Thursday, January 8, 2009

Can I contend that …

Deflation ...

The current threat of deflation, its countermeasures such as printing money Harare-style and the generally unquestioning media view that deflation "is a bad thing" is purely to do with housing. When the government says they are going to tackle deflation, what they are attempting to prevent is not the lowering of prices of inflation-basket essentials (which by all accounts should be seen as a good thing by end consumers), but to ringfence the debts of homeowners who piled into property to make sure that their debts don't start inflating relative to their incomes (which is exactly what happens with deflation). This is purely my own speculation, so I'd like to get any other views on whether this is likely to be an accurate reflection of the current drivers behind tackling deflation.

Posted by paul @ 09:20 AM (1553 views)
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18 thoughts on “Can I contend that …

  • Deflation means people don’t buy piles of tat they don’t need because they think that things will get cheaper. The UK (and US) economies are built on over consumption (to the detriment of the environment) and our current government are trying their best to encourage that over consumption to return to get back to the situation that caused the crash in the first place.

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  • The belief that deflation is very very bad seems to be based entirely on the experience of the Japanese in the 90s and the US in the 30s.

    The Japanese (and Asians in general, it seems) appear to have a very different attitude to money and are far more likely to save, and the 30s was a long long time ago.

    And anyone who takes even a passing interest in electrical gadgets and computers (pretty much everyone under the age of 50) is used to the idea that things get cheaper over time and yet they still go out and buy new items…

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  • Joe Murphy in the Standard said..”It would mean a historic retreat from the economic housekeeping rules that have held sway since Margaret Thatcher wrested control of the money supply in the Eighties in her crusade to drive out inflation.

    Printing more money would release a flood of extra funds to buy assets, with the new cash filtering through to businesses and families. It is aimed at preventing a sharp shrinkage in the money supply, a move that could prolong the recession. However, a policy of printing more cash has never been openly practised in Britain”.

    Argentina practiced the art of printing money in the 70’s I recall.

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  • Not just home owners are in debt, many companies and governments are too, and any threat of a deflationary spiral is best attacked earlier rather than later (it takes much less to put a fire blanket over the burning fat than to hose down a burning house, and the resulting destruction is less).

    However I am not convinced there is any need to pre-empt a deflationary spiral, in fact in the scenario we are in I believe it would be fruitless – the recessionary pressures are global for one.

    I think the point of the current regime of ‘inflation urging’ * is for the governments (here, in the U.S., Italy, Spain, Switzerland…) to reduce the value of their own debts.

    * Is that a good phrase? I copyright it ;p Only occurrence on the web according to Google have a comma in the middle (bar one regarding a patent for valve technology).

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  • japanese uncle says:

    In a longer term perspective, deflation and associated contraction of economy is the only answer for our sustainable existence, given limited resources of this planet, which is particularly true about the far bloated UK/US economy.

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  • Sustained low house prices are good for everyone. But falling houses are bad as people with negative equity walk away from their debts as they have nothing to lose, but plenty to gain from it. The banks and the economy suffer badly if enough people default on mortgages.

    Real deflation isn’t goods price deflation or house price deflation or wage deflation. Real deflation is the reduction in the amount of money that exists.
    They fear real deflation as in this debt based money system you need more and more money each year to pay the compound interest that is due. If the amount of money in the system shrinks it becomes mathematically impossible for the economy to pay the interest due on all the previous money in existence, this leads to a spiral of bankruptcies, which is what we are seeing. And it is also why interest rates are now zero and why they want to print more money.

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  • JU

    Agree with you there and what better time to start to try and live within the means of global resources.

    Re: the artcle, unless paycuts are forced on people then deflation of the price of goods will make people richer and more able to cope with repaying their oversized debts.

    My example – flat screen tv’s have come down from about £4k on release some years ago to £500-£1000 now.A drop of roughly 75% and for a better product. I don’t recall a time when these weren’t in demand due to anticipated price falls.

    I cars become less expensive (which they have anyway) people may hang onto their existing one for an exta year or 2 on average, but there comes a time when you change your car because you want/need to.

    And re : cars, if we did something useful with the Ford and GM factories (instead of just bailing them out to make more average cars) then the remaining factories would cope quite nicely with slightly less demand.

    I’ll shut up now.

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  • mark wadsworth says:

    Obviously the government’s prime concern is to prop up house prices, at least in nominal terms.

    This can’t possibly work of course.

    This insane idea that governments can sort things out by putting numbers on bits of paper is insanity.

    ‘Money’ is merely a way of measuring or quantifying the amount of future consumption opportunities that people owe each other. People are only prepared to forego consumption opportunities (i.e. ‘save’ or ‘invest’) if they think that the counter party (who accelerates his own consumption or invests that money in productive assets) is going to be able to repay, so ‘credit’ is just a formalised way of saying ‘confidence in the economy in general and in the ability of your specific counter party to repay in future’

    It is that confidence that has now more or less evaporate, so credit shrinks, so ‘money’ must also shrink, so prices, in particular non-essentials such as house prices (we can always rent for another couple of years before we buy) tumble.

    Here endeth.

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  • Well said Mark

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  • mark wadsworth:

    Exactly.

    Look at the Etymology of the word credit to become enlightened to the fact that fiat currency is a derivative of trust (/ belief / honour).

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  • inflation is eating my savings says:

    >This insane idea that governments can sort things out by putting numbers on bits of paper is insanity

    Not sure about this- combine printing some money with scaring us (I mean the herd) that we’ll miss the boat?

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  • notaneconomicsguru says:

    Housing is a significant part of it for sure, but not the only part. As the quantity of money shrinks, prices will fall which reduces revenues, and therefore costs cannot remain the same as revenues shrink, because companies would go bust. So in addition to the cost of raw materials falling, the cost of labour must also fall. That means personal, company and government incomes will all fall in response to deflation. That is bad news for anyone that has a debt (i.e most of us) , because the monetary value of that debt remains the same, but the income by means of which the debt is serviced, shrinks. The other bad effect, I think, is that the price of assets against which existing debts are secured, also tends to fall because the quantity of money which kept the asset prices high has been reduced, so the risk of the debt and hence the cost of the debt will increase. That seems seriously pernicious because its a double effect – your debt starts costing more but you start earning less and on top of that your assets are worth a fraction of what they were when you bought them. Nasty.

    Thus the process of deflation causes much pain, but I can’t think of a reason to believe that the eventual equilibrium state to which we would transition to would be any worse than the one we have fallen from.

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  • notaneconomicsguru says:

    I’ve just thought of some reason why the final deflated state may not be so good. As the governement income will be lower , it won’t be able to maintain the same level of expenditure on education, health, defence, environmental protection, contribution to famine relief etc etc. Of course, it may be that the cost of the existing level of quality in those programmes does gets less in proportion (it certainly should) and the quality can be maintained, but my worry would be that the cost of government debt would increase, and that would inevitably mean the programmes would be cut in real terms.

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  • Iron Condor – first point is wrong. if you hand the keys back you are still liable for the negative equity. No issue with your second point.

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  • not only that but the banks do have MI insurance (although i think this started to be forgotten about as a consequence of competition etc – another sign that the bull market was mature). So the insurance companies may be holding some very large babies!

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  • Techie. I think Iron Condor might live in US – as he/she refers to zero interest rates NOW. I understand they can walk away from mortgage debt there.

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  • p doff – ok re the IRs i thought (s)he was just approximating. Point taken. I ‘spose we could ask. I am a bit surprised though , i mean i dont go on HPC florida or whatever. Each to his own though!

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  • Again governments ‘printing money’ is raised without considering fractional-reserve banking, or zero-reserve ‘capital ratio’ banking. Under FRB the banks have been ‘printing money’ like no tomorrow for years. That is how we got into the bubble – huge amounts of money created by borrowers borrowing excessively, and banks doing their utmost to encourage it.

    The bank bailouts have been funded by the government borrowing money from the banks, then giving it back to them in a different guise, but one where, legally, we have no recourse to recover the money. Once shares are issued, the investor cannot recover their capital from the business, only by selling the shares to someone else. Because there’s no recourse the bank counts it as capital, not as a debt. It’s all an accounting trick, but then so is all money. The net effect is to improve the bank’s capital ratio, even though the money came out of thin air.

    If inflation means anything, it’s the term we use when the actual amount of money available – including everything created by banks and money-market funds – exceeds the supply of goods, pushing the price of the goods up. I’m including everything bought and sold in that – if you include house prices and stock and commodity futures markets, we had massive inflation from 1999 to 2007. The lack of new borrowing means that less money is being created, while the falls in house prices, shares and commodities mean plenty of money is being destroyed. That means we’re already in deflation.

    I don’t think it matters much whether government borrows to create money, or simply prints it, with one exception: if the government borrows, it has to pay back interest on the ‘debt’ (remember, the bank didn’t use their own money or even yours, they just created it from thin air) whereas printed money is interest-free. The thing to watch out for is excessive money-creation, whether debt-based or interest-free: that printed money is interest-free could lead governments to overspend. However, we’re already in a situation where private spending isn’t enough to sustain production – worry about overspending once the recession is over.

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