Thursday, November 13, 2008

Credit destruction exceeds central bank printing, hence deflation

Abandon all hope once you enter deflation

The price of white truffles has fallen 84pc. Fines wines have dropped 65pc. Lobsters are off 52pc. Deflation has reached the City. It has engulfed housing and now threatens to spread through the broader economy, lodging like a virus in the British and global monetary systems. Mervyn King, the Governor of the Bank of England, says it is now "very likely" that the UK retail price index will turn negative next year. This is a drastic reversal of the oil and food spike that played such havoc with monetary policy over the summer. The curse of deflation is that it increases the burden of debts. Incomes fall: debts stay the same. This way lies suffocation. [Personal gloat: it's nice to be debt-free and mortgage-free!]

Posted by drewster @ 01:12 AM (9195 views)
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42 thoughts on “Credit destruction exceeds central bank printing, hence deflation

  • Letsgetreadytotumble says:

    “income from working people with mortgages to bondholders” That happens anyway if house prices increase.

    Shock, horror, the indebted get stuffed and the prudent saver gets the benefit. Heaven forbid this should happen.
    Maybe it’s the laws of economics saying that savers should be looked after by the money gods, and maybe the debtors can get stuffed (and will be).
    What an atitude, we have to protect the reckless and slaughter the saver. Well I’m looking forward to deflation, bring it on. I have no debts, and if interest rates are going to be so unrealistically low, then let deflation make my savings increase in value. All sounds very fair to me.
    Oh, and shoppers might hold back. About time we returned to manufacturing, mining, farming and fishing to generate some wealth, instead of all this shopping and selling houses to each other, continuously racking up debt. I think that deflation and the removal of the ZanuNuLiebor bunch may give this emerald Isle a chance.

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  • yes how things have changed – on this site everybody was having a go about inflation being 5% and on the up. So now the strategy is clear lower rates to stimulate demand, lower the fiscal burden to stimulate demand and if the pound sinks – so be it – its inflationary to the extent it can be afforded. Will these weapons be enough? Will either they will be enough, not enough or too much.

    Out of those three the middle one is the one the govns sh1t themselves over. Goldilocks have def left the three bears to their own devices.

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  • Actually a good article : “This is already nearing the danger level. If the Government now lets rip on fiscal policy, we could face a ‘gilts strike’ as foreign investors retreat from UK debt.”

    Yes a gilt strike would push interest rates on Gilts up – so you can forget about the base rate. If that happens then corporate bonds also yeild more – more risk than soverign debt – so then more babkruptcies / restructurings as corporations have a bigger debt burden?

    The article asks if the physology has turned – and thats the crux. If the penny (whatever it becomes worth) has dropped that things are really bad and regardless of the stimulus people need to save in case they get turffed out of their jobs, then this becomes self re-inforcing, and REAL prudence over the last few years finally gets rewarded, just dont expect a cheap holiday in Malaga.

    The interesting thing to me is how the public sector reacts to a deflationary environment. [Assuming this point of view is right]. The joker in the pack?> Oil.

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  • mark wadsworth says:

    The problem is wishful thinking.

    Like Drewster I am mortgage free and debt free. And asset free. All my money is tied up in cash. So deflation would be vastly preferably to inflation, from my point of view. But if I forecast it, is that just wishful thinking?

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  • the big difference when deflation hit japan is that personal savings in Japan was already high. In the UK, it is completely the opposite. I think that deflation will encourage people to save and that’s ultimately what the country needs to do.

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  • Never forget Mervyn King’s habit of trying to shape expectations.

    I still believe that the deflation spectre is an devisive myth – it is a monetary problem with a very simple monetary solution which is no stranger to the Bank of England – rev up the money printing presses and *poof* deflation dissapears.

    In a post-1968 fiat currency world deflation just does not happen.

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  • So where does this leave gold as the ultimate safe haven?????????????

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  • Everyone appears to be stating that a Japan style decade of deflation is a bad thing. To me its the best possible senario for everyone! We need to devalue the debt bubble, contract the money supply and reward prudent business/people. The only way that this can be done in the correct way is to have a decade or so of deflation.

    I just don’t think we have the self disipline in this country, as the article states there is an easy way out for all countries from deflation just print money – why didn’t the Japanese think of this!

    I don’t think this idea will get many votes though so inflation goes it.

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  • matt, deflation does not erode debt – quite the opposite.

    The spending power of money increases. Therefore if you owe someone money, the relative value of that money also increases.

