Why Is Deflation Scary?

I have several times in my blog questioned why it is that deflation might be a bad thing, including in my discussion of a new form of money. Having presented my arguments, I thought it might be useful to find out exactly why economists insist that deflation is something to be feared. Having read through some academic literature, I found an excellent paper which clearly shows that the deflation scare is exactly that - a scare.

There is absolutely no evidence that deflation will cause depression. I have therefore written a summary of the paper in question below, which is by Gregor Smith (reference at end). It might be noted that his paper is written in the polite tones of academic discussion, but the message is clear. He divides up his paper into some basic arguments and I will follow the format.

1. Deflation is associated with depression

Smith reviews the study of Atkeson and Kehoe (2004) who considered the empirical evidence for a link between the deflation and depression. He summarises their work by concluding that only ‘for 1929-34 is there a positive relationship between the inflation rate and the output growth rate’ and that ‘excluding 1929-34, there is virtually no link [between deflation and depression], even though there were other periods of deflation, especially under the gold standard’ (p1046).

My comment: The important point here is that there have been many, many deflations in which there has been a growth in output.

2. Unexpected deflations are associated with depression

In a contrast to the work of Atkeson and Kehoe, Smith reviews the work of other researchers who have utilised different analytical models which have found a relationship between depression and deflation, for example in Canada 1870-96. However, when models take into account other shocks in the economy, the correlations found appear to be coincidental rather than causal, and such shocks also serve to explain the only correlation found by Atkeson and Kehoe.

My Comment: Again, it appears that there is no evidence that deflation and depression are connected and as Atkeson and Kehoe identify, there are many examples that directly contradict the idea that deflation and depression are linked.

3. Sticky nominal wages

In his review of the literature, Smith finds some problematic findings on the relationship between wages and deflation, such that each of the studies fails to fully explain the relationship between wages and deflation. For example, he reviews the work of Bordo, Erceg and Evans (2000) which explains wage stickiness for the period of the early 1930s, but fails to explain wages in the slow recovery for the period of monetary growth after 1933. His conclusion is that there is a need for further research if there is to be a meaningful debate on how wages might be determined in deflations. In summary, there is a general lack of research that might present any firm conclusions on the relationship between deflation and wages.

My Comment: It is worth noting that, if wages were to remain static in monetary unit terms during a period of steady deflation, the recipient of the wages would find the purchasing power of their wage increasing. As such, the person would, in real terms, see an increase in their wealth. Even if the person’s wage were to decrease in a period of deflation provided that the decrease is less than the rate of deflation, they would still be seeing an increase in their wealth. Why such outcome might be viewed as problematic is entirely unclear. Actual wages in monetary unit terms are irrelevant without relating them to what they might purchase in terms of goods and services.

4. Debt deflation

Smith identifies Fisher's (1933) work as being the key work on debt deflation, whose theory Smith summarises as ‘depressions begin with debt liquidation, leading to deflation and then to bankruptcies, and to a fall in output and employment’ and that there is an association between these events and ‘a nominal fall in interest rates and a rise in real interest rates’ (p1050). Smith then identifies that Fisher is rarely cited in empirical studies, that the majority of studies cover the period of the Great Depression, and that the studies that cite Fisher provide ‘little empirical evidence on the mechanisms Fisher outlined’ (p1051). From this starting point, Smith reviews many studies, and concludes that ‘the historical research does not seem to me to provide much evidence on the debt deflation mechanism in the 1930s’, and that no recent studies are identifying debt deflation in a deflationary environment that might support a ‘spectre’ of deflation hypothesis.

5. Deferred Spending

The idea that deferred spending is a result of deflation is described by Smith as the worst argument made against deflation, noting that the saving from deferred spending will lower the rate of interest and increase investment. Smith is quite right to question the principles of deferred spending, but his questioning might be taken further.

Smith later looks at some modern deflations, such as Hong Kong coming out of the Asian crisis, and finds that there is a correlation in these cases with unemployment. However, in some of the cases that he examines, the deflation appears to be resultant from shocks (i.e. the shock of the Asian crisis itself for Hong Kong and the collapse of property prices, the property and equity melt down in Japan). In two cases, Britain and Canada in the 1920s and 30s, the explanations are less clear, though some of the deflationary episodes followed episodes of high inflation, and other parts of his analysis again cover the Great Depression. Without more detail on the episodes in these countries, with which I am not familiar, I am unable to comment on these.

