Deflation Looms

My realtor tells me my mother's house is losing 1% of its value every month. That's not because it's falling down; we've spent almost $200,000 to renovate it. It's not because the neighborhood is going downhill, either. The land around it is held by people whose deeds, or zoning, restrict them to one house only, and across the road land is preserved through a conservation easement, allowing no additional houses.

No, the price is going down because there are too many houses and too little money--in the local housing market. And what's happening here is happening elsewhere even more dramatically. That's why so many homeowners are "underwater," and walking away from their homes. Many of them can't find jobs, so, foreclosures are increasing and a record number of people have been forced from their homes.

Foreclosures build downward pressure on house prices: banks try to unload the houses they're stuck with.

There are short-term fixes, such as renegotiating mortgages, or allowing defaulting owners to rent in the interim: both would reduce the number of under-priced houses flooding the market, but the first isn't working--many don't have jobs, or have declining earnings--and the second has hardly been tried.

Falling prices might be a good thing for someone with money, but the reason for it is: most people have too little: it's called price deflation.

Price deflation can be self-reinforcing, i.e. can trigger a downward spiral. Lower prices mean businesses make less in profits. A home-builder, for example, will have to lay off his workers, because he can't sell the houses he builds, or has to sell them at cost, or less. He's losing money, so he lays off workers, or goes out of business, which increases unemployment, so fewer, still, have money. That drives prices even lower.

Even some inflation hawks on the Fed Board of Governors are warning of deflation danger. The Fed sets a goal of moderate inflation (2-3%), which keeps the economy moving, but deflation could stop the economy dead in its tracks. It happened in Japan in their "lost decade," it happened in the Great Depression and it could happen now.

It happened in the last two centuries of the Roman Empire, too, and was a major contributor to its fall. There it happened because the wealthy, accumulated almost all the wealth, hoarded gold and evaded taxes. Here, sharp traders threaten speculation against government borrowing, borrowing needed to stimulate world economies.

The financial industry is like those Roman Senators hoarding gold. Since more demand is needed, and since interest rates are basically zero, the Fed could create more money, buying up treasuries, to curb deflation. More focused would be a government stimulus targeted on creating jobs in the public investments we need.

The latter isn't likely in this corrosive political climate, but the former could be rendered worse than useless if big banks still prefer gambling to loans.