    Example. A tenner buys you a 12 pack of beer today. After a year of deflation (falling prices), a tenner buys you a 12 pack of beer and a bottle of alcopop.
    Today if you are indebted to the tune of a tenner, that would buy the creditor a 12 pack, ina a year a 12 pack and an alcopop.

    This is why DEFLATION WILL NOT BE ALLOWED TO HAPPEN by the Bank of England, and why Mervyn King keeps talking about it even though he will never let it happen.

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  • How about a relatively short period (say 12-18 months) of deflation followed by years of inflation?

    Your thoughts Gentlemen please.

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  • I don’t agree with this bit:

    “It also redistributes wealth – the wrong way. Savings appreciate, which is nice for the “rentiers” with capital. The effect is a large transfer of income from working people with mortgages to bondholders. (These may be pension funds, of course).”

    Not all working people have mortgages and no savings. In fact only 11 million of the 26 million households in the UK have a mortgage.

    Now, what business opportunities open up in a deflationary environment apart from hoarding cash ?

    Also the Japanese voters in the 80s probably had less debt and more savings than the West. Which is why I think the West will scramble the “cash-copters” rather than follow the Japanese route.

    Be in no doubt, mass debt is now “built in” to our way of life unfortunately.

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  • welcome back voiceofreason long time no see

    off topic
    anybody see the new advert for location,location,location
    “if you don’t buy now you may never be able to”
    what a discrace

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  • A Survival Guide – more like how to be in imediate negative equity

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  • it_is_going_with_a_bang says:

    The only thing Kirstie and Phil are worried about is not having a job.
    Expert advice from tv personalities. I’d rather take advice from Mickey Mouse.

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  • I posted this yesterday “The Truth about Deflation”
    http://www.itulip.com/forums/showthread.php?p=57193#post57193

    Its got some really good Graghs and explains Deflation historically.

    “This ain’t deflation

    We’re not nit picking terminology here. We’ll show you what a real deflation spiral looks like: nothing whatsoever like the deflation we are seeing today that we have long forecast and call disinflation to distinguish it from the run-away deflations that occurred under the gold standard in the pre Bretton Woods era.

    Deflation was common back in the days when there was something for a currency to deflate against for more than a brief period of time before the government got involved: gold. Even then, governments often abandoned the gold standard to inflate the money supply to stop deflation, especially in times of war. If you are a government and need to inflate and there’s no war to fight, then make something up–like an oil “shortage” in the 1970s.”

    “The period of deflation that occurred in the early 1930s is the one that most people think about when they hear the word “deflation.” What they really mean is a deflation spiral, with the money supply imploding, credit contacting, large scale bankruptcies, rising unemployment, and falling economic output. Note that there was not a single month of inflation from 1930 to 1933. Prices went down and down and down. For years.”

    “The critical take-away is that we are indeed experiencing short term deflation. We call it disinflation here in the context of Ka-Poom Theory to keep readers from confusing the process with the start of a deflation spiral–which cannot happen under a floating exchange rate, fiat money system. The only way it could is if governments around the world all got together and decided to crash the global economy. That strikes us as unlikely. More likely one or more will move to reflate using currency devaluation.

    If the Fed so desired the US could have 100% inflation by the middle of 2009 as the US did in 1946. All that is needed is for Congress to borrow a few more trillion into existence to fund old and new liabilities and have the Fed print it because our government cannot borrow the money from overseas or raise taxes, or devalue the dollar, or both.

    It’s just that simple. Wish it wasn’t so. Trust your government not to do it?

    Neither do we.”

    The conclusion I have drawn from this article in context of the UK is
    Short term Deflation
    Currency devaluation
    Longer term Inflation

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  • Japan-style-deflation here we come. Deflation is and has always been the only possible outcome to all our years of ever-expanding debt. Luckily for Japan, they were able to devalue the yen and focus on exports to keep their economy afloat – feeding off the rest of the world’s expanding debt. Now our time has come, and there is nowhere left on Earth with increasing debt and cash to spend. Intergalactic debt expansion, anyone?

    Have been thinking a lot about a ‘printing-money response’ to stave off deflation. I really don’t see how this can work. Deflation is due to falling demand (for goods and services), right? Increasing the amount of sterling in circulation, from say £100bn to £200bn, isn’t going to create demand for goods again – it’s just going to halve the value of all exisiting money (all debts and all savings) in circulation, correct? So really just a rebalancing between savings and debts. So OK, it may put a bit more value from the hands of the savers into the hands of the spenders, but it’s not going to do anything whatsoever to affect deflation. Someone shoot me down here!

