Glen’s World

Economics is starting to make sense. I was drafting a post a couple days ago that started by asking “what makes the economy go – consumers or producers?” In my mind it’s both, but I couldn’t figure out how to best articulate that. Then, thanks to an article by Ravi Batra, it made sense.

Economies are balanced when supply (production) = demand (consumption). If demand goes up but supply doesn’t, then you get inflation (rising prices). If supply (productivity) goes up but demand doesn’t, you see deflation (falling prices).

But what has been happening for the last 25+ years is that productivity has gone up, but real wages (demand) has not. When that happens, the way the economy grows is by creating debt. Debt temporarily increases demand. So we’ve been under the illusion of a growing economy, but as we’ve seen it’s starting to unravel in a nasty way. That’s because eventually you have to pay the debt back.

While the debt is being paid back then demand really drops, you end up with oversupply, and prices start to fall. When prices fall, people wait to spend their money because it will be worth more tomorrow than it is today. That, of course, exacerbates the deflation problem. It’s what happened in 1929.

In a way, the Suzie Ormann’s of the world are right. Getting out of debt is the answer. It will hurt for the short run but once the economy stablizes it will help a lot for the long run.