Posted on 11/02/2009 7:53:41 PM PST by blam
Is Debt-Deflation Economic Depression Just Beginning?
Economics / Great Depression II
Nov 02, 2009 - 03:12 AM
By: Mike_Shedlock
Last Thursday I received an email from David Meier, Associate Advisor at the MotleyFool concerning Debt-Deflation.
David asked if I had any comments on his article Debt-deflation: Just the beginning? Here is a partial listing:
The debate rages on.
Is inflation or deflation the bigger threat? There are lots of people -- lots of smart people -- on both sides of the debate and they present lots of good arguments. One thing that I have not seen -- and maybe I just missed it -- was an analysis using Irving Fisher's debt-deflation framework. So I decided to put one together myself and to inject my understanding of what Bernanke is try to do to stop deflation from taking hold.
The question I keep coming back to, especially as I read more about the situation Japan faced (I'm reading everything I can by Richard Koo, including his book "The Holy Grail of Macroeconomics."
And just to make sure I am not being one-sided, I am countering my fears of deflation with "Monetary Regimes and Inflation" by Peter Bernholz, which should arrive next week.
Without further ado, below is my research on debt-deflation.
Dave
Dave's research is a 70 Slideshow Page On Debt-Deflation that is easy enough to read or download from Scribd.
Here is my response ....
You should not be afraid of deflation.
You should be afraid of policies attempting to fight it.
[snip]
Deflation??? Are things getting cheaper where you are, besides houses?
I’ll believe in deflation when I see it. Even last year, the only thing that really deflated in price was gas.
Deflation is a real issue as it makes people not want to buy anything so they just wait to buy it. Our economy is based largely on consumption so it would be very bad for us. However, to fight it all the gov’t would do is print more money to pay off our debt...which in turn causes other issues.
Eventually everyone needs to pay the piper...just how long they can drag it out is the question.
No. And, contrary to what everyone is saying, food prices are rising, with the exception of milk.
Commodity-based products like food and gasoline may show a short-term uptick now and again. But without the ability to borrow money to buy big-ticket items, where is the driver for consumer price inflation? The government can't begin to print enough money to make up for all the credit that has been destroyed, so we are in for a long, slow, Japan-style grind down to a lower standard of living. People with cash will do pretty well - the average American with nothing but debt is in big trouble, as that debt gets progressively more expensive to service.
I-think-my-head’s-gonna-explomode-’cause-I-can’t-take-any-more-economic-angst self-ping. Dying to see what comes of this thread.
One thing the federal reserve re-inflated successfully: the stock market. Your theory is correct as long as things get worse. Any real improvement will lead us to what we saw in 2007-2008 food and energy and metal inflation and moans and groans again.
I do see really low prices on food and clothing lately. Last week I bought pork chops for $1.37lb and I'm seeing beef steaks and roasts for under 2 bucks a pound regularly. Maybe it's just supply and demand, prices being reduced because sales are down, but it's noticable.
I fully do expect to see massive inflation eventually, but I don't really know when.
Recently I bought whole pork tenderloin for .99 cents a pound and roasting chickens (huge) for .69 cents a pound. .99 cent a pound boneless skinless chicken breasts have been very common this summer as well. My freezer is full, everytime they run these sales I fill my basket.
It absolutely can happen and does happen. We can print how ever much money we want...sure no one will ever invest in our dollars so we’d need to find something else to back our currency (like US land or gold).
Here’s the thing. Money in circulation only gets destroyed when loans to commercial banks—there’s alot of them that were never considered banks before, ie Government Sachs, Amex—get paid back at a higher rate than new ones are made. Certainly this is happening, but you have to look at the money supply. Up to this point it hasn’t been diminishing, except M3 which has gone down for the past few months. But then we have the outright monetization of debt, where the Fed simply creates new dollars out of thin air which is then paid to holders of government agency debt. This money, once created will never be destroyed and it will have a much faster inflationary affect. When Friedman timed the inflationary affects of new money in the system, he was simply measuring inflation due to credit creation, whereby money breeds like rabbits due to fractional banking. Outright monetization was a relatively rare phenomena back then. Now through the glories of quantitative easing, it is the rule of the land. And QE is like rocket fuel to inflation. Look at oil, gold, copper and other commodities since the QE started. And you ain’t seen nothing yet. Just wait six months. But then the massive deflation will set in.
Or eliminate it through bankruptcy or foreclosure?
Not 100% sure, but I think discharged debt has the same money destroying effect.
