Wednesday, July 21, 2010

You don’t get deflation in a fiat system – here’s why:

Bank of England could pump more cash into the economy: MPC minutes

''Economists have raised the prospect that the Bank of England could restart quantitative easing after minutes from this month’s rate-setting meeting showed that “money printing” was discussed for the first time since February.''

Posted by hpwatcher @ 07:11 PM (3762 views)
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38 thoughts on “You don’t get deflation in a fiat system – here’s why:

  • fallingbuzzard says:

    Its not how much you pump in but what the people at the end of the pump do with it!

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  • Its not how much you pump in but what the people at the end of the pump do with it!

    Well, sadly, so far it has kept stock, housing and some other asset prices high.

    And late yesterday, the FED have announced more measures to boost the economy….

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  • “I will try, once again, to put this into it’s VERY simplest terms.

    1. Rapid decrease in credit follows HUGE rapid expansion. Deflationists have forgotton about the expansion as it doesn’t always suit their argument; they attempt to maintain some kind of equilibrium by maintaining the same large levels of expansion. It’s becomes clear that this might not be possible.

    2. Fear of another great depression and prices falling – not really an issue in a fiat system – led the FED in America, & BOE in the UK, to create trillions and trillions. In the 1930’s America was tied to the Gold standard; politicians can’t create gold from nothing so money effectively dried-up – that’s NOT the same as what is happening today.

    3. A FLOOD of money finds it’s way into a number of investment activities, and amounts also seep into the wider economy. A significant amount still sits in banks. People like Techieman make a little bit of money – due to the opposing forces of the ”real” market and the inflated ”false” market – these people convince themselves they are genuises and know everything.

    4. Some asset items devalue, most asset items slowly increase in price.

    5. Over time, the money sitting in the banks continues to seep into the wider economy, inflation continues to increase.

    6. FED paranoia about deflation continues and they carry on creating trillions and trillions of new money.

    7. Failure to get the right balance – and fear of undercooking the hot-pot – means the FED overshoots causing hyperinflation. FED not really concerned as it helps with paying off the debt.”

    The gospel according to St HPW….. End of discussion….. Ahmen!!

    Of course there can be alternative arguments as to why all this is shall we say (being polite) POTENTIALLY incorrect, but these arguments are obviously pointless. FB has one such argument.

    recaptcha : 46 baloney [is that an omen or what?]

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  • mark wadsworth says:

    Of course you can have deflation in a fiat system*. Just watch and learn. Collapsing house prices destroy money. So they have to keep “printing” more money to reinflate bubble. But money is still being destroyed at the margin, it’s like pumping air into a balloon with a hole in it. So we end up with more and more debts but the people who owe those debts are less and less able to pay them.

    Whether that’s the over-indebted borrower who can’t pay his mortgage or the taxpayer who can’t pay off the national debt is neither here nor there.

    (*G-d how I hate that word. All money – i.e. all debts – apart from physical gold coins is “fiat money”. Even if you have a gold standard.)

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  • QE will never have the effect the MPC would like it to (i.e. to reflate the housing market).

    I’m gobsmacked that the media haven’t ripped them apart over this – the MPC’s official remit is tackling inflation and now with inflation waay over target they want to crank up the money printing presses to create even more inflation? Alarm bells should be ringing.

    Only they are not because the only sign of deflation is in the housing market.

    Central bankers own property too remember!!

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  • The gospel according to St HPW….. End of discussion….. Ahmen!!
    Clearly you are finding it very difficult to understand, but just try to accept that someone has a different point of view from you.

    Of course you can have deflation in a fiat system*.
    Expect the FED to adopt more bizarre methods to get the money into the system – it seems they are already considering several new and different forms of money creation. Also, BOE has also indicated that they may resume money creation – hence my statement.

    Collapsing house prices destroy money
    Maybe in the US – although house prices are still holding up pretty well – but exactly where are you seeing these house prices collapse in the UK? Last time I looked, house prices were more or less the same that they have been for the past three years.

    So we end up with more and more debts but the people who owe those debts are less and less able to pay them.
    Does anyone really care?

    I know that ”Deflation” is very trendy – it’s a nice word & concept, rolls off the tongue, good to impress your friends etc – but as far as the UK goes, my pounds are buying a hell of a lot less than they did two years ago, even a year ago. And….until my pounds start allowing me to buy more stuff, I am not really going to take this ”threat” too seriously.