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  • Another important point to consider about deflation, is that while the value of your money at the bank does go up, the banks ability to honour it goes down. Arguing that deflation makes debt more expensive to service misses the point that deflation makes debt -impossible- to service.
    Given that our banks have needed extensive hand-outs prior to deflation, they will be right next to grave in a deflationary situation.

    I had a thought that we could argue that China and the other main exporters are breaking their terms of trade by refusing to buy British exports, or effectively refusing to let us work off our trade deficit. However, what they have done is to purchase treasury bonds. From which it follows that government spending is not virtuous and is not likely to provide a stimulus because the circle consumer-chinese goods-uk bonds-government spendingXconsumer obviously cannot be completing the last section.
    I think this a key issue because it suggests that as things stand -government spending has been acting as a brake on consumption-, and further increased government spending is therefore likely to act as more of a brake. Or to put it another way, pay a nurse 22K a year and she will spend it all, but spend 150K on consultants, or doctors, or the legal aid fees of solicitors and they are likely to just bank the money.
    Which is in support of the idea that what should be doing is cutting taxes and public spending. What to do about the squeeze on borrowers by the wealthy is really a social issue. Don’t forget the ‘paradox of thrift’, we cannot all be savers because collective saving is impossible.

    I don’t think that it is fair to blame -small- savers either, but I can see their point, they want to blame people who delay consumption, or who fail to complete the cycle such as above, and misidentify savers, but I think what has happened is that wealth distribution in the UK has skewed since 1997, and that you can’t necessarily describe somebody with a lot of money in the bank as a saver. You could call them rich, but there aren’t really savers as such. This comes back to the problem of the 100K winners from the property boom, they need to spend that money and they aren’t. Hence the encouragement… Unfortunately true low level savers such as pensioners, people looking to get a house deposit get lumped in together.

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  • does this mean that I have to charge my customers less or not?

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  • Isn’t this discussion starting from the wrong point in time ?

    We have just had 10 years of massive inflation and a big year on year increase in money supply, this has already happened.

    The question is whether “we” borrow more to pay off existing loans or stand still for a while and pay off our debts.

    Deflation it will be.

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  • Let me put that another way.
    When the government taxes me, they are deferring my consumption. I think this is true because for most people taxes reduce spending.
    However, whenever any of this taxed money ends up in the hands of somebody who then banks it, consumption is effectively permanently deferred.
    But when I pay tax what I am really doing is paying with work time, the government is appropriating 3 or 4 months of my labour each year.
    If for some reason that money does not come back to my company then this virtuous cycle is broken.
    In the example that I pay 4 months work in money, but the money representing 2 months of work is saved, then my company is being expected to continue paying me 12 months of wages but only receives payment for 10 months. In the end the company will be bankrupted.
    So there is something seriously wrong with wherever government spending ultimately goes, and I think this ‘hole in the accounts’ has been covered up through borrowing i.e. thus far although I pay 4 and get 2 back, the missing 2 being saved, the government borrows an additional 2 which does make its way back to me.

    When this system breaks is when the government cannot borrow enough to fill in the missing 2 and so complete the virtuous circle. This is the point we are at now I think, and this leads directly to bankruptcy and unemployment.

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  • japanese uncle says:

    What has irrationally boosted by Maggie’s Big Bang will have to come back to the original point, quite like our universe.

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  • 6. paul

    Sorry paul I wasn’t implying that devaluation will devalue debt by its very process. I was implying there would be less insetive to borrow money and more insentive to save. Looking at the direction this thread has taken for example – i.e talking about popular culture – instead of talking about real problems. We are doomed.

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  • Maggie’s big bang started in the mid 80’s. Brown has had all of 12 years to manage – unsuccessfully

    He wants the job, he takes responsibility

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  • Paul’s on the money. As the iTulip article indicates, we’re probably in for a short period of disinflation (as opposed to defation) followed by serious inflation.

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  • sold out:
    Yes, I didn’t see that post, but, one minor adjustment…

    “If the Fed so desired the US could have 100% inflation by the middle of 2009 as the US did in 1946. All that is needed is for Congress to borrow a few more trillion into existence to fund old and new liabilities and have the Fed print it because our government cannot borrow the money from overseas or raise taxes, or devalue the dollar, or both.”

