Deflation: In Need of a New Definition

While it is true that we cannot have monetary deflation with all the money that is being printed, we can have the effects of monetary deflation.

Deflation today is another animal than it was in the 30s. If you don’t believe me, just ask the Japanese. They have had assets deflation for the better part of 20 years or so.

Today’s deflation is not a monetary phenomenon, but an assets price phenomenon. Furthermore, today’s deflation has more to do with deleveraging than with the total supply of money.

As such, central bank authorities have to keep an eye on the total leverage in the system and then set monetary policy.

The major policy mistake that the Fed and ECB made was to hike interest rates much higher than the market was willing to handle due to leverage. That series of events brought us here today.

The correct thing to do was first to change the laws and give the market time to deleverage, and then to hike interest rates.

Now they are running for cover to try to stop asset deflation which, if not stopped, will cause even bigger problems.

So yes, monetary deflation can’t happen anymore because the central banks are printing money, but that’s because we still use the old definition of deflation.

I think it’s time to change definitions, because at the end of the day, it’s the effects of falling assets prices that are of concern and not whether the money supply is contracting or not.

Deflation today is as real as it was in the 30s. The only difference is the root cause, which today is not a contracting monetary base, but contracting credit.

Comments

[paulsjj]

I've always thought the the terms "inflation" and "deflation" are deceptive. They subconciously make one think of mysterious hidden forces that are uncontrollable. They draw attention away from the dollars in our pockets and our savings and investments. The 1913 dollar buys less than 0.05 cents of stuff today. The dollars in our pockets have devalued(inflated) that much. Revaluation (deflation) is the better term. The purchasing value of the dollar should be maintained by the government over time.

2008 Oct 31 08:44 AM

[investor88]

Most enlightening ie the 1930s deflation was due to a contracting monetary base. Today governments are in full printing mode but contracting credit is the cause of asset deflation.

2008 Oct 31 09:01 AM

[Pipo]

Funny because Jim Rogers is worried about a financial holocaust...

jimrogers-investments..../

2008 Oct 31 03:19 PM

[derryl]

Good point about the difference between asset price deflation like we're seeing now and money supply contraction. The Fed and commercial banks can make all the money available that they please, but if there are no takers for new loans to buy stuff, the prices of stuff keeps going down. Hence, asset price deflation.

2008 Nov 02 01:23 AM