    RECAPTCHA: Keep going [I fully intend to]

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  • @6. hpwatcher…

    I know that ”Deflation” is very trendy – it’s a nice word & concept, rolls off the tongue, good to impress your friends etc – but as far as the UK goes, my pounds are buying a hell of a lot less than they did two years ago, even a year ago. And….until my pounds start allowing me to buy more stuff, I am not really going to take this ”threat” too seriously.

    I’m seeing this too. The stuff I always buy down the supermarket is going up massively. £7 to £8, £10 to £12, £4 to £6. A quid or two may sound neither here nor there, but when you look at it in terms of percentage then the rises are way above the official inflation numbers.

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  • i remember the 90`s says:

    You might as well print and give it to your people ,the banks well just hoard it and that won`t help savers (me)as there will no incentive to attract those that are frugal,nor will it do any good to small business!!!!!!!!!

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  • This generation, and apologies to all the 55 plus year old’s. But the financial guru’s, wizard’s of oz, have been everything in their power to delay, postpone, prevent the inevitable tsunami. Like many of this delusional, control freakery, walter mittee generation, they should have accepted their medicine years ago. IMO we will shortly see the varnish and wall-paper peeling off this pretence. The days of the lunatics running the asylum are fast coming to an end. This system, fiat money, has no credibility, yes it buys you are car, house or even food. But money and the illusion that it presents is now a dead duck. I’m not on any medication or suffering from depression, just finding the denial thing, a tad boring. I’m looking forward to the revolution, change, however traumatic, painful because it’s what this country and the global economy needs.

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  • cynicalsoothsayer says:

    Banks really aren’t interested in attracting retail savings, so pre-boom. Much more to be had from frightening the authorities into just giving it to them.

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  • @HPW

    You DO get deflation in a fiat money system – here’s evidence:

    Hong Kong
    Japan
    Ireland

    http://en.wikipedia.org/wiki/Deflation

    See section 5. Google them. “Ireland deflation” etc.

    Do not say ‘it must be so and so,” but look and see… Hoe many more cases would you need?

    Nick

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  • cynicalsoothsayer says:

    It’s arguable that deflation is more likely in a fiat money system, just as inflation is. People can hoard money rather than real things, causing deflation, just as easily as they can hoard real stuff and offload the money (=inflation).

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  • Wageslavex14 says:

    I had been afraid of this.

    What a [email protected] start to the day.

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  • Do not say ‘it must be so and so,” but look and see…

    Have you actually been to any of those places? I have some friends in Ireland and some work collegues in Hong Kong; most report that prices have only fallen in very nominal terms, maybe some property devaluation – but it isn’t half as bad as reported. Japan is very different from the rest of the world, as they are almost exclusively savers – as opposed to spenders.

    You may well get some deflation if you have a very tight and responsible government, but most countries simply aren’t like that.

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  • cynicalsoothsayer says:

    @12 Are you talking about asking prices? All very good except they’re not selling at those prices.

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  • HPW
    I don’t need to go there to read or understand the figures; that is irrelevant. Deflation JUST IS a general fall in nominal prices, so as a matter of logic if most prices have fallen ‘in very nominal terms’, as you say, there is deflation. Could it be more simple to understand? Incomes may be falling too, as one would expect, since credit money is being destroyed. But that is just the reason that deflation is no party.
    recaptcha: divvies The
    Nick

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  • HPW

    Of course I can accept you have a different opinion – that’s called debate. Lots of others have different opinions on this site that are put in a way that are respected, although not agreed that really isn’t the point. [ even in this thread lots of people are saying there is no deflation because the price of goods in the shops are on the way up, however that is a bit of a moot point].

    The fact is that you are never balanced in your posts. The fact that you tried to support an increase in the money supply by putting up a chart of the monetary base, merely shows you complete lack of understanding.

    Lets put to one side the UK for one moment and look at the US. There can be no argument that there is deflation in the US. The reason there is no argument is that the definition of inflation is an increase in Money supply, and the definition of deflation is a contraction. Money supply is in its broadest form – i.e. Money AND CREDIT. And as i have pointed out to you (and you can compare the monetary base chart with the M3 chart – CREDIT DWARFS money.