I believe I’ve already read that the big box chain stores have given analysts “guidance” that holiday season discounting will start very early and go very deep — you can be sure that electronics will be a lot cheaper than last year. I’m also definitely seeing deflation in second-hand items, which I shop for a lot. Stuff is going on eBay for significantly less than the same items a year or two ago, and many things are going unsold that would previously have sold with multiple bidders.
Deflation is much prefered. Inflation has no ceiling. Deflation has a bottom.
Wages will lag behind so you’ll last longer in a deflationary cycle than an inflationary cycle.
Neither is desired but, given one over the other, I’d choose deflation. The Great Depression is filled with stories of people who learned how to get by without much money. It’s worse if your money is simply worthless becuase everything costs too much.
Definitely true!
When I need replacement parts for my computers or peripherals I usually find them there for almost nothing. Got three new in box HP 3900-a cartridges for $18. (normally $75 each)
Last summer, I got a nice HP Pavilion box with XP, hard drive wiped and restored with original factory disks, which were included, for $175, *including* shipping. Works great! I’m a happy Vista-free camper :-)
You actually have major deflation all around you.
I'll prove it to you...
First, you must understand that what we call "money" is actually the same as debt. Money is based on debt. Money = debt, and debt = money.
Once you understand this, then a bright light shines on our whole economic mess.
Think of all of the debt destruction happening in our country right now. Housing foreclosures, commercial real estate, bankruptcies, job losses, benefit cuts, etc., etc., etc.
All of that debt destruction is ALSO money destruction, since debt = money and money = debt.
Have you ever heard of the Marianas Trench? It's the deepest part of the ocean. Think of our country's debt hole as the Marianas Trench. It's there creating a huge sucking sound - but many people ignore it since they can't see the scope of the Trench with their own eyes.
Now we have the huge amount of debt that the Federal government is taking on - and encouraging the public to take on through participation in "cash for clunkers", first-time homebuyers, etc.
Let's call the pile of new debt Mt. Everest. Everyone can see it spiraling up into the sky. Yet people can't figure out why the government is creating so much new debt since they think that we're heading to major inflation or hyper-inflation.
The answer lies in the fact that the Federal government is desperately trying to fill the Marianas Trench with Mt. Everest. They're trying to stop the deflation monster that threatens to swallow them whole.
There's only one slight problem. The Marianas Trench can swallow Mt. Everest whole, and still have over one mile of water left over on the top.
Our country is in HUGE trouble. The deflation monster has been unleashed - and it was unleashed on purpose by the multi-national bankers.
Our government is running scared at all levels. They are powerless to stop this - and their very power structure is at stake.
Very cogent explanation!
(put on your flame suit, the crazies are coming)
Very interesting and vibrant example...you’ve given me something to think about.
Wages are also declining.
The exchange value of money has increased on fear trades sparking debt liquidation. In Euros, the US economy bottomed in April of 2008; in dollars, back in March of 2009, lagging. Everything that flew to insane in the bubble collapsed about twice as far as it needed to and retraced about half the move - from oil, to stocks. House prices haven't retraced, but weren't 4 times out of whack to start with, only about 1.5 times.
Total paid has been flat even with higher unemployment; real wages for those actually working have not declined at all. Tax reductions have covered nearly the entire hit to nominal incomes, leaving real disposable practically unchanged. The initial drop in consumer spending raised the savings rate; as that rate stopped rising consumer spending reversed. The spending swing reflects a savings rate swing and not an income swing. The drop in GDP was instead due to a 20-25% reduction in overall investment and the sharpest inventory contraction in modern times.
One entry accounting is the source of practically every doom mongering error there is. Every transaction has two sides; it suffices to willfully ignore one to pretend all value will disappear. But it is utter poppycock.
The rest of your post is merely incoherent gibberish.
Milk is cheap because dairy farmers are just about done for.
I expect it will get expensive when there isn’t any?
Deflation is great for the consumer, because things are getting cheaper. Except, the consumer loses his job, which complicates things.
Well, personally I own my house outright and have a short commute, so housing and gas “deflation” don’t impact me much. It seems the cost of everything else is continuing to go up.
Even prior to the Financial crisis, I felt that this country was addicted to growth in the way that some athletes are addicted to steroids. Not that growth is bad, but growth at ANY COST is bad. For example, importing illegals in by the truckload to give the illusion of growth is bad. Giving people loans to buy houses they can’t afford is bad. Encouraging people to take on home equity loans to buy junk they don’t need is bad. People working 24/7, either in the office or using an electronic leash, is bad. Kids who get obese gorging themselves on junk food is bad. This was the America I saw (and stil see) all around me. I kind of got the impression that the second we stopped growing, we might collapse. Perhaps that is what is happening now. We’ll see.
