Deflation – employment, wages, tax revenue

Few are ready for a bout of deflation. Even fewer understand the consequences of a deflationary recession which at this point is probable will turn into a depression.

In an unchecked fiat monetary system, inflation progressively becomes the ultimate and only goal. Towards the end of the inflationary dynamic, credit creation expands exponentially till inflation overwhelms the GDP number. The natural result is that financial value progressively runs away from intrinsic value at an accelerating rate. However, when the underlying economy no longer generates sufficient revenue to service the debt, then asset liquidation is the only solution.

Asset liquidation causes a decrease in nominal wealth, thus in earnings. Decreasing earnings have a double effect: they are responsible for lower tax revenue for the state and they cause layoffs. In turn, layoffs put more pressure on the state in two ways: first because unemployed people pay less taxes but need more state services and second because unemployed people consume less thus generating less revenue for the private sector and, yet again, less revenue for the state and more layoffs.

In recent decades, layoffs were the standard procedure for shrinking labor costs. Reducing the wages of those who remained on the job was considered demoralizing and risky: the best workers would jump to another employer. But now pay cuts, sometimes the result of downgrades in rank or shortened workweeks, are occurring more frequently than at any time since the Great Depression.

Colorado voters approved an adjustable minimum wage in 2006. Supporters of that amendment said they did not intend for wages to fall, but the provision allowing it to fall was crucial to its passage. They have pointed out employers of the estimated 50,000 to 70,000 Coloradans making minimum wage are free to leave wages flat.,0,7605979.story

An unusual pension benefit for police and firefighters could cost Baltimore $164.9 million next year, nearly double what the city is now paying and a figure that the city’s finance director says taxpayers cannot afford. […] Pension costs for the roughly 5,800 retired police and firefighters are soaring at a time of deep budget problems. The city recently forced employees to take five unpaid furlough days, laid off workers and halted capital projects to chop $60 million from its current budget. Declines in projected tax revenues and cuts from the state prompted cuts. Another round of budget reductions is expected early next year.

For all intents and purposes, most people alive today, particularly in the West, have lived in an inflationary environment that has caused a steady rise in the cost of living. Few can contemplate an environment of falling wages and reduction of public services let alone the discontinuation of some public services that we have come to take for granted.

When the streets of Western capitals will be teeming with unemployed, homeless and angry citizens, a world war will be the only way our politicians will be able to maintain a grip on power. It has happened before. There is absolutely no reason why it should not happen again this time around. Deflationary busts are stealthy, insidious even if all too predictable.

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