Posted on 06/24/2013 9:47:17 AM PDT by blam
The Deflationist Error
Economics / Deflation
June 24, 2013 - 05:52 PM GMT
By: Alasdair Macleod
Many people believe there is a significant risk that the Irving Fisher debt-deflation theory of great depressions is still an economic threat today. They overlook the fact that Fisher published his theory examining debt-deflation events under a gold standard, which does not apply today. Financial credit contractions therefore take a different appearance.
The events he described arose as a consequence of the earlier expansion of bank credit in a fractional reserve system when the currency being used was convertible into gold. This was the case until 1933, when Fisher wrote his definitive article for Econometrica. Under those circumstances, it is obvious that contracting credit leads to a self-feeding liquidation of assets, driving their prices down, and an increasing demand for money, i.e. gold. This was reflected in the gold revaluation that took place that year.
This is not the situation today. The absence of the gold discipline allows central banks to replace credit with quantities of raw money sufficient to ensure that Fisher's debt-deflation is bought off.
Another way of looking at it is in the context of the aftermath of the banking crisis five years ago. Before the banking crisis both banks and their customers were happily expanding their credit and debt respectively, and it was the crisis that brought a sudden end to those care-free days. There was a sudden switch in behaviour that Irving Fisher would have recognised as tipping us into a debt-deflation depression. Initially, the price effect was dramatic: in the UK for example, new luxury cars suddenly became available at discounts of up to 40%. It affected Europe and the US as well, which is why governments stepped in with scrappage schemes, cash-for-clunkers and so on. Other capital goods, such as property were similarly affected.
What had happened was an increase in preference for money over capital and consumer goods, or a dash for cash. The price effect was contained and reversed through unprecedented government intervention by TARP and other programmes in the US, and by bank rescues in the UK and Europe. This has been backed up by quantitative easing and zero interest rate policies that persist to this day.
Fisher's debt-deflation event happened five years ago and was bought off by ensuring banks had enough new money to ride out the storm. None of this would have been possible without the freedom to expand the money quantity indefinitely. No longer do we have to find gold to repay our creditors.
Now we can consider a second question: will gold be sold in order to pay back currency-denominated debt?
This could be a factor when gold is widely owned, but it is not. The recent shake-out in gold prices has certainly taken care of that, and there has been a substantial transfer of ownership to Asian countries and Russia. These new owners generally regard gold as a refuge from paper money, not as an asset to liquidate to pay down debt. To them it is super-money, to be hoarded.
It is indicative of our economic biases that we completely overlook the differences between the sound money of 1929/30 and the infinitely expandable money of 2008/09. We make this error because today's economists lead us astray with a fundamental belief that the state through monetary intervention can fix everything.
Even though today's economists are a broad church they follow beliefs instead of well-reasoned economic theory. Beliefs are better left to clerics.
The reason we don’t have deflation is because many developed nations turned on the printing presses to prevent deflation.
That's when I realized what I'd thought was useful info was just another worthless rant from a complete idiot. People do that though, they get carried away with a fantasy dream of the good old days when all was well --if only we had gold again, if only we lived like 'native Americans', if only...
The US didn't 'prevent' anything. We had a severe deflation that went on for half of '08 and we're lucky we re-flated the dollar enough to get through it. It's a shame much of the damage still remains.
The stone’s been rolled back some, but that doesn’t stop the stone from rolling back forever.
Look at the interest rates now. 2.6 percent. Obama’s got a bit of leeway (about 4.4 percent or so), before he’ll be crushed.
Certainly not the beginning of the end but the end of the beginning. Borrowing has long term deflationary costs. So long as the US continues borrowing and undertaking accounting gimmicks to stave off the crunch, deflation is inevitable.
We had the popping of the commodity bubble around July 2008. Then we had massive deleveraging of some of the piles of worthless debt that people built up during the inflationary phase. The dirty secret of 2008 was the number of financials that held positions in commodities either directly or through loans. What was written about was the bad mortgage debt but not the extent that was bad and swept under the rug (e.g. bank-owned houses that have now been vacant for five years).
we're lucky we re-flated the dollar enough to get through it
We're lucky that the Fed printed dollars to buy bad debt from banks? I suppose if their mission is saving big banks. We're lucky that the Fed printed dollars to give to politicians to spend? Sorry, that one is just wrong. The Fed printed enough dollars to accumulate a giant pile of worthless debt. The result is they are boxed in. 1. They can buy more debt and continue to expand the securities bubble. 2. They can stop and watch the bubble implode. 3. They can print helicopter money.
By their debt bubble creation the past five years they have put us closer to scenario 3. What should they have done instead? Simple, let the unsound banks deleverage and fail. That would have created the conditions for an economic boom simply from the future soundness of dollars. Instead the trillions of idle dollars will continue to chase short term greater fool stocks, carry trades, commodity booms (and subsequent busts) etc.
So what’s up with the tanking metals market?
I thought I was getting a bargain a couple of weeks ago with silver at $22.75, but today it’s down to $19.76 spot.
Never expected the crash to go on this long or this deep; what’s up with that?
Is this another bubble that could burst at any moment?
What do you expect to see happening with metals over the summer?
I’m amazed that our dollar hasn’t gone the way of the Weimar Deutchmark long before now.
Obama's not that important, I'm worried about America.
Interest rates for the general economy are nothing --they've been lest than inflation for the past few years now even though over decades they're supposed to be a few points above. It's because private debt's been cut way back.
Not so with federal debt, and that's where we're up against a wall. The low interest rates have been allowing the looney left to borrow and spend like crazy but as rates come back up to normal we're going to be seeing $trillions/year going for debt interest payments. My concern is whether the American people are willing to take responsibility and force their gov't to sober up --like we did in the late '90's. It's either that or a federal debt default scare and then watch the rates & interest payments soar.
Interest rates are already soaring. Obama’s not going to finish his term before the reckoning hits.
I believe I called for the dollar quite some time ago.
In 2008, I went 100 percent into the USD after selling the stuff I had invested. I’m actually ahead of the folks who stuck with the market despite the ‘rally’.
It’s simply that the dollar was underpriced relative to the other assets, and that correction is finally happening. Waited 5 years for this. Now I have to wait and see whether to re swap my dollars back.
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