    If China decide it’s no longer worth supporting their most reliable consumer, Uncle Sam, this may well no longer be a decision, it could be imposed. At some point there will be no upside to the cash rich countries to subsidise the indebted ones.

    So, it’s not just, ‘do you trust your govt’?’ – it is more like, ‘do you really think the Chinese government, the UAE, Singapore, etc will not do what is in their best interests when push comes to shove?’

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  • stillthinking:
    Agreed in principle, but when you say
    “However, whenever any of this taxed money ends up in the hands of somebody who then banks it, consumption is effectively permanently deferred.”
    I’d point out that when the economy is in good working order their saving is fine – in fact it’s good:

    The money that is saved is geared up and lent out to those who spend it on improving their businesses.

    Of course this does not work so well if the institutions borrowing from these savers and lending don’t do due diligence on their borrowers (because of other incentives, such as short term overriding factors, or a herding due to common knowledge that the entire industry cannot be allowed to fail).

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  • The pound is below $1.50. £ is down against the Euro, again.

    That means stuff I buy from abroad is getting dearer. How then can inflation drop to 1% (as B of E suggest)?

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  • If the money that is saved is used by another through borrowing then consumption is not deferred. What I mean is that the savings are -not- used in that way. People have savings which -do not- find their way back as somebodies wage, they just sit there,

    @51ck-6-51x, I completely agree the savings->investment cycle would be fantastic but that hasn’t happened for a long time. The situation we have now is that John borrowed a 100 from me on the understanding he could work it off for ten pounds a week. I welsch on the agreement and have no work for him. Suddenly John is not only unemployed his remaining assets are subject to foreclosure.

    Separate point, another thing to realise about deflation is that while the value of your money goes up, the probability of you successfully withdrawing it from the banks goes down. Or to put it another way, while you have 100 in the bank and celebrate the fact it has doubled in purchasing power, the actual amount you could withdraw is only 50. Hence deflationary crisis’ for banks. The longer I wait as a depositor the more I have in purchasing power but I also run an increasing risk of the bank defaulting on me, better to take my 50 and somebody else’s 50 while the going is good.

    I think the government might put exchange controls in place at some point, they can’t try the same escape methods as Japan unless they close the economy, because they start off nearly busted to begin with. Keynes stimulus plans won’t work against capital flight.

    Or they could just slash public spending and taxes of course. Doh !

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  • Deflation versus inflation is an ongoing debate but not helped by reporting the prices of truffles and luxuries is dropping therefore we have deflation. In the past few years the prices electronics goods have gone down, that wasn’t deflation either.

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  • planning4acrash says:

    Guys. Between 1800’s and 1900’s, America had a stable money supply, no inflation or deflation. But prices deflated throughout the entire period because productivity soared, so the same quantity of money buying a larger volume of goods. Goods price deflation is not money supply deflation, and, combined with a stable money supply is desirable for the general public, not desirable for the establishment because i democratizes progress. Inflation is the theft of progress via the establishment printing enough money for themselves to take the additional wealth from productivity plus a bit.

    In Japan, the money supply of Yen continued to inflate, but, via the carry trade, lots of that money went abroad.

    Please listen to: What you should know about inflation to see what inflation and deflation really are, and that what you are discussing, i.e. price inflation/deflation, are symptoms of money supply inflation/deflation.

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  • p4c, Not just money supply, I think productivity – availability of goods is also very important.

    Really the money has to match the availability of goods available to buy with it.

    Didn’t the BoE used to have a weather vane on the roof in the 1600s ?
    If the wind was blowing in from the East, they expected more ships to arrive bearing goods. So they increased money supply. And vica versa.

    If money supply increased with productivity then prices would remain stable.
    We have had a greater increase in money than productivity via the credit boom. Hence inflation.
    Now we have had money supply fall of a cliff.

    So the answer I think lies in levels of both money supply AND productivity …?

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  • planning4acrash says:

    The Federal Reserve Is Inflating at 341% per Annum. (Don’t Look for the Decimal Point.) The increase in the monetary base is $300 billion. For those wondering why some product prices are falling, collapsing demand can occur in sectors of the economy whilst the money supply is inflated, but, these are all parts of the complexity of the symptoms of money supply inflation. So, the debate about whether we have inflation or deflation is based on deficiencies in our propaganda newspeak language, we don’t have the language to understand it, so cannot discuss it meaningfully, each person parroting what they heard on the news the night before. Money supply up = inflation, money supply down = deflation. So, money supply is inflating, question is, where is the bubble and the bulk of general price inflation and where are the pockets of demand destruction and deflation.