It should be noted here that he is presenting a very limited number of examples in which there is a correlation between unemployment and deflation, and his conclusion is that, whilst he has found a link between deflation and depression (in the form of unemployment), he can not square this with the other studies. Most importantly, he points out that there are 'different kinds of deflations', meaning that there is no reason to link deflation to depression. His own examples, are therefore not indicative of the idea that deflation will cause a depression, or that deflation must be accompanied by depression. Even Smith, despite a genuine intention to examine deflation from a firmly empirical point of view, appears to have a basic confusion in the cases that he studies. The confusion arises from trying to impose economic theory on to the evidence.

The source of the unemployment in Japan and Hong Kong was, in both cases, the result of unwinding bubbles in which resources were allocated in unsustainable ways. The bubbles in the economies led to the destruction and misallocation of capital, and labour being directed into unsustainable businesses. Unemployment is inevitable. It will take a considerable amount of time for the bubble based businesses to unwind, and further time for retraining and redeployment/retraining of workers who are laid off as a result. It is a simple and logical explanation. Why on earth would deflation result in unemployment? As Smith himself identifies, there is a lack of evidence for this mechanism.

The interesting thing about Smith's work is that it is a review from academia (interestingly including work of Ben Bernanke). As was mentioned at the start, he uses polite academic language, which is the language of polite questioning and requests for further study. Nevertheless, he presents a compelling demolition of the idea that there is any evidence that deflation will lead to depression, or that depression accompanies deflation.

The most important point in the paper by Smith is that it shows that deflation can take place during periods of growth in output, that the deflations associated with depressions are mostly the result of shocks and were not causal. At the moment the world economy is undergoing a shock. That this shock might cause deflation does not make deflation a 'bad thing'. It would simply means that it is associated with a 'bad thing'. However, the scare of deflation has been used to justify the printing of money, low interest rates and the fiscal stimuli.

As I argued in an earlier post, it is not deflation that is a problem, but the move from inflation to deflation, or even high inflation to low inflation. What we are seeing in the stimuli and money printing is an attempt to prevent such an occurrence. For any borrowing undertaken at a fixed interest rate before the change, these result in real increases in the burden of debt for the period of the fix. Preventing this problem might be seen as a justification for the policy, but the broader cost of these policies is a risk of hyper-inflation. The scale of the potential problem of the increase in the debt burden has never been spelt out, but it is the only legitimate reason that might be used to justify the deflation scare. More to the point, the transition from high inflation to low inflation has an identical effect upon debt burdens (see notes for further explanation), but we have never heard arguments against moving from high to low inflation. Why is that?

At the moment, the depression is already taking place. That depression might create deflation is not to say that the deflation is itself problematic. When looking at the deflation scare, it is a genuine puzzle that the scare has been allowed to gain so much traction. There is simply no evidence that a deflation would take the economy deeper into depression. Despite this, all over the OECD there is a huge experiment in monetary expansion, and an explosion of debt, with the fight against deflation as one of the explanations for this policy.

It just does not add up.

References:

Atkeson, A. and P. J. Kehoe (2004), "Deflation and depression: is there an empirical link?," American Economic Review, 99-103.

Bordo, M. D., C. J. Erceg, and C. L. Evans (2000), "Money, sticky wages, and the Great Depression," American Economic Review, 1447-63.

Fisher, I. (1933), "The debt-deflation theory of great depressions," Econometrica: Journal of the Econometric Society, 337-57.

Notes

Note1: I have included a previous discussion of deflation from a previous post in the notes below, and have added an additional example that shows that consumers do not defer spending:

In the following examples, it will be shown that the reality is that people do not delay purchases in the expectation of lower prices.

