Economic Outlook: Debt Deflation

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Illustration by Jaroslav Machacek/Fotolia
The bursting of a debt bubble marks the start of debt deflation.

Once again, this column takes advantage of the wisdom of Vern Myers, the perceptive and often outspoken publisher of Myers Finance & Energy, a 14-issue-a-year economic newsletter that we’ve found well worth its $200-per-year, $110-for-seven-issues price.

The following essay, reprinted with permissions from Mr. Myers’ October 1, 1982 issue, is representative of this writer’s ability to dig to the roots of the crises facing us today, and then to rinse off those roots and show us very clearly just how we’ve gotten into a deflationary spiral — the economic mess that has been building for so long and that looks to haunt us for longer still.

The Little Red Hen

Almost half a century ago an enduring financial philosophy was summer-fallowed.

A general discrediting of old-fashioned wisdom took place right after the war. People under 60 hardly remember teachings inherent in our society beginning with the first grade readers.

For some decades prior to that, the earliest stories read by young children praised the concepts of frugality, industry, incentive, responsibility. But the story of The Little Red Hen no longer appears in our primary readers. Many of my readers will not even know it. I have to tell it to them.

The Little Red Hen wanted some help to prepare the ground to plant the wheat. When she asked who would help her she got these replies: “Not I,” said the cat. “Not I,” said the dog. “Not I,” said the mouse. To make a long story short, when she had gone through all the processes of preparing the ground, planting the grain, pulling the weeds, reaping the harvest, gathering the grain and baking it into bread — when all this was finally done she said, “Who will come and help me eat this bread?” “I will,” said the cat. “I will,” said the dog. “I will,” said the mouse. And so on.

“No, you will not,” said the Little Red Hen, “for I shall eat it all myself.” And she did.

Very potent medicine for young children of five and six years of age.

If that story were to appear in modern readers, its ending would be as follows:

“Who will come and help me eat this bread?” said the Little Red Hen. “I will,” was the answer in chorus. “Yes, please do,” said the Little Red Hen, “for why should I have all this bread to myself while you have none?”

Then there was the story of The Grasshopper and the Ant, and other similar teachings. There were the slogans: Pay as you go. Never mortgage your home. Avoid debt. All of these things may seem trifles, but generations lived by these and similar precepts. Frugality, responsibility, industry, the spurning of debt were the cornerstones of economic philosophy.

Then somehow that all got turned around. This philosophy did a flip-flop. As much as 20 or 30 years ago we began to hear the following slogans: Fly now, pay later. No down payment needed. 25 years to pay. Only $15 a month. This new philosophy asked the question, why should your pleasure await the accumulation of the means to have it? Have your pleasure now.

And a whole economic house of cards has been built up on this philosophy.

Recently the most prominent bankrupt corporation in North America, Dome Petroleum, had to sell off enormously wealthy holdings in Indonesia at fire sale prices to pay the interest to keep the wolf from the door another 30 days. Smiling Jack Gallagher, the founder of Dome, not long ago made this boast: “Dome Petroleum started on $250,000 cash and $7.5 million debt; that’s the way we’ve kept it.”

Not long ago an author by the name of Lowry told you how to make fortunes in real estate by putting $1,000 down, buying a house, turning around and selling this house at a profit of $10,000, then buying another house, and so on, and so on, until you became rich. But today those people who have built up that pyramid can only watch as it slowly crumbles.

Obviously, the flip-flopped philosophy has met its comeuppance, and it is now suffering the convulsions of death.

If the new philosophy be dead, then we are moving away from a society of debt. As soon as our society bows its neck in the direction of frugality and the avoidance of debt, we will have entered a new economic climate that traps the big debtors. The meaning is a stark change, for as we begin to pay the debt — either first of all with equity, secondly with bankruptcy, thirdly with default — as we begin to erase this debt, we erase the means of inflation. As we move in this direction, away from permissiveness back to the dictums of philosophy on which America was built, then we are passing from a warm room into a very cold room, and the shock will be traumatic.

That shock is deflation.

I see it in the newspapers. I see the bankruptcies in Germany, in Italy, in Australia, in the United States — last week the greatest number in a single week since 1932. I see it in the reports of the number of gardens being planted, the pullback by consumers, the reduced mileage on cars, the reduced occupancy in hotels, the reduced occupancy in apartment buildings across the North American continent, the ruinously reduced number of autos sold, the poverty of the building industry, and the rarity of new homes.

I think this is all big enough now to be termed a somersault in philosophy.

If so, this is the biggest clue you will find to the deflationary years directly ahead.

More Notes and Quotes

Of course, Vern Myers isn’t the only economic commentator involved in the struggle to throw a little light on our problems, as the following bits of excerpted wisdom prove.

“Every 1% increase in unemployment leads to a $25 to $28 billion increase in federal spending. Thus a contracting economy will force even further federal government borrowing in the marketplace, competing for money against the private sector and possibly driving up interest rates.”

The Reaper
October 1, 1982
R.E. McMaster, Jr.

“Note that the interest on the national debt for 11 months is $108 billion, so we’re looking at near $120 billion for the full fiscal year. That means that 16% of all government spending now goes toward carrying the debt (a decade ago it was around 10%). This is the compounding effect. Within a few years, the government will be spending $1 out of every $5 to carry its debt burden. It’s an interesting process. The process is called ‘eating yourself alive’.”

Richard Russell’s Dow Theory Letters, Inc.
October 6, 1982

“These loan guarantees [to Poland, etc.] are the sleaziest thing going. The taxpayers are getting raped by the system. This administration didn’t invent it, but they have no business promoting it. We are paying for the soldiers who are sitting on the heads of the Polish workers.”

Dan M. Burt, President
Capital Legal Foundation

“There’s only one sure bet in the world of economics, and that is that debts will grow larger. Between 1971 and 1981 U.S. credit market debt grew from $1.8 trillion to $5.5 trillion. During the same period Free World debt exploded from $3.7 trillion to $14.3 trillion, and interbank Eurocurrency debt rocketed from $6.5 billion to $1.3 trillion.

“This mountain of debt represents the mortgaging of many future generations.”

Richard Russell’s Dow Theory Letters, Inc.
November 3, 1982

“Do you know why I think we are still in our economic infancy, why we still have not had a working, successful economic theory long term? Because all economic theories to date are based upon assumptions which are radically flawed! Man does not necessarily have unlimited wants. He can overcome that desire through self-discipline. This is not definitively a world of scarcity. Higher and better creative uses of resources are all around us. All we have to do is harvest same. Plus, the sun gives us free wealth every day. No wonder to this point economics has been called the dismal science. It has operated with cursed assumption.”

The Reaper, November 5, 1982
R.E. McMaster, Jr.