Risk of Long Term Deflation Is Low but Growing 8 comments
Dr. Scott Brown
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Excerpt from Raymond James Economist Dr. Scott Brown's latest economic commentary:
Deflation refers to a general decline in the price level of goods and services (as opposed to disinflation, which is a decline in the inflation rate). There is big difference between short-term deflation (a brief decline in prices) and long-term deflation (a sustained rate of decline in the overall price level). The U.S. economy has experienced deflation in the past, but not in a very long time. When we speak of “deflation,” we are usually talking about the long-term variety, such as occurred in Japan in the 1990s or in the Great Depression. Currently, the deflation we see appears to be the short-term variety, fed by an unwinding of the prices of energy and other commodities. Nevertheless, there is fear that the weakening global economy could generate a more severe and longer-lasting decline in the price level. The odds of a more significant deflation are still low, but are somewhat higher than a few months ago.
Why is deflation a bad thing? In deflation, consumers are better off postponing purchases. Why should I buy now, when what I want will be cheaper in a month or two? Hence, consumer spending will be a lot weaker. Borrowers will have to pay back loans in dollars that are worth more than what was borrowed, so they become reluctant to borrow. Returns on business investment will be in lower-valued dollars. Hence, firms will be reluctant to expand. Overall growth will be weaker – and weak growth will help push prices down further – leading to a deflationary spiral.
...
While serious deflation is a low risk, it is a possibility. The bigger worry is the slowdown in global growth. Efforts to support economic growth through monetary and government efforts will continue both here and abroad. These efforts should support growth by the end of the year. However, the global economy remains in panic mode for the near term. Things will get worse before they get better, but they will get better.
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This article has 8 comments:
bucks...better than whats out there in the stock market..MarvinMBA
won't the treasury be forced to print money like crazy?
You are correct in the long run if "money is printed like crazy" in enough quantity. However, in the short run money may not be printed fast enough to prevent deflation.
Over the past decade, a lot of money has been printed. It was not printed by the U.S. Treasury but in the form of debt instruments by investment banks and others. These debt instruments (which were not subject to any regulation or oversight) became currency which was spent on commodities, stocks, bonds and real estate, including houses. Because this new currency was so plentiful, all of these things had their prices inflated to bubble levels. When a few of the debt instruments became subject to default, a wide range of debt came into doubt and the liquidity of this manufactured currency dried up - financial institutions became reluctant to recognize that it had the value that had been previously assumed. The fact that the new currency was not working the way it had been caused demand for the inflated items (commodities, houses, etc) to fall. When demand falls, and the supply remains constant (or increasing), prices fall. Falling prices produces additional default and we end up in a deflationary spiral.
The magnitude of the debt pyramid is in the tens of trillions of dollars. With the deflationary spiral, the notional value of the debt instruments is still at the high level, but the exchange value is falling as the underlying assets decline in value. The result is that, based on the exchange value, balance sheets of financial institutions go negative. They are forced to raise more capital or go bankrupt. Only a national government is able to continue in business with a negative net worth, although many will question for how long.
So the action that national governments take (with the aid of their central banks) is to take on more sovereign debt and print additional currency to provide liquidity to the otherwise bankrupt financial institutions. To do otherwise would put the entire financial system out of business via bankruptcy. The effect of the newly minted money is initially to supply capital to the reserve assets of the otherwise failing institutions. This money replaces the assets formerly on the books which have been diminished as described above. The money does not go into general circulation; it simply replaces money already spent on the inflated bubble assets. Since these assets are now worth less than before, the new money simply disappears into a "black hole" - it replaces the money represented by the lost value.
Through lack of regulation, people were allowed to spend money that didn't really exist. Now we are printing that money and it can not be spent again.
If not enough money is printed to replace the trillions of lost value in the debt instrument "currency" that was used to create the bubble valuations, the deflationary spiral continues. If more money is printed than is necessary, inflation will result from the excess money. Big problem: No one has a clue how much money will be enough.
I keep suggesting that the tipping point between not enough new money and too much new money is like a knife edge, rather than a balance beam or some other broader platform. A major challenge is to keep from falling off the knife edge. It may not be possible.
On Nov 25 08:13 PM ktchnsnk wrote:
> how can deflation possibly co-exist w "bailout fever" & 'tax
> cuts for 95% of all workers'?