Are they? I see eggs way down, produce staples like potatoes and now apples too. Meat fairly steady. Seafood, no—but that’s a special case.
You’re quite right that tends to have cyclical pricing: when it’s high or other incentives are in place, farmers increase their herds to the point of lowering prices. When the price is too low, the farmers cull so many of their cows that the stock becomes too low, which causes a shortage until the population can again be restored.
No, I’m saying that dairy farmers are losing their shirt. That’s one of the reasons for farm price supports of the 30s up until recently. A gallon of milk swinging from .75c to 15 bucks and back down again isn’t a good thing. Things are dire for hog producers too. Enjoy the cheaper prices for now...
I know they are, which is unfortunate. But if you don’t actually have the discipline of market prices you end up with huge government-subsidized overproduction. Cheap credit hurt overexpanding farmers too.
You're correct, I never stated otherwise.
Many have experienced declines in compensation from reduced wages, reduced hours, and lower benefits, in particular employer retirement contributions. In some industries, particularly some government areas, compensation has increased. State government in areas outside of education has been hit hard in many states. Federal government compensation has increased offsetting many other areas of the economy. The impact on the overall economy may be neutral. The decline in compensation across many private areas of the economy is unprecedented.
These inconvenient facts are ignored by the doom monger pundit and journalist set because they do not fit the stylist narrative of the death of capitalism, which the left is peddling for all its old Marxist reasons and the right it peddling in me-too populist fashion, hoping it sticks to the current administration.
The sober reality is all the political spins both ways are overblown hype, and we've had a typical recession that caused a large spike in unemployment with only a modest drop in actual income, largely because fiscal policy has maintained incomes etc. And as usual the whole thing has been brief and already merits a past tense, but everyone on earth wants to pretend it will last forever and fly off to zero.
Well, what theories do you support?
How does no reality correspond? Increasing the money supply puts upward pressure on prices as that money is released into the economy. That’s what happened with the stock market and real estate bubbles. It’s Econ 101.
Are you an economist?
Do you think deflation is a good thing?
Which part of my post is gibberish, as you say?
Don’t be ridiculous.
The amount of deficits the administration are running are unprecedented and unsustainable. Sure, being against ‘Doom Mongering’ is a noble pursuit and all, but you can’t ignore the obvious.
I happen to believe that those who think the printing presses are running day and night are wrong. We aren’t doing that. We are merely running unprecedented debt. We are basically borrowing every dollar we demand to borrow. I am not a ‘doom monger.’
Short terms scenarios and doom mongering aside, none of this looks good for the longer term. I don’t care who you are. You shouldn’t behave as if it’s ‘no big deal.’
This administration must be held accountable for the economic damage that they are inflicting. They must be stopped in this ‘transformation’ that they are implementing. I say call them to the carpet. If you have a problem with Conservative populism, you’re on the wrong board, buddy. You know where to stick you elitism, buddy.
In the meantime, we shouldn’t trust anyone who stands to gain from speculation off the next ‘big thing.’
Are you one of these people?
Conservatives are not peddling anything, especially nothing populist. The current recession has never been the issue aside from fear of a banking collapse last fall. The issue is the long term direction of the economy. There are plenty of reasons to be alarmed by the long term direction of the economy, almost all political reasons. The poltical process and resulting policies are the issue. Entitlement spending threatens to swamp capital markets and pressure the dollar. Existing entitlement programs are a big problem but Democrats want many new entitlements, especially health care rights. Democrats have unleashed a barrage of new regulation and litigation potential. Cap and trade is a huge expansion of regulation and potential litigation. Democrats have nationalized a number of key industries, most notably energy production. Innovation is being heavily skewed towards politically favored areas. Democrats have revealed plans to drop huge tax increases on the economy, further draining investment capital. I am not alone in pessimism about long term economic growth if these economic policies are not thwarted.
But you are wrong about the economic attitudes on the right, and on this site in particular, and their relation to the present recession. They emphatically do think it is the issue, and regularly tell me that the economy will go straight down indefinitely because their preferred policies are not being followed, and hell must be loosed in consequence. This is, needless to say, bumbcomb.
