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Guest Post: A Short Note On Deflation
Submitted by Z. Bukhari
Just a short note on Deflation
Oooh, it’s terrible. Like anything, if there’s too much of it. But there’s a context- obviously there’s a reference- in that Deflation is occurring in the middle of either this or that. That this is what ‘it’ means because it has ‘these’ consequences, that this is what it does because this is how it works. And a lot of people say, Deflation! gosh, didn’t we just expand the Fed balance sheet, isn’t that currency, or what about the Stimulus programs and all that cash created through the Treasury there- and then those reserves at the banks…I mean there was mention of some quite large sums? A lot of people feel that adding money to a fixed pool of resources is Inflationary. ..to which the short answer is that we have lower employment than before the money was added as well as lower payrolls on average than before, too, so no, it was not inflationary. Somewhere, the money disappeared. We know where, it’s called toxic assets. The Fed is part-buying them at north of fifty cents on the dollar and helping move those that are worth anything onto private balance sheets at pennies: don’t let a good crisis go to waste. Alright, I’ve simplified – the reason is that there’s been a lot of recent market chatter about the grand cleanser of Deflation sharpening its scythe and preparing to walk amongst the doe-eyed innocents. Let’s be clear, Deflation is what happens if the Demand function contracts and the requirement for money falls.
I suppose the argument goes, if you need less and/or, spend less there starts a vicious downward spiral. Except- that’s an extrapolation that doesn’t necessarily hold – examine the rephrase: if you need to spend less…well then, you have more to spend on discretionaries. The Demand function is after all constructed from the current aggregate spending – mortgages, utilities, foods, gas, schooling, bills, beer, women, crisps- and it is exactly this Demand function that is being defended when we talk of the threat of Deflation. In essence, the argument goes, when things get really bad then what happens is that, as a population, we stop being able to support the spending on these items...jobs will go, investment will collapse, services will vanish... and the government won’t have enough money, for one- there won’t be any tax revenue, to help. Except of course, that this is the situation we have right now. Perhaps then, yes, it should be stymied, but what is meant by Fighting Deflation is exactly a continuation of the policy we have to date – and this is where the defending of the Demand function is important to understand - that essentially, the FRBNY is asking to preserve the current cost ratio of all major items in the personal budget.
In my opinion, this is the beginning of a serious mistake. I feel that the Demand function has collapsed because it could not be borne, that the cost of living was too high a proportion of disposable income. There is a necessary time lag between price inflation and wage inflation –and when the tipping point is reached – when price inflation rises that little bit too much for wages to manage - the system crashes. The provision of Personal Credit pushes us further into the red for a while, but mortgages securitization cemented the inevitability of a crash. ..and meanwhile, the efficiencies which have brought profits to credit-worthy companies will, in turn, allow them to downsize and ride out any crash. The Bail-out, the current policy, resulted in the original debt being left with the homeowner while the banks were allowed to sell their ‘toxic assets’- which Sylvain Raynes categorically stated as in the most part as being unnecessarily complex and having no real financial use- to the Federal Reserve, with the Freddies and Fannies as off-balance sheet special vehicles. Breathtakingly cannibalistic.
…and these are the people who want to fix the problem…
Yet, I don’t see the mistake of fighting Deflation as belonging to the misanthropy of dubious financial dealings. I feel there is a second component to the general price structure which is being overlooked, the man-who-saw-tomorrow effect. In short, with access to information and the new technologies fighting their way through regulation and discovery, it is only a question of time before could well be a real, substantitive change in the actual costs of provision for physical items, food and energy. It may be ten years, worldwide maybe twenty, before the Demand function itself changes quite dramatically, as the internet changed things. Stepping in front of it now, when there is a natural juncture, could easily be the most annoyingly stupid thing that banks could ever do and also quite probably, one of their last.
We need money, we don’t necessarily need banks (if enough were willing to keep open books). Certainly, we don’t need more than one.
But that is as may be… Deflation, I think we have already been going through this for some time now. If it is slated to become more serious, meaning a greater fall-off in the money travelling about the economy, then I don’t believe that the administration is looking to actually change the costs-of-living to accommodate that…whereas that is exactly what should be done, not by two or three percent but by twenty or thirty percent. Effectively placing the economy on the other side of a deflationary clearing- thereby removing the ‘animal spirits’ (!?). The stