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Deflation. What’s all the fuss?

February 21, 2010

The Fed attempts to control the supply of money by adjusting interest rates and increasing or decreasing the demand for money/loans. By keeping rates low (making debt less expensive) the Govt is encouraging people to go into debt and borrow to buy things such as homes and cars etc.. This easy money policy has been blamed for causing the recent crisis. So what have we learned by this policy of easy money? Easier money…? The Fed has moved rates to the lowest level ever. instead of promoting saving, less debt and less speculation – the Govt has instead attempted to artificially prop up soured markets by promoting easy / lazy money.

Printing money and propping up the market is creating a mirage of a stable economy and serving to reward the debtors at the expense of savers. By printing money and keeping int. rates artificially low you deprive prudent savers the benefits they would reap from deflation. Ben Bernanke and the rest of the central bankers are saying fuck you savers. Borrow and spend and yee shall be saved

The reason prices are deflating is because they were simply artificially INFLATED to begin with. Even with the printing press running all day (and night) the Fed has been unable to stoke the banks to lend and the stubborn consumers to borrow and spend (perhaps somebody learned their lesson). Money currently has no velocity. It isn’t hitting the wallets on main street (just wall st) and as such, it is not inflationary….yet.

Where did all the money go?

The Fed has pumped over 1 Trillion onto banks balance sheets (and bonus pools) But banks are not lending this money… Why would banks lend (willfully) in this environment when they can invest in other markets mostly risk free? (somebody learned their lesson). Once it becomes advantageous for banks to lend watch the fuck out. Then we see Inflation. The Fed knows this and instead selling assets back to the banks they plan on paying banks interest on their excess cash reserves… So banks will earn risk free money in lieu of making loans to consumers – and this interest is paid for by the US tax payer. (My bonus is looking safe again next year. Thanks)

According to the recent CPI figure, all that FED printing has not caused the hyperinflation many have been afraid of. The CPI figure print perhaps yielded something far worse.. Something that keeps central bankers up at night.

DEFLATION- But is this such a bad thing?

“deflation can be a welcome development. The value of your money increases while the price of the things you want or need decreases. If everyone was prepared for deflation then many would welcome it’s coming. Unfortunately, virtually everyone has leveraged themselves to the hilt. Years of low- and no-interest financing schemes on houses, autos, furniture, electronics, etc. have created years of negative savings rates for Americans.”

So, if you generally live within our means, invest your savings in “producing” assets (such as bonds) instead of speculative assets (such as real estate, commodities or stocks) – you will benefit from deflation and are getting the big fuck you from the Govt. (Deflation is also an ideal environment for those living on fixed income – such as the retired/elderly……. Sorry Ma and Pa.)

Well, Economist fear inflation may bring on the mindset of “Why buy today if prices will be lower tomorrow”? which would slow the velocity of money and kill GDP. I disagree. Consumers will ALWAYS buy at the right price. Problem now is consumers have no saving to spend and are unwilling to go back into debt..

Economists also fear “money illusion”: Workers will not account for deflation and accept a lower wage. Truth is,
(aside from financial companies) Wages and hours worked have been falling. ALSO – Real wages (accounting for inflation) have been declining since the 70’s… Americans are working longer hours, needing two-incomes and borrowing more to create the illusion of prosperity. Workers should welcome deflation but instead accept lower real wages and higher taxes via inflation (Perhaps this calls for a workers party).

By far the bIggest downside of deflation is the increase in REAL interest rates. The Govt is in debt (big time) and deflation will only increase the “real” interest paid on this debt. The Federal govt will do anything to avoid deflation so – Monkey see monkey do. Misery loves company. Cant beat em join em etc. Govt will do whats best for the govt so get out there borrow and spend because the govt will bail out debt holders and avoid deflation.

As for savers – You just get shafted.

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8 Comments leave one →
  1. Mutterskopf permalink
    February 22, 2010 5:19 pm

    My understanding is that the problem with deflation is that it incentivizes “hoarding,” which is the cardinal sin in keynesian economics. “hoarding” being when you stuff your money under the mattress rather than doing stuff with it (like investing or spending it in ways that lead to employment/creation of stuff/etc.).