Example 1 – Fast Moving Consumer Goods

If shampoo manufacturers were to improve their output by 5% through a manufacturing innovation each year, their output of shampoo would increase, and this would reflect in a decrease in the price of shampoo. In other words, there will be a steady and continued deflation in the price of shampoo. According to the idea that consumers will delay purchases in an environment of deflation, in such a situation, consumers would choose to walk around with greasy hair, never buying shampoo in the expectation of further price decreases. Such a proposition is fatuous.

Example 2 – Hedonic Goods

Over the last few years countries such as the UK have seen the emergence of many discount airlines, such as Easyjet. The emergence of these kinds of airlines, and the increase in competition within the sector, has seen the price of air travel deflating. Much of the utilisation of these airlines has been by consumers using the discount airlines to have cheap foreign holidays, and this can be described as a hedonic good. It is an entirely discretionary expenditure as there is no necessity to go on holiday to another country. Despite the continual deflation, there have been many years of continual expansion in the discount air travel market. The deflation has not prevented consumers from taking flights to go on holiday, but rather has had the opposite effect.

Example 3 – Computers

Personal computers (PCs) are an interesting case, as they have year on year improved performance and year on year seen deflation of actual prices. It is also an example that includes both business purchases and consumer purchases. Despite the ongoing deflation in the prices, the market for PCs has had a long period of explosive growth throughout this deflationary period. It seems that the steady deflation in prices has had no impact through the postponement of purchases.

Example 4 – Special Cases

Remaining with the example of PCs, it is possible to construct a hypothetical example of how consumers might indeed delay their purchase in expectation of deflation. If one of the large computer manufacturers were to announce that they would be introducing a new type of computer in the coming year, and that the computer was to offer twice the performance at half the cost, it is quite likely, assuming their claim were credible, that consumers might delay their purchase of computers in expectation of this future deflation.

Example 5 – Purchasing on Credit

The example of purchases on credit with interest of goods and services suggests that there is a fundamental flaw in the deferred purchase argument; that theorists have misunderstood the psychology of consumers. Purchasing a product on credit at interest is a real increase in the cost that will be paid for the good, whilst saving the money with interest paid is a real decrease in the cost paid for the good. Despite this, many consumers do not defer the purchase, but instead choose to purchase the good at greater cost now, than the cost in the future. Furthermore, in sectors such as computers, the deflation of the good does not prevent purchases utilising credit.

If the thinking of those who argue against deflation is considered, such a deflation is a ‘bad thing’ as consumers withhold their money in expectation of lower prices. If this logic is followed, then the new and more effective design of computer is not a good thing for the economy, as it has created a deflation in the price of computers, and has caused a delay in the purchasing of computers. However, once the computer is introduced, it will make more computing power available to more people. How this might be a ‘bad thing’ is not entirely clear. Everyone who purchases a computer sees their wealth increase, as they are able to enjoy relatively more computing power in relation to their income. They are quite literally wealthier.

Comments

[TCK:]

Inflation only benefits the government and other excess debtors. Like any Ponzi scheme, ( such as Social Security, etc. ) the continuation is based on new money coming into the system.

Aug 03 10:35 AM

[Michael Clark:]

Nothing in nature expands for ever, and this includes social systems and economies.

A heavy debt burden comes from too easy credit, not from hard credit. A society can't pay off its debts UNLESS it saves to do so. Lower interest rates discourage saving -- and encourage taking on more debt.

The only way deflation makes the debt burden more difficult is that it generates defaults, which is the unwinding of debt that should not have been taken on in the first place.

What's worse: bankruptcy now; or indentured servitude forever. Bankruptcy now punishes banks that should not have made the loans they made; indentured servitude forever is great for the banks but for no one else.

An economy cannot and is not meant to grow (expand) for ever. Nothing is nature grows for ever. Nature has a time of rest, latency, dormancy. This period of dormancy is the Winter Season, the Deflation, the Contraction of the Economy.

On Aug 03 07:25 AM chap08 wrote:

> This article dismisses debt deflation too lightly (doesn't really
> address it at all). Surely one of the lessons of the last few years
> is that alongside our nice economic theories, we need something called
> common sense.
>
> The main problem in this country is a high debt burden. Ask yourself
> if it is a good idea to make this problem worse (through deflation)?
> Common sense will give you the answer.

