However you choose to define it -- falling commodity prices, contraction of money supply and credit marked to market, decline in the velocity of money, a $2 gallon of milk -- Mish Shedlock of Mish's Global Economic Trend Analysis and Botanica says the debate is over: Deflation is here, and it's awesome:
Deflation is not a threat because deflation is here by any practical measurement. Deflation is also here by impractical measurements such as falling prices...
Moreover, deflation is not a threat in a second sense. Deflation is needed to purge the excesses of the last credit cycle. Attempts to defeat deflation by force will only prolong the agony while accumulating government debt, just as happened in Japan's two lost decades.
Finally, deflation is not a threat in a third sense. Falling prices are a natural state of affairs because of rising productivity over time. Inflation is a direct (and unnatural) state of affairs caused by the Fed and fractional reserve lending.
There follow many paragraphs and visual aids in support of this thesis. Most of this material will be familiar to regular Hit & Run readers, but some is new. (Disposable Personal Income, welcome to Subzero World.) Then a closing peroration worth quoting in full:
In light of all of the above, the deflation "denial phase" should now be over for all but the most stubborn inflationistas. The "recognition phase" has finally arrived. The Bernanke "panic phase" is waiting on deck.
Please note that Bernanke's Deflation Preventing Scorecard is a perfect zero. Lord knows what Bernanke will try next.
The Real Threat
We are already in uncharted territory, and the risk is what the Fed, Congress, the Treasury department, the Administration, and central bankers globally do to prevent something that needs to happen: the liquidation of malinvestments and debt.
Thus the "real threat" (and risk) is not deflation, but rather the foolish attempts by Keynesian clowns to circumvent what needs happen.
Japan is proof that such efforts are futile. Note that Japan is once again back in deflation, and all the government has to show for its efforts is debt equaling 150% of GDP. Falling prices, lower wages, lower asset prices, and especially debt liquidation are not to be feared, they are a necessary part of the healing process, lest the country stagnate for years.
On the what-will-Bernanke-think-of-next question, forcing banks to lend would be the next logical step, but the Fed chairman probably wouldn't take it because 1) it could actually be controversial and 2) his pattern so far has been to put bank solvency above all other concerns. Bernanke's wisdom from the Great Depression -- which in practice is not as nuanced or interesting as it seemed in theory -- doesn't seem to draw a clear distinction between a zombie bank and a lending bank. Both need to be kept alive until the Great American Economic Machine comes to our rescue, at which time the fatter and more robust banks can start lending into a boom. If the Fed were seriously interested in getting banks to start lending now, it could stop paying them interest to keep money in their vaults. It isn't doing that. So we have a policy that combines big cash infusions for banks with an austerity program for everybody else. Theoretically, you could keep that policy in place for a long time. It even makes sense, if your only goal is to make banks healthy.