Pete’s blog

Going to try and challenge conventional wisdom this week and try and look at the current economic crisis from a different angle.

First going to look at deflation. Spoke a little about deflation in a previous blog about how it is a bad thing… but this time I’m going to argue that maybe it is exactly what we currently need. Several Western countries are currently facing the possibility of deflation and have cut their interest rates to extremely low levels (the lowest rate in the history of the Bank of England) in order to reduce the risk of this occurring. Deflation is something feared by economists, and rightly so, it does weird things to your economy. What deflation means is that goods will become cheaper, so if you wait, you can buy something for less. People stop spending now, because they know they could get it cheaper later. People buying less stuff is not a good thing, especially if you are in a recession. Deflation also causes very bad psychological issues in your economy – companies’ profits fall every year, you get an annual salary reduction, your house is worth less every year… Seriously demoralising.

One of the root causes of this current crisis is that people spend now on credit rather than saving and buying later. Credit flowed too freely, and people are in masses of debt. People do not know how to save any more and to manage their finances. So how do you teach them? Incentivise them? Well if goods were cheaper in the future, people would have a very obvious reason to consider waiting before making a purchase. Why buy a car now on credit, when you could wait a year and buy it cheaper using savings? So bring in deflation, it will teach people how to save. The initial transition will be painful – people will stop buying things and start saving instead and the economy will take a nosedive. But long-term it will lead to a far healthier economy. Normally you spend your way out of a recession – you lower interest rates and encourage people to spend and buy stuff and thereby generate economic growth. Except I think this time people no longer have anything left to spend, you can lower interest rates as much as you want, people cannot and will not borrow any more. Cutting interest rates might avoid deflation, but will probably lead to several years of minimal growth à la Japan. Leave interest rates high, deflation happens, you have an acute recession for a year, followed by robust growth supported by high savings levels and more financially secure consumers… perhaps?

But that is the nice way of looking at the benefits of deflation, there are another more extreme way. Most of the world’s current problems are the result of consumerism gone wild – environmental degradation, climate change, financial crisis, etc. If consumerism is out of control, how do you reign it in? Create deflation – high levels of deflation. People will delay any purchase that is not critical or necessary for survival, consumerism comes to a grinding halt, the planet is saved and we all live happily ever after… Oh yeah and any economy based on consumerism completely collapses and everyone loses their jobs, but at least we’ll save the environment and won’t be such irresponsible spenders any more. Change management is always such a difficult problem. But why not ignore the consequences of switching systems for a second and have a think about an alternate society where deflation is the norm. Interesting world I think…

And then one more quick counterintuitive idea, I think this recession will create jobs and boost entrepreneurship. A lot of people have lost their jobs, and quite a few of them in the financial sector. Qualified, educated people have been retrenched. Now people like security and do not like risks, so given the choice between an office job working for a company and starting your own business, most people would choose the office job. Now what happens if you lose your office job? Now you don’t have a choice, you need to start you own business to survive. Educated people being retrenched? Perfect people to start their own businesses. Expect large growth in small businesses in the next few years.

Think about it