>
> won't the treasury be forced to print money like crazy?
>
>
>
>
>
In this case, is the inflationary consequence of printing too much money resulting in a loss of faith in the US dollar relative to its debt more than the result of looser bank lending?
Leverage has a profound impact on inflation in such a short time when the masses of investors sell dollars to buy commodities and vice-versa as we have seen.
I wonder how effective regulating leverage to regulate inflation would really be?
On Nov 26 01:23 AM jlounsbury59 wrote:
> ktchnsnk - - -
>
> You are correct in the long run if "money is printed like crazy"
> in enough quantity. However, in the short run money may not be printed
> fast enough to prevent deflation.
>
> Over the past decade, a lot of money has been printed. It was not
> printed by the U.S. Treasury but in the form of debt instruments
> by investment banks and others. These debt instruments (which were
> not subject to any regulation or oversight) became currency which
> was spent on commodities, stocks, bonds and real estate, including
> houses. Because this new currency was so plentiful, all of these
> things had their prices inflated to bubble levels. When a few of
> the debt instruments became subject to default, a wide range of debt
> came into doubt and the liquidity of this manufactured currency dried
> up - financial institutions became reluctant to recognize that it
> had the value that had been previously assumed. The fact that the
> new currency was not working the way it had been caused demand for
> the inflated items (commodities, houses, etc) to fall. When demand
> falls, and the supply remains constant (or increasing), prices fall.
> Falling prices produces additional default and we end up in a deflationary
> spiral.
>
> The magnitude of the debt pyramid is in the tens of trillions of
> dollars. With the deflationary spiral, the notional value of the
> debt instruments is still at the high level, but the exchange value
> is falling as the underlying assets decline in value. The result
> is that, based on the exchange value, balance sheets of financial
> institutions go negative. They are forced to raise more capital
> or go bankrupt. Only a national government is able to continue in
> business with a negative net worth, although many will question for
> how long.
>
> So the action that national governments take (with the aid of their
> central banks) is to take on more sovereign debt and print additional
> currency to provide liquidity to the otherwise bankrupt financial
> institutions. To do otherwise would put the entire financial system
> out of business via bankruptcy. The effect of the newly minted money
> is initially to supply capital to the reserve assets of the otherwise
> failing institutions. This money replaces the assets formerly on
> the books which have been diminished as described above. The money
> does not go into general circulation; it simply replaces money already
> spent on the inflated bubble assets. Since these assets are now
> worth less than before, the new money simply disappears into a "black
> hole" - it replaces the money represented by the lost value.
>
>
> Through lack of regulation, people were allowed to spend money that
> didn't really exist. Now we are printing that money and it can not
> be spent again.
>
> If not enough money is printed to replace the trillions of lost value
> in the debt instrument "currency" that was used to create the bubble
> valuations, the deflationary spiral continues. If more money is
> printed than is necessary, inflation will result from the excess
> money. Big problem: No one has a clue how much money will be enough.
>
>
> I keep suggesting that the tipping point between not enough new money
> and too much new money is like a knife edge, rather than a balance
> beam or some other broader platform. A major challenge is to keep
> from falling off the knife edge. It may not be possible.
>
>
>
>
> On Nov 25 08:13 PM ktchnsnk wrote:
Since deflation can be defeated by printing ever more paper, I think that we will eventually end up in an inflationary spiral.
Hyper-inflation causes people to spend money as soon as they get it. Clearly. Deflation prompts people to save money, because they can buy something for less money by waiting? It sounds logical, but is that what's really happening right now? Isn't the American consumer plain tapped out? Isn't it worth the distinction, if we want to raise the spectre of deflation?
Deflation in Japan, I don't know much about that. But I do know that the Japanese have always been notorious savers. Hasn't their government always had a problem stimulating consumer spending? We don't have that problem here, in fact, we have the opposite problem.
Can anyone paint a real picture of what deflation in the US would look like, and why it would be disastrous, aside from deflation as the corollary to hyperinflation. The author refers to it..." The U.S. economy has experienced deflation in the past, but not in a very long time." Was it really that bad? I don't know, I was a kid then.
I live in Los Angeles. Home sales are up because prices are down. Something like 50% of homes sold were foreclosures last month. The market is moving. Sounds like deflation is working to me.
Seriously, anyone with a better explanation.