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U.S. Could Be in Danger of Exporting Deflation

October 25, 1987|DON R. CONLAN | DON R. CONLAN is president of Capital Strategy Research Inc. in Los Angeles. He was chief economist for the Cost of Living Council during the Nixon Administration. and

The world's financial markets have made it through "The Week That Was" more or less intact. Stock market trading in Hong Kong presumably will open soon for the first time in a week, and the world will be watching to see whether closing the market worked any better than just toughing it out the way other markets did.

The experience has been pretty incredible, to say the least, and, unfortunately, was the media event of the decade. I say unfortunately because of its probable impact on the mind-set of the ordinary individual who knows next to nothing about stocks or the stock market and, until Monday, couldn't have cared less.

It would be nice to think that the economies of the world can be isolated from these mind-boggling gyrations and that we can write the whole thing off to computer trading strategies gone amok in brokers' trading rooms. Unfortunately, it doesn't matter what caused it. It's what happened that will do the damage.

This is not to say that stock market events overwhelm our lives. Just as you got up every morning last week and went about your business as before, so did almost everyone else around the world.

Real Economy Still There

If you looked out any window wherever you were in the world (I was in Tokyo), you saw fantastic economic systems with huge stocks of physical capital--buildings, machines and people--in place and still functioning.

The so-called real side of the world economy didn't disappear along with disappearing asset values. But let's not kid ourselves. The psychological impact has been too large not to have had an effect outside the financial markets themselves. Events on Wall Street have captured the attention of virtually every individual, and confidence in the future has been badly shaken.

Almost nothing will be quite the same in the months ahead. Indeed, the parallels between the recent earthquakes and the stock market's decline are interesting to contemplate. We never paid much attention to the risk until it hit us. Now, every little tremor makes us tense. We never gave much thought before to the need for earthquake insurance or even a flashlight and a portable radio. Now we do. We look around at our homes and are less concerned now by how nicely they're decorated than by how well they are built.

So it will be with our finances, both individually and nationally. We have had the financial equivalent of an earthquake. The preference for liquidity probably has leaped by a quantum overnight. The desire to save no doubt increased considerably as well.

However, the other side of that coin is that what we save, we don't spend. What we don't buy doesn't get sold. What doesn't get sold doesn't get produced, etc.

At least so far as the United States is concerned, my sense is that it is not whether there will be a recession but how sharp and how long. It isn't absolutely certain, of course, but it would be wise at least to be concerned about it.

No Inflation Worries

What we don't have to worry about, however, is inflation. That is the last of my concerns. About 10 days ago, I wrote a column trying to make the case that inflation in the United States was an overrated issue that had distorted expectations beyond reason.

I did not expect, did not need and did not want a severe market decline to support my case, but I am now more convinced than ever. Accordingly, I hope that we are not about to embark on a major effort to fight today's war with yesterday's solutions. The issue is potential deflation, not inflation.

Over the coming weeks and months we should be very wary of the word "must." We "must" raise taxes. We "must" cut government spending. We "must" eliminate the trade deficit right away by any means possible, including protectionist trade legislation. We "must" do this. We "must" do that. It is not at all clear what we "must" do, yards and yards of pompous pronouncements to the contrary notwithstanding. In the words of the late historian/philosopher Will Durant, "Lord, forgive us for our terrible certainties."

It boggles my mind that people are proposing the same solutions this week--for what, in my view, is a potentially deflationary situation--that they were proposing last week for inflation. Talk about repeating 1929. Most of Herbert Hoover's inaugural address dealt with the need to balance the federal budget and correct our trade problems.

If I were making government economic policy just now, I would assume that the problem is deflation until the facts prove otherwise. A dramatic shift in liquidity preference such as we no doubt have just experienced can chew up a lot of money supply without ever having financed a nickel's worth of economic growth or a basis point of inflation.

The drop in consumer demand we may be about to witness is not effectively cushioned by an increase in taxes. There's a better than even chance that what we will need to be doing is to encourage spending, not quash it.

Dollar Overvalued

Well, you may say, won't that be bad for the dollar? Possibly, but chances are that if recession is in the cards, the United States will feel it first. If so, then imports will go down faster than exports and the trade deficit could show fairly dramatic short-term improvement. Besides, the old "safe haven" idea may loom again as a reason not to short the dollar just now.

But, if not, then what some of our trading partners have been telling us all along must be true; namely, that the U.S. dollar is considerably overvalued and must go down.

If the dollar has to go down, it's probably better that it happens sooner rather than later. If it happens over the next few months, domestic demand may be too weak to support the inflation that would result from higher prices on imported goods.

It would be ironic and unfortunate, however, if the United States, after being accused of exporting inflation, ended up exporting deflation.

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