    M3 – as I have pointed out – is contracting at the fastest rate since the 30s. Which is of course why Helicopter ben is trying to do what he can to stop that. However I don’t know if you think they can just carry on “printing money”. In fact they don’t print money per se, they create money by buying assets. Now I cant see the fed buying poor quality assets i.e. non performing loans UNLESS these loans are guaranteed by the Treasury. Possible? yes likely? no – at least not in the short term. And even if they did, people would just create more non performing loans safe in the knowledge that the Fed would step in to buy them.

    I think you are under the impression that governments can manage the economy to do whatever it likes. If that’s the case I don’t understand why we don’t have full employment, no inflation and no business cycle.

    It looks to me like the markets think that Ben is a bit of a dikhead, and they (including me incidentally) have sold off the dollar, this morning. Now that – IMO – wont last. “Soon” they will realise that Ben is actually impotent, and the markets will react by selling shares and buying the dollar. Of course my definition of “soon” is a closely guarded secret! Thats a high risk strategy and of course i accept i could very well be wrong.

    OK now over to the UK. Yes as I have said CURRENTLY you have a point. Personally I am surprised at how well the reflation has done, but that don’t mean it will carry on doing well – or even that they will carry on doing it.

    Now deflation being trendy. Wow ! Deflation is the least trendy and least believed postion there is. Its easy actually to say there is inflation and there is likely to be inflation. Throughout my life I have said the same thing. However I do believe now that we are on the cusp of such deflation, although as I have said its similar to being bullish about being bearish on houseprices. That position (deflation) is of course an outsider, because of our core inflationary pressures.So it actually makes it an even better call if we do end up in a deflationary environment.
    Of course you might say in the future – see told you no deflation, but really thats a bit of a hollow victory.

    I actually hope that there isnt deflation in any great way.

    No doubt you will do some silly extraction of this post using italics and show me the error of my ways – good luck on that!!

    Eventually we may very well get lots of inflation or even hyperinflation because the authorities may undertake measures that are outside the box, that’s an interesting question as to IF and WHEN they will do this. However we will just have to wait and see. In the meantime (at least until M3 stops contracting) in the US we HAVE deflation. Despite the trillions of dollars thrown at it, the war is not being won by the US monetary authorities, the question is will Ben now fire real bullets or blanks or will he actually be stopped firing any by the court of public opinion.

    nick, MW , MG, B/weather, myself [and a few others on here] and history are all correct.. you are just plain WRONG when you say that you cant get deflation in a fiat money system.

    That is why i say you go around with yr fingers stuck in your ears going la li la li la. Mind you i suppose there are worse places to stick em.

    This is actually a very short post on reasons why there can be (and actually is in the US) deflation i can expand on it, but it is a bit pointless – on that at least we can probably both agree.

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  • “prices have only fallen in very nominal terms,”

    I think you might mean notional?!?

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  • Having just read the minutes in full, I can sum them up in one sentence “we don’t really know..”

    I think Mr Sentance is probably a little more streetwise, and a little less reliant on the basket of data which most of the committee bury their noses in – data which is not currently showing any consistant trend or direction..

    I think he will be proven right, and the MPC will come round to his take that rate hikes are necesary; but I don’t now think it likely that we will see one next month, and it’s probably 50:50 for September.

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  • mark wadsworth says:

    @ Techie 17, keep up the good work.

    @ NickB, it’s mainly Japan & Ireland that are relevant (not sure about HK). This is a shining example of the Home-Owner-Ist Death Spiral.

    1. Central bank (i.e. part of government) buys crappy mortgages off banks to prop up land prices. or just nationalises them like Fannie Maw, HBOS etc. Banks no longer need to pay decent deposit interest rates, so savers get sh4fted.
    2. Hence government liabilities goes up (where else does the government get the money from to pay the banks?)
    3. Taxes have to go up, now or in future to repay those government debts, plus to cover the losses the central bank incurred by buying up crap at overvalue.
    4. Therefore people’s net income from wealth creating activities go down, people incentives to work and save go down.
    5. This puts brake on economy and hence downward pressure on house prices. Oops!
    6. Go back to step one and repeat ad infinitum for a couple of decades.

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  • 20. mark wadsworth said…1. Central bank (i.e. part of government)

    …..lol

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  • M3 – as I have pointed out – is contracting at the fastest rate since the 30s.

    This is absolutely key. There was deflation in the 1930s, as the US was on the gold standard, this is precisely why the government wasn’t able to respond – they weren’t able to create gold from nothing. The value of gold could not fall, but everything else did.