Aug 03 10:53 AM

[Michael Clark:]

When assets 'lose touch with reality' God reminds them what reality is.

Much US and global wealth will be wiped out by deflation. That's what happens during Night-Cycles. Falsely inflated assets get knocked down to their knees.

If you understand the implicit meaning of Judeo-Christian mythology, and the Days of Creation: for six days the world is created, and on the 7th Day, the sabbath, Saturday, Saturn's Day, everything stops. Saturn carries a scythe. He is the end of Time.

Death (deflation) is built into the bud, as Dylan Thomas wrote.


On Aug 03 10:05 AM Gregory Orr wrote:

> It's all about debt. Deflation means that assets are worth less than
> the debt against them, therefore wiping out wealth created through
> leverage. As DebtNation, much US wealth would be wiped out by deflation,
> and really inflation and strong economic growth are the only exit
> doors for a high-debt nation.

Aug 03 11:06 AM

[chap08:]

Michael, you are wrong. Inflation eases the debt burden and deflation increases it. This works at both the micro and macro level.

If you have a housing debt to service and your wages go up due to inflation, your debt burden is eased. If your wages go down due to defaltion, your real debt burden is increased. Same for the US government which has to service debt from GDP.

This is a key consideration for the government and that is one reason why it has a policy of inflation over deflation (much to the anger of the Chinese).


On Aug 03 10:53 AM Michael Clark wrote:

> Nothing in nature expands for ever, and this includes social systems
> and economies.
>
> A heavy debt burden comes from too easy credit, not from hard credit.
> A society can't pay off its debts UNLESS it saves to do so. Lower
> interest rates discourage saving -- and encourage taking on more
> debt.
>
> The only way deflation makes the debt burden more difficult is that
> it generates defaults, which is the unwinding of debt that should
> not have been taken on in the first place.
>
> What's worse: bankruptcy now; or indentured servitude forever. Bankruptcy
> now punishes banks that should not have made the loans they made;
> indentured servitude forever is great for the banks but for no one
> else.
>
> An economy cannot and is not meant to grow (expand) for ever. Nothing
> is nature grows for ever. Nature has a time of rest, latency, dormancy.
> This period of dormancy is the Winter Season, the Deflation, the
> Contraction of the Economy.
>
> On Aug 03 07:25 AM chap08 wrote:

Aug 03 11:59 AM

[Howard_T:]

Deflation is only 'scary' to those in government who seek to enhance their power. As long as there is a graduated income tax, inflation will tend to push a certain number of taxpayers into a higher bracket, thus increasing federal revenues. The taxpayer's wages, in terms of constant dollars, have not increased, so he is now stuck paying more tax on the same salary. (I remember on at least one occasion getting a "cost of living" raise and winding up with less take-home pay because of a higher bracket.) As long as those in government continue in the same direction, we will have inflation. Our only hope is that by some miracle, the voters of this country will wake up and put nothing but fiscal conservatives, who will insist upon a complete change in the way the monetary system is run, back in charge.

Aug 03 12:02 PM

[richcam:]

The best argument I have seen in support of deflation is by Bob Prechter at elliottewave.com .
In the lower right hand pane of the website is his reader's digest version of why we are and will continue at least in the near term to experience deflation. "You can't fight deflation in a credit economy".

Aug 03 12:20 PM

[richcam:]

put one too many letters in my link above

elliottwave.com

Aug 03 12:22 PM

[thesheet:]

Something else to consider.

The vested interests in the fractional banking system prefer inflation.

When the monetary supply is initially inflated, the people that benefit the most are those who get the new money first. Before the inevitable inflation occurs. The money they get is in today's dollars. Once they use the money, it gets out into the general economy and that is when inflation hits. The average person gets money last in the form of wage increases (if you're lucky), but only once inflation occurs. In other words normal folks are not benefiting from inflation at all. In fact it is a tax, an indirect tax, a sneaky quiet tax; but a tax...