Outside of activist circles, approximately half the world (journalists, financial commentators, investment gurus, etc) is also screaming that the dollar must be worthless in the near future, despite the stubborn unwillingness of actual markets to reflect this supposedly obvious and necessary prediction. They link this prediction to endless doom mongering about the economy, do not believe government GDP or CPI numbers, and think making up disaster movie scripts can be passed off as economic analysis.
And they endlessly require correction. You may not bother, but I do.
There is no tendency for the so-called "velocity of money" to reflect actual transactions, nor as a measured variable to remain stable. It is a fudge factor number between the quantity of money and the rate of GDP income. Quantity theorists originally predicted that it would be a constant and therefore that the price level would always move in synch with the money supply. Since manifestly this does *not* happen, empirically, Irving Fisher invented the "velocity" notion to stand between them, and supposedly save the prediction "in the long run" or "on average". Which, there being no tendency for this measured item to remain stable, it utterly fails to accomplish.
The actual size of transactions in the economy isn't GDP to start with. GDP measures value added, not transactions. The same transformation of goods from input factors to final consumer goods purchased can touch 48 pairs of hands or 1 pair of hands; if the difference between the cost of the inputs and the value of the outputs is the same, the GDP impact in the same. But "velocity" intepreted literally, if meant to reflect actual dollars changing hands against goods, is 48 times higher in the former case. As measured, it isn't, because those citing it never measure against transactions, but instead against GDP (an income, and therefore a value added, item; not a cash flow and therefore gross transactions, item).
The empirical turnover of $1 of money in existence is about 1000 times higher in New York City than in the midwest. If anyone cared about actual transactions velocity, it would bounce around like a ping-pong ball as money sluices into financial circulation where it turns over forty times a day as fast as computers can make trades, or out into the eddies of small business cash registers where it will sit, and the like.
Next there is the question of which money is being measured as an income velocity, ignoring the transactions velocity meaning as a red herring. Currency, or M1, or broad savings forms of "near money", used not for transactions but as a preferred form of investment? Because they are not remotely the same thing, and they do not remotely have the same relation to the price level, empirically.
One can prove as a theorem that the belief that the price level will generally move in line with broad money (including savings forms) is equivalent to denying the possibility of real economic growth, except as a temporary illusion bound to reverse. Needless to say, this is false empirically. To see this, just imagine that people want to continually keep say 10% of their total wealth in savings forms of near-money. Now let their total wealth rise with nominal GDP. According to the idea that velocity will be broadly stable, what is supposed to happen to the price level?
Answer, as pure math, it must rise as fast as nominal GDP. Ergo, real economic growth is impossible on those assumptions. Ergo, those assumptions are bumbcomb.
The reality is, income velocity measured against broad money falls continually as wealth increases. Not that this means economic transactions are endlessly slowing down - it is a mere mathematical byproduct of how the terms have been defined, and the reality of real not just price-inflation growth of wealth.
Hence my comment that "the velocity of money" does not exist, and all the theories erected on its supposed tendency to remain stable are rot. Top to bottom. Incoherent, falsified.
Next to the statement that "increasing the money supply puts upward pressure on prices". Like most things in economics, only under the proviso "all other things being equal", which they never are. In fact, the exchange value of any commodity, including money, it set not just by the supply of it, but by the demand for it. The implicit belief behind the statement is that the demand for money is as constant. And this is quite false, empirically.
If the demand for Toyota pickup trucks increases and Toyota decides not to make any new Toyota pickup trucks, then the exchange value of existing Toyota pickup trucks will increase. This will give a windfall to existing owners of Toyota pickup trucks. It is not remotely the case that complete cessation of supply of some commodity will cause its price to be stable. One, because existing exchange values presume an expected supply. Two, because demand varies continually, independent of the supply.
When a producer, say Toyota, responds to an increase in demand for a commodity it produces by raising production, this need not result in a fall in the exchange value of the item produced. It is true, that exchange value will be lower than it would be if they never made another pickup truck. But it may be higher than it was last month or last year, if the increase in the demand is larger than the increase in the supply.
It can also be proven as a theorem of basic micro that the maximization of social utility for all the actors combined, to be shared out however one imagines between them all, is emphatically not maximized by a producer cutting new supply to zero, with demand unchanged let alone in response to a demand spike. On the contrary, it is maximized by the producer increasing the production of the desired commodity to meet the new demand.
The relations are precisely the same when the commodity in question is money. This is obscured by confusion between money as one commodity among others, and wealth, which is not money but comes in many other forms, dwarfing money, and merely measured in money units as an accounting convenience.