    My central point, relates to the determination of central banks to be able to respond to the thread of deflation, which they are all too happy to do – by simply expanding the money supply / keeping interest rates low. I think we could all be underestimating how far they are prepared to go. In the UK they have basically saved housing twice 2004 and 2008 – they simply can’t let it fail now as it will take the banks with it.

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  • deflation will occur, but it will be deflation of our purchasing power. This has been happening for a very long time, just that housing prices have been inflating making people feel like they are getting wealthier.

    whether prices go up or down i don’t really care about. our standard of living will decline rapidly. things will become more expensive relative to the services we can provide, i.e. our wages.

    We have had a good 20 years in the west, now it’s time to pay, it’s just that simple. how it washes out is the only thing left to decide, there is no magic policy to save us, no capitalistic, socialistic, etc, solution to this. The road that the can has been kicked down is starting to turn up hill.

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  • mark wadsworth says:

    Dear HPW, just because you have the gold standard for your currency does not stop the government from borrowing money; and it does not stop M3 (or whatever we want to call it) from being a large multiple of all the gold coins in existence.

    Even if there were no national paper currency and the only currency were gold coins (as was teh case for centuries), we know from the ancient lessons about fractional reserve banking that the “bank” (or goldsmith with a vault) can lend out a multiple of the physical gold coins in the vault, provided he can get the people who receive the gold coins from the borrowers to deposit them back with him.

    i.e. bank starts off with ten gold coins (assets) and “shareholders’ funds” of ten gold coins (non-repayable liabilities), after a while he has ten gold coins in vault and loans to the value of ninety gold coins (assets); and repayable deposits worth ninety gold coins and shareholders funds of ten (liabilities, wether repayable or not). Teh M3 money supply has gone up tenfold. How is this not “inflation”?

    Let us assume that half his borrowers default. He can only repay his creditors just over half what he owes them. So the M3 money supply has halved. How is this not “deflation”?

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  • cynicalsoothsayer says:

    You mean silver coins. That’s why bank notes say “promise to pay the bearer on demand x pounds STERLING” as in sterling silver. The British gold standard didn’t come in until 1821, with other major countries following later that century.

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  • “That’s why bank notes say “promise to pay the bearer on demand x pounds STERLING” ”

    – No they don’t! – they just say x pounds, the word Sterling isn’t there.

    – Go look at one!

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  • cynicalsoothsayer says:

    All notes in my wallet say sterling. But then I’m scottish.

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  • general congreve says:

    House prices going down is merely the ‘devaluation’ of a previously over-valued ‘bubble’ market, it is not deflation.

    Prices of consumer items, such as food, going down in price, therefore making the cost of living lower (for those who are cash rich anyway), will prove we are experiencing deflation (please don’t get this confused with laptops and flat screen tellies getting cheaper due to technological maturity and economies of scale).

    So, has deflation happened for you yet?

    Thought not. GOT GOLD?

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  • “My central point, relates to the determination of central banks to be able to respond to the thread of deflation, which they are all too happy to do – by simply expanding the money supply / keeping interest rates low. I think we could all be underestimating how far they are prepared to go. In the UK they have basically saved housing twice 2004 and 2008 – they simply can’t let it fail now as it will take the banks with it.”

    Fair enough except for one thing. Its not how far they are prepared to go, its how far they will be ALLOWED to go. By definition you must think only people that do not agree with your analysis are underestimating how far they will go. Anyway as we have said in the US its not a threat its actual!!

    I see the central point has moved from there not being the possibility of deflation in a fiat system, to it being possible for a while but ultimately always thwarted by central banks. That then depends on your definition of ultimately. I love the way you do that without ever admitting being wrong.

    MW is of course right re Gold.

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  • mark wadsworth says:

    @ General C. Things in UK shops ARE getting cheaper, the problem is that our currency is going down faster than global prices, so to us they look more expensive.

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  • GC – so was house prices going up not inflation?!?!? A while back i showed MW a paper from the Fed about the correlation of HPs with M3.

    There was a very tight correlation. So if there was this correlation and the Hps fall – then assuming the correlation holds – isnt that a probable / possible indication of deflation?

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  • “GOT GOLD?”

    Nope, but I bought heavily into BP this morning at 393p – see if that pays off 🙂

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  • mark wadsworth says:

    @ Techie 31, yes you did and this confirmed what we had always assumed – beyond a certain level there is a nigh perfect correlation as credit bubble and land price bubble are two sides of same coin.

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  • in response to techie at 17 and a nod to nod2glod at 22, I have said for a while that although credit money far exceeds physical money, there have not been the inflationary consequences (excepting house prices) as a result of the creation of the credit as there would have been with the equivalent creation of physical money. This must surely be because credit is the spending of our future earnings, whereas creation of physical money has a straight forward diluting effect on the power of that money. Credit can contract, but it does not affect the outstanding debt. You still owe your mortgage.

    IMO there wont be any significant deflation as a result of contraction of credit supply, because there was not any inflation as a result of its expansion originally. But it will prove to be a very convenient excuse for the creation of physical money, the wiping out of governments debts, and by extension hyperinflation.

    I guess what my mind is trying to tell me is that there will either be house price deflation in line with a credit contraction (which is what I fear we have all been duped into thinking) or there will be a rapid printing of money (via obvious justifications) to wipe out debt, ruin savings, and we will get inflation in everything except houses.

    No?

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  • Although I agree that there is a theoretical risk of deflation, all the evidence gives the indication that it simply isn’t going to happen in any major way in the current situation. Many have stated that deflation is the current threat, despite the fact that in the UK prices have risen and RPI and CPI have been going increasing. QE has performed the important function of keeping interest rates low, thereby keeping money cheap and plentiful – and by inflation – the price of goods high. If any deflation has occurred, it is within the currency itself.

    The problem is that a FIAT system affords the luxury of extensive manipulation to try and prevent anything like it from happening…my original point. Although I hope that some form of devaluation will occur in UK property, I don’t see the dream of deflation coming true as the creation of new money – is now so plastic – it demands nothing other that a few strokes on a computer keyboard.

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  • @inbreda

    “IMO there wont be any significant deflation as a result of contraction of credit supply, because there was not any inflation as a result of its expansion originally.”

    The overall trend over the last decade or two has surely been inflationary. Try one of Denninger’s recent commentaries:

    http://market-ticker.denninger.net/archives/2516-Crack-Smoking-Part-Deux.html

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  • “The problem is that a FIAT system affords the luxury of extensive manipulation to try and prevent anything like it from happening..”

    YES on that we can all agree the emphasis is on “TRY”.

    “… my original point.” well thats a bit disingenuous – your point was it CANT happen in a fiat environment. The point is it CAN happen, how likely it is to happen is a different issue. It might even be argued that “problem” is the wrong word – you might say the “benefit” of a fiat system is that they can manipulate things so that the evil deflation is unlikely.

    So yes it is unlikely – which is why it has hardly ever happened in history. The fact that they have thrown the kitchen sink at it to try (and up until now in the UK successfully) to stop it, makes you wonder. In “normal” times had this been done then the aggregate monetary indicators would be through the roof and yes we would probably be well on the way to high inflation or even hyper inflation.

    Falling buzzard @1 has it in a nutshell. People need to take up the slack – and (however unlikely i believe that to be) maybe they will!

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  • james stephenson says:

    @9 SD

    You are being a tad overoptimistic. Of course we will see ‘The Greatest Depression’. It is inevitable and people who say, ‘but things are different this time’ are just delusional. The planet is in negative equity and governments have been attempting to solve a debt problem by racking up more debt. It is not complicated. But if anyone thinks that this is an accident and that the people making financial policy decisions are that stupid (okay, maybe Brown and Darling, but not Bernanke, Greenspan, Paulson, Geitner etc.) then they are also delusional. This is all about a mass consolidation of power and there is no popular revolution coming. The conditions to pull this off have been slowly put in place over decades. The dismantling of barriers between States, be they political, economic, trade, judicial, or legislative barriers is a necessary mechanism in the coming global power-grab by the financial elite. Just look at the calls for a Global Tax by the UN on the back of the Millenium Declaration – this should demonstrate where we are headed.

    The coming financial tsunami will be the basis for a tightening of control by the elite, not something that will see us freed from the current system.

    As Rahm Emanual said, ‘Never let a crisis go to waste.’ I would add, ‘especially if you created it in the first place’.

    Removal of the Glass-Steagall act, Greenspan reducing the cost of money after the dot com crash, the destruction of regulation of the markets, people like Barney Frank pushing for companies like Fannie & Freddie to loan billions to people who would never be able to pay back and packaging them up and selling them on to infect most national markets etc. The list goes on and on and this stuff is not incompetency – if you think that then look at the recaptcha.

    Recaptcha – ‘Useful Idiots’

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