Aug 03 01:37 PM

[ebreen:]

One problem with the discussion is that you have to define deflation as a monetary phenomenon apart from a fiscal result. Index measures of inflation/deflation capture supply/demand imbalance as well as monetary imbalance. A slight monetary deflation could take place in a diversified large economy and not result in an immediate reduction in output growth. This is what happened in the U.S. economy in the run up to the Asian monetary crises...we were running a deflationary monetary policy that was absorbed in out economy but that could not be absorbed in those smaller economies that tied their currencies to the dollar...so imported the deflation and did not have the capacity to absorb it. A similar effect occurs in the inflation of the dollar where the inflation is translated to smaller economies (due to reserve character of $) and can lead to big problems in emerging markets magnified beyond the effect on our market. The issue in a depression is really the effect of a credit collapse. Fisher's theory addresses the spiral of collateral asset devaluation that occurs when credit collapses in a previously leveraged economy. That credit collapse, which you call a "shock" does not need to have strict monetary predicate...as in the case of the Collapse of theh Knickerbocker Trust that sparked the credit collapse that lead to the panic of 1907...you can have a fiscal or market or bubble event that collapses credit and then leads to a collateral asset devaluation as the panic and defaults spread...not exactly a deflation cause ...if you define deflation only as an imbalance in the suppy of money in relation to the demand for money. In any case, once you have a collateral asset devaluation spiral in progress the result is one of expected decline in asset values until you find a market clearing price and a managed return to credit liquidity.

Aug 03 02:05 PM

[stojan nena...:]

If money is debt (credit), there is inflation, deflation and economic crisis. Money must be gift, as a non-credit money. Non-credit money is the necessary additional quantity of money in circulation (dM) as percentage (k) of existing quantity of money in circulation (M) .
dM = kM ; k = (offer - demand)/demand ; If non-credit money is emitted according to the cited formula, inflation and deflation cannot exist. Also, taxes are annulled for the amount of non-credit money. The consumers pay less and producers get more than today, in the order of credit money. All get in the order of non-credit money.

Aug 03 03:11 PM

[Louis G Whe...:]

We can hardly tell what a deflation is or if it is a bad thing unless we understand what an inflation is. Consider a balloon: is it a bad thing if the air is let out? What put the air inside the balloon in the first place? How does a money supply inflate and are their bad consequences from that? Why assume that the bad consequences derive from the deflation, not from the delayed results of inflation?

The old name for a deflation was a Banking Panic; It was replaced with words like deflation or depression, because it was too descriptive. It all has to do with fractional reserve banking, but a better term for that would be checking account counterfeiting or creating bank accounts out of thin air.

At one time, there were honest banks. If you placed your money in a checking account, the bank was too honest to touch it. They were called 100% fractional reserve banks. You could loan your money to the bank so they could loan it out to someone else. You got an interest rate from doing that, because you were taking a risk. The point about a checking account was that you knew that you could instantly receive your money back or transfer it to someone else, but dissolving a loan meant waiting until the loan period was over.

The owners of dishonest banks noticed that many people parked their funds in the bank and only a small percentage withdrew their funds. This meant that dishonest banks could take the funds which were safeguarded with them and steal it temporarily. This is what embezzlers always do; they start out intending to repay what they steal.

These dishonest bankers could steal the money and spend it on high living. The problem with doing this is that eventually enough people want their money back from the bank. If it isn't there; then rumors cause a panic. It creates what is known as a run on a bank when people try to get their money back. An honest bank would have no problem if there were a bank run. They would simply repay what was deposited in their vaults.

A smarter way for the dishonest bankers is to steal the money which is in checking accounts and to make loans with it. That way the loans would be constantly rotating, interest would be charged on the stolen money, so the profits went into the banker's pockets. No one would be the wiser if the banker didn't get too greedy.

But, there are results from this, too. The numbers of good and valid loans were small. Every loan you made beyond that was more risky, because of the bad character of the person you were loaning to or the validity of their business plan. Also, making this loan meant that the recipient bid up the price of goods and services. So, monetary inflation always causes an increase in general prices. This causes the value of the checking account to fall in the good or services it could buy.

Factional reserve banking is a confidence game, so the dishonest bankers have to keep up appearances. Just like, in Gresham's law, bad money drives out good, hence debased or paper money drives out gold coinage, dishonest bankers drive out the good bankers. The dishonest bankers must confuse their victims, too, so honest economists, politicians and newspapermen must be corrupted, as well.