When men want to hold less of their wealth in stock or in real estate and more of it in insured bank debt and CDs and money market accounts that in turn hold T-bills and short term commercial paper, they issue "sell" orders for the former that are also "buy" orders for the latter. All of the latter represent new demand for broad money as a savings medium. If this demand hits an unchanged supply, then the exchange value of money must soar. That is equivalent to saying, the money-price quoted for all of the other investment forms must plummet.
Nobody can in the aggregate get out of real estate or stocks and into money, if the supply of broad money does not move. The value of the former in units of the latter can fall as much as you like, but it won't increase the aggregate value held in the latter a dime.
The only way men can in the aggregate succeed in an attempt to shift the portion of their total wealth held in broad money form, is if the amount of broad money in existence rises in line with their increased demand. We say, the suppliers of money let investors out of the other forms, and accomodate their demand for money.
If one wants to know whether the new supply exceeds the new demand, for any commodity, it suffices to look at its price. If the supply far exceeds the new demand, then the exchange value of the commodity in question must fall.
Well, it flat hasn't, in the present case. A US dollar buys more today than it did on the day Lehman went bankrupt. There are a lot more broad money dollars in existence, about $1 trillion more. But each one buys more, not less.
And it is easy enough to see why, if one drops the fetish of a money as supposedly magical among assets. Because in the same period the amount of money owned by US households rose $1 trillion, the value of all of their other forms of wealth fell $11 trillion. Expecting the former to be more inflationary, than the latter is deflationary, to overall prices, is a belief that money is magical (or that only money is wealth and all other wealth is make believe, which is nuts since money is only about 10% of wealth), and it is nonsense.
Then there is the question what the monetary authorities and the banks have actually done in the present financial crisis. It is rarely talked about, but the reality is the Fed's actions increasing the money supply peaked last December, and after a brief ebb in the early winter, made another lower but similar high in late April. Fed actions since then have been net contractive.
The reason is, most of the short term forms of support to the banking system have been getting paid back since the bond market turned around and companies were able to raise money on the capital markets again. Foreign central banks have repaid 3/4 of their swap lines, the commercial paper market has repaid 60% of the stuff the Fed lent there, banks have repaid 45% of the extra discount window and term financing stuff, etc.
If the Fed had done nothing as that happened, the money supply would have contracted between April of this year and today, at more than twice the fastest rate of money supply contraction seen in the 1930s. Needless to say, this would have been extremely reckless with the economy in its present condition, and a repeat of the mistakes of the 30s, decrying as horrible errors by every sane monetarist with a pulse.
The Fed instead redeploy most but not all of this gusher of repayment, into first treasury debt (since completed) and then mortgage backed securities (scheduled to complete next March, as things stand now).
The net change in the Fed's position in treasuries due to all of this, since the day Bear Sterns when bankrupt, is --- zero. The Fed merely rebuilt the treasury position it sold off in the course of 2008, as it extended loans to the banking system directly. The only new asset on its sheet, besides a modest $100 billion for its part of the various bailouts of Fannie, Freddie, AIG, Bear, etc, is a big new position in agency mortgage backed securities, about 3/4 of a trillion worth, and scheduled to rise to one trillion before they are done.
In case everyone just forgot, Fannie and Freddie are in receivorship. The Fed is taking on a role previously performed by the agencies.
Now, explain to me again how in any of that there is a reckless expansion destined to cause hyperinflation "once" the "velocity of money" increases (which it magically must do, why?)
The money supply is not being managed for partisan political ends, nor even for the benefit of the treasury particularly. It is being managed professionally by technocrat economists for the good of the entire economy, starting with the banking and financial system.
They did the right things and they saved your ungrateful backside in the process.
The policies they put in place to meet the crisis were recommended by career professionals to the Bush administration, approved by the Bush administration, signed off on after populist dickering and messing-up by congress (e.g. the auto bailout boondoggle), and largely implemented by Bernanke, a career civil servant and a conservative republican.
And they have worked. GDP has stopped falling, and the value of financial assets has recovered half the ground lost to the lows of March, housing is bottoming, the banks have gone from illiquid to sound. Half the money the treasury provided to the banking system in TARP specifically has been repaid with interest and, outside of the auto boondoggle forced by populists as a sop to their voters, none of it is going to cost the US taxpayer a dime, net.
But you aren't interested in such distinctions. You just want to fling poo at the democrats. Find another subject, because your aim stinks. Monetary policy is not in their hands and it is not wrong.
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