the great depression are no longer around. Most of us can’t imagine what it will be like for things to suddenly get vastly cheaper as the availability of money dries up.

Some of the factors that will contribute to an economy of hyper-deflation are:

  • Americans are earning less and continuing to lose their jobs. Government stopgap funding to keep police, fire departments, and teachers employed will ultimately come to an end which will cause more layoffs. States and local governments will be forced to do massive layoffs to balance their budgets. States must pay a portion of the unemployment benefits being funded by the federal government which is expensive for them to maintain and adding their financial shortages.
  • The government stimulus programs that paid Americans to buy houses, cars and appliances have ended. These programs emptied the market of buyers for the next 36 months and created artificially high prices. Now prices are dropping back to a non subsidized market level leaving many of the buyers in debt for overpriced houses and cars.
  • New higher taxes are about to be added to cash-short Americans. These taxes will further reduce American’s income and further depress consumer spending. The current six tax-rate brackets of 10%, 15%, 25%, 28%, 33% and 35% will be replaced by five new brackets with the higher rates of 15%, 28%, 31%, 36% and 39.6%. The maximum tax rate on long-term capital gains will go to 20% from 15%. Maximum rates on dividends will skyrocket to 39.6%. The marriage penalty tax will return and the death tax will jump to 55%.
  • Most State and local governments will have a harder time borrowing due their high debt and lower tax bases. The higher federal taxes will further decrease tax income to the States as they are deductible in most States. Less tax income will force many State governments to cut spending even more.

An extended period of deflation in the US may be similar to the deflationary cycle that Japan has been stuck in for the past 20 years. Japan has endured an almost continuous drop in real estate prices over the last 20 years. When Americans experience real estate and cars getting cheaper each month, they will delay their spending and wait for prices to become even cheaper, further reducing consumer spending. If hyper deflation gets started it may be as hard to stop as the seemingly permanent inflation cycle that the US economy has been in for the last 50 years.


larry said...

it's pretty much already here ... and continued government spending will only make it worse not better ...

Steve S. said...

There will most likely be a lot of money injected into the economy. In other words, the U.S. will just print more cash and disperse it through the banks. This normally causes inflation, given the idea that this should counter the deflation. This still will not provide jobs though. The U.S. needs to manufacture stuff more and preferably sell it to other countries.