The meanings of words must be changed to protect the guilty: a mythical Business Cycle must be invented to explain away the effects of dishonest banking.

The Bankers always fear a deflation because that is when their corrupt game is over. But there are worse things than a delation. The dishonest bankers have used many mechanisms to keep their Con game going, but the most common is a Central Bank like the Bank of England or the US Federal Reserve Bank.

The Central Bank tries to keep the dishonest bankers from getting too greedy and ruining the scam for everyone. Consequently, the Central Bank tells the bankers how much money they can steal from their depositors and what interest rates that can charge on loans.

The Central Banker, to protect themselves from the crimes they are committing, combine with government officials and politicians. So, the government become a major beneficiary of the con game. No Welfare state can be run without dishonest banks. The problem is the politicians always get too greedy. They need money to buy votes from the voters. They constantly need give new away programs so that the PUBLIC sector must increase and regulations increase to control the economy. If the con game is carried too far, then there is a risk that people will avoid taking the dollar in return for goods and services. The Federal Reserve bank temporarily curtails stealing bank deposits and making loans, so it creates the boom / bust cycle which it blames on everyone else.

Banking Panics were usually over very fast until the government started to interfere in the economy after the 1929 crash. The economy recovers only when wages and prices, which were bid up out of reality, fall. Only those industries where misallocated funds were placed must fold, so a banking Panic was usually over in six to nine months.

But, when President Hoover interfered in the financial markets, and propped up wage and prices in 1929, the bad economy lasted much longer. FDR continued Hoover's interventions and added new ones of his own. Hence, a Banking Panic which should have been over in 1931, lasted for 13 years.

The reason that it lasted so long was that the government would never allow the economy to recover. It was not until after World War two impoverished the country sufficiently to make up for the disparity in wage and price rates. Only then was the economy allowed to recover.

The point is that we should hope for a recession where the government doesn't try to repeat Hoover's and FDR's mistakes. So far, given the fact that the Obama is out bidding FDR in his foolishness, there as been no hope for a recovery. But, all is not lost. This recession is world wide. Actions are being taken in the rest of the world which may spike Obama's guns. But, since the Obama lunatics are running the asylum, much economic insanity lies before us.

Aug 03 03:52 PM

[Cynicus Eco...:]

Many thanks for the interesting comments. There have been some interesting points raised. In my original article, the following was included and may address some of the concerns (I am guessing the article was too long for SA:
-------
Debt and Deflation

There is an argument that suggests that deflation causes problems with the servicing of debt, as the value of the debt sees relative increases through the deflation. This is a scenario that appears to be very plausible, and can be backed by some solid calculations and formulae. However, what is missed in such arguments is that it is not deflation that is problematic, but the move from inflation to deflation. It is not the change in the value of money that is problematic, but the change in inflation/deflation from the original inflation/deflation position from the time of the issuance of the loan.

A good example of this can be seen in private mortgages on housing. If a loan is taken out in a high inflation environment, the interest rate will be relatively high. The targeted central bank interest rate will be high, and the lenders will seek to account for the high inflation by charging a rate of interest that will overcome the devaluation of the money that they are lending, such that they can achieve a positive return. If the interest rate is fixed over a period of, for example, five years and at year four the rate of inflation has fallen by a half, the holder of the debt is effectively seeing the value of their debt inflating. The earlier rate of inflation was eroding the value of their overall debt, and this was accounted for in the interest rate. However, with inflation falling, their debt value is no longer declining at the same high rate, but they are still servicing the debt as if this were the case. Their payments in relation to the actual value of the debt have increased.

If we think of this example and think of a change in the rate of inflation from 5% to 2%, and compare this with a change from 2% inflation to deflation of 1%, we can see that there is the same process taking place. In both cases we are seeing the relative burden of debt in relation to income moving in exactly the same way. In the inflation and deflation environment, interest rates will move to reflect the underlying changes in the value of money, and debt burdens will be locked into repayments that are based upon an out of date criterion.

In other words, it is not inflation or deflation that is problematic, but rather it is the change in inflation/deflation that alters the burden of the debt. As such, any monetary system should aim to achieve either stable inflation or stable deflation.
------
I hope this helps. If I have a chance, I will try to return to address some other points.

Aug 03 04:54 PM

[chap08:]

Cynicus ...

Thanks for addressing my point about debt defaltion. However, I do not think that your answer resolves the issue. Even accepting your answer that the problem only occurs through the transition, the point remains that we currently have extraordinarily high levels of debt. Hence, making the transition with this level of debt will create extraordinary problems. Perhaps the transition would have been possible with the debt levels that we had in the 90s, but now it is totally unrealistic.

Aug 03 05:23 PM

[snorake:]

Seems like deflation would be scary for holders of debt secured by deflating assets. While one could argue that forclosure would yield the same property and therefore deflation would not affect the "real" value of the debt, it is certainly far more likely that the debt will not be serviced and that the planned income stream is in jeopardy. That should give those living on their investments a reason to be concerned. It would also give most landlords a reason to be concerned if they are using any leverage. In fact since commercial loans can be called if the loan amount exceed the appraised value of the collateral, They could lose their entire positions even if the rentals cover the debt service.



On Aug 03 02:46 AM Egg wrote:

> Well said.
>
> I've always thought deflation was something to be welcomed and would
> be beneficial to a lot of people. Especially people with low debt.
> Buying power increases even without wage increases. Most people in
> Japan during the 90s deflation have actually thrived.
>
> The obvious reason the U.S. government fears it so much is, of course,
> the growing national debt since deflation (in real terms) increases
> the principal owed on top of paying the interest.
>
> So the people who would benefit are out of luck since the government
> has run up such a massive debt in their names. The Fed will print
> and print in order to destroy the dollar and keep inflating away
> the debt. And even though deflationary pressures exist, I have little
> doubt the government will eventually get its way.

Aug 03 09:13 PM

[Gregman2:]

This thread is one of the most enaging I've ever read...EVER. Thank you, all. Fantastic thoughts. I'm just a very simple guy. I don't put much credence into the concept of unearned income. If I invest in/buy an asset it needs to ultimately be able to pay for itself, which means servicing the amount of debt taken on...could be a car, house, factory, apartment building. When the ratios are out of whack, too much income must be applied to debt service. If everyone is overloaded and no one can really buy...the price I'm trying to sell at, well, I keep having to drop it, just to find someone to buy. So, this is debt deflation to me. I think this is the general situation we find ourselves in--systemically now.

Aug 03 10:00 PM

[Michael Clark:]

Yes, inflation eases the debt burden in that it ruins the local currency. More dollars means the debt you owe is monetized, your debt is liquidized, but at the same time the dollars you are holding become worthless.

Deflation eases debt in the sense that it reduces NEW debt -- since deflation and higher interest rates are supposed to go together.

Deflation changes the society from a DEBTOR society to a SAVER society and ultimately makes the consumer more powerful and the banks less i control of the consumer's life.

We cannot ignore the fact that the longer we keep interest rates low, the weaker the dollar becomes, and the wealth that we own currently becomes more and more worthless.


On Aug 03 11:59 AM chap08 wrote:

> Michael, you are wrong. Inflation eases the debt burden and deflation
> increases it. This works at both the micro and macro level.
>
> If you have a housing debt to service and your wages go up due to
> inflation, your debt burden is eased. If your wages go down due to
> defaltion, your real debt burden is increased. Same for the US government
> which has to service debt from GDP.
>
> This is a key consideration for the government and that is one reason
> why it has a policy of inflation over deflation (much to the anger
> of the Chinese).

Aug 04 12:45 AM

[Michael Clark:]

That's it in a nutshell. Maxed out on debt. When the consumer can no longer service their debt, consumer finances implode. They stop taking on debt and begin selling what they can to cover the cost of their debt. It becomes a buyer's market. Assets for sale bring less and less at the great auctionhouse of the free market. Prices deflate.

When the psychology of ever-and-ever good times changes to oh-my-god-I'm-going-to... there is a sea-change...and people begin saving, they become tight-fisted. It's called 'Fear of God' in the bible.