    Sure, 1 year of deflation isn’t bad, everything just gets cheaper. good for savers, as you say. but prolonged deflation removes the incentive for making investments. if i can make 3% risk free just by stuffing my money under the mattress, why use it as capital for a business that might fail? etc. etc. so deflation can discourage economic activity.

    or so i have read…

  2. debaseface permalink
    February 22, 2010 8:37 pm

    Good article came out today–>http://caps.fool.com/Blogs/ViewPost.aspx?bpid=344916&t=01000860093551905860

    Yes, Hoarding is the theory. But I disagree with it along with most/all Keynesian theories.

    deflation does not discourage economic activity. (Moderate deflation)

    if you earn 3% risk free hoarding cash in your mattress this 3% is simply the premium you would require in order to take your capital and invest. So treasuries would yield 6% instead of the current 3%. Those on a fixed income would applaud while the Govt and the other slobs who have borrowed too much would spill tears as their debt service increases.

    If investors earned a bit more yield this may dissuade them from moving out on the risk curve in order to earn extra yield. Take a second to think why the junk bond market has skyrocketed lately..

    Via the threat of inflation, people are forced to buy negative yielding assets or risk their capital to make money instead of having the right to just plunk their cash under their mattress if they so please

    Falling prices will not dissuade people from starting a business as lower prices will translate into lower fixed costs.

    Why is the feds goal not 2% deflation instead of inflation? Or, why not quit fucking meddling all together. Control.. They need to be able to control the money supply and demand and interest etc..

    The St. Louis Fed chief recently bemoaned that the current US deficit would dissuade the Fed from raising rates. The Fed is not independent.

  3. la mama permalink
    February 22, 2010 9:37 pm

    There’s something to be said for the double benefit of hoarding CANNED GOODS. You go out and buy boxloads of canned goods and other long-shelf-life foods/nonperishables … double bonus: You are spending money and helping the economy with ye olde cash flow AND you are getting stuff at the now lower deflated prices. It’s pretty much win-win, right? the only loss might come if you croak before you can eat that tuna. Of course, if you croak, the money in the mattress does you no good either.

  4. debaseface permalink
    February 23, 2010 1:52 pm

    I think  Ma Fite has the right idea.  Everybody takes all their cash and buys box loads of say nonperishable canned corn.  Everybody needs and loves canned corn and it’s an excellent store of value – so Corn becomes the new medium if exchange for goods and services. As cans take up too much room in ones purse – institutions arise that, for a fee,  store your cans in a vault and provide you with a paper receipt representing said cans – which merchants accept as a money.

    The current paper in our wallets represents a Gov’t IOU and is a reflection of govt’s fiscal health and ability to charge taxes. Govt cut taxes and your IOU’s get whacked. Gov’t lowers rates – your IOU’s get whacked. Govt borrows and goes into debt and your IOU’ get whacked.  Govt uses tax dollars to bail out banks and home owners – your IOU’s get whacked.. Sure you can poke holes in my canned goods monetary analogy, but I think you get my point…

    Lastly –  Banks  currently can take your one dollar (can of corn) and either lend out 9 cans of corn or invest your can and 9 others in a hedge fund. Welcome to fractional reserve banking.  

  5. Mutterskopf permalink
    February 23, 2010 2:41 pm

    “falling prices will not dissuade people from starting a business as falling prices will lead them to have lower fixed costs.”

    yeah i’m not so sure about that one. let’s say i’m thinking about making widgets, a useful and wholesome enterprise. but, to get going, i need to buy a factory, which costs $1 million. ok. now what you are saying is that deflation is good, because last year the factory cost $1.1 million. so it’s cheaper, so that’s good right? except that it’s not, because next year the factory will only be worth $0.9 million. so i’ve already lost money simply by committing my money into a factory! it would have been better for me to just sit on my million and do nothing.

    i think the idea is that currency stability is the optimal situation.

    mama fite, the issue with hoarding isn’t so much that it’s bad for the hoarder, it’s that if we’re all hoarding then that’s bad for the economy as a whole. kind of a “tragedy of the commons” type thing. or think kant- the categorical imperative. universalizing the maxim of behavior. etc.

    go Keynes! his theories presided over America’s economic peak! (the mid-twentieth century)

  6. debaseface permalink
    February 23, 2010 4:08 pm

    Factory / real estate prices not factored into inflation / CPI figure. Rent is.
    If you rent the proprerty your store is on (which most sm businesses do) then your fixed costs go down.

  7. A. Strung permalink*
    February 24, 2010 11:05 pm

    “[Low interest rates have] been blamed for causing the recent crisis.” Wholesale? By whom? I get the distinct impression there are other major factors.

  8. Mutterskopf permalink
    February 25, 2010 10:29 am

    that statistical distinction doesn’t really address the problem. if currency is getting more valuable, all “stuff” (real property included) will be getting cheaper

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