    What Inflation Is
    No subject is so much discussed today — or so little understood — as inflation. The politicians in Washington talk of it as if it were some horrible visitation from without, over which they had no control — like a flood, a foreign invasion, or a plague. It is something they are always promising to “fight” — if Congress or the people will only give them the “weapons” or “a strong law” to do the job.

    Yet the plain truth is that our political leaders have brought on inflation by their own money and fiscal policies. They are promising to fight with their right hand the conditions brought on with their left.

    Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. In fact, inflation is the increase in the supply of money and credit. If you turn to the American College Dictionary, for example, you will find the first definition of inflation given as follows:

    Undue expansion or increase of the currency of a country, especially by the issuing of paper money not redeemable in specie.
    In recent years, however, the term has come to be used in a radically different sense. This is recognized in the second definition given by the American College Dictionary:

    A substantial rise of prices caused by an undue expansion in paper money or bank credit.
    Now obviously a rise of prices caused by an expansion of the money supply is not the same thing as the expansion of the money supply itself. A cause or condition is clearly not identical with one of its consequences. The use of the word “inflation” with these two quite different meanings leads to endless confusion.

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  • planning4acrash says:

    Now listen, its very simple, inflation is a moral issue, it is neo-serfdom. It is an extraction of all our growth in productivity via inflation, the establishment printing enough money to keep our prices kind of stable, when they should be coming down for us as a result of our efforts to improve productivity. If we spent just 10% of our time fighting for liberty to retain our productivity and end inflation, the amazing steps we take to improve productivity would be felt by us, our friends and our children and family.

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  • Uh Oh, P4C is mad as hell and not going to take it anymore.

    But seriously. The key point made in the article is this : “The curse of deflation is that it increases the burden of debts. Incomes fall: debts stay the same. This way lies suffocation.”

    As we know the citizens of this country have record personal debt. So everyone who believes we will have deflation is probably wrong. This really is the “abandon all hope” scenario.

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  • Lets take a slightly longer term look at this. The £ has fallen, and will continue to fall against the currencies of India and China until the trade imbalances even out. The oil price has dipped, but supply/demand factors will almost certainly see it rebound over the next year or two. Going forward, there is still a lot of inflationary pressure in the system.

    British workers, especially in the public sector, do not ‘do’ pay cuts – they never have, and with many struggling to service their debt obligations, that attitude is not going to change. They will strike and riot before accepting lower pay. Businesses have such a burden of overheads that in a slack market they have few options to cut prices; it is actually easier to discount in a buoyant market than in a slack one.

    Inflation will dip, and might fleetingly go negative, before taking off again. As part of its recovery strategy, the government should aim for an inflation rate of around 5%, but managing inflation will not be easy over the next few years.

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  • p4ac, money supply is only up if the new money created outweighs money destruction. As far as I know money supply measures only take into account the money that is produced, so only provide half the picture.
    Am I wrong on this?

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  • planning4acrash says:

    Regardless of that, the establishment are still printing money for themselves, which always extracts wealth from us, parasitically, via inflation, PERIOD!!!

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  • planning4acrash says:

    The government is a gang of counterfeiting criminals, PERIOD!!!

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  • The Japansese could have avoided much of the disinflation experienced by pursuing policies to devalue the yen. The Japansese however like their currency strong. Ambrose is dramatic but always good value.

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  • planning4acrash says:

    Japanese did devalue their currency. Their currency inflated, but went abroad, via the carry trade, starving the local economy of credit. This is my point, inflation is theft and bad for the economy, and it can manifest in a number of ways. We are conditioned, via the dialectic, to shout for inflation or deflation, and are never allowed to discuss sound, stable money, which is the only real issue, and our ancestors understood personal gold standard. The water is muddied because sound money results in price deflation as productivity rises along with the value of money. More production, same quantity of money, lower prices. Of course, deflation, via money supply contraction, as engineered during the depression is real deflation, but again, that is purely manufactured by the central bank. The other way of deflation, via bankruptcy is good and natural, because prices adjust at the same rate as the debt destruction, so, totally positive, because we get lower prices, the bonus of less interest to pay bankers, and, assets priced at a level where they can be productive once more.

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  • Uncle Tom yes a government bond buyers strike doesnt seem to be on many minds yet. But it is logical that it will eventually. There is $500 trillion of fictious money to unwind, the bailouts will go on and on unless the slate gets wiped somehow.

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