Everything in nature breathes. When nature breathes out it fills a bubble. An atom is a filled bubble in a sense. That is inflation. Vitalization of the object, the body, the material world. When nature breathes in it empties the bubble. That is deflation. De-vitalization of the object, the body, the material world. All things collapse.

Nature can't breathe out for ever. There is a cycle of breathing out: the Day-Cycle. And a cycle of breathing-in: the Night-Cycle.


On Aug 03 10:00 PM Gregman2 wrote:

> This thread is one of the most enaging I've ever read...EVER. Thank
> you, all. Fantastic thoughts. I'm just a very simple guy. I don't
> put much credence into the concept of unearned income. If I invest
> in/buy an asset it needs to ultimately be able to pay for itself,
> which means servicing the amount of debt taken on...could be a car,
> house, factory, apartment building. When the ratios are out of whack,
> too much income must be applied to debt service. If everyone is overloaded
> and no one can really buy...the price I'm trying to sell at, well,
> I keep having to drop it, just to find someone to buy. So, this is
> debt deflation to me. I think this is the general situation we find
> ourselves in--systemically now.

Aug 04 12:55 AM

[Erick Tippett:]

Mr. Syniucus Economicus,

You seem quite attached (as the result of your 'research' no doubt)
to the notion that '' there is absolutely no evidence that deflations
will cause depressions". In your references I failed to notice any mention of such economists as Ludwig Von Mises, Friedrich Hayek, or Elliot Wave expert Hamilton Bolton who in a 1957 study
stated:
In reading a history of major depressions in the U. S.
from 1830 on, I was impressed with the following:

(a) All were set off by a deflation of excess credit. This
was the one factor in common.

(b) Sometimes the excess-of-credit situation seemed to
last years before the bubble broke.

(c) Some outside event, such as a major failure, brought
the thing to a head, but the signs were visible many
months, and in some cases years, in advance.

(d) None was ever quite like the last, so that the public
was always fooled thereby.

(e) Some panics occured under great government sur-
pluses of revenue (1837, for instance) and some
under great government deficits.

(f) Credit is credit, whether non-self-liquidating or self-
liquidating*

(g) Deflation of non-self-liquidating credit usually pro-
duces greater slumps.

*(Self-liquiddating credit is a loan that is paid back, with interest, in a moderately short time from production and generates a financial return. Non-self-liquidating credit is a loan tht is not tied to production and tends to stay in the system).

Reference:

(Robert R. Prechter Jr." Conquer The Crash" (2002), Pgs. 88-89)

Though a considerable amount of literature has appeared relating
to this subject of deflation/depression, the few economists who
have warned of the preconditions causing its creation have been
ignored for the most part.

E. Tippett
Chicago, Illiinois

Aug 04 04:35 AM

[Ray Winter:]

Deflation is hated by Banks and Governments as they are forced to pay back their borrowings in 'hard' (real-value) currency.

Inflation is loved by borrowers of all kinds because today's hard dollar is tomorrow's cheap one.

The one group that never wins is the 'Saver'. They get penalised every which way and yet, if they received a decent interest rate on their cash they would be the major beneficiaries of deflation, with real increases in their wealth.

Governments, in particular, do not like to see its people getting rich, as 'money equals power' and hence their need to keep taxes at the maximum levels to keep the population under their control. Hence, it's only Governments that see deflation as scary.

Inflation delivers people with a feeling of increasing wealth, but in reality it is illusionary. However, the masses think they are getting richer with inflation, and in deflationary times they would get depressed if their wealth simply remained static.

Clearly, paying savers a decent interest rate in deflationary times, would in itself either cause inflation as money has to be found by governments to repay debts, unless productivity and manufacturing output can be increased sufficiently to create real wealth to deliver the increased levels of taxation needed to cover the Governments costs of borrowing.

Inflation is always the easy option for Governments.

Aug 04 10:42 AM

[Fred Linn:]

Inflation is when you are working your butt off and you can't buy anything because you are being paid in worthless dollars.

Deflation is when you can't buy anything because you don't have a job or any dollars.

Aug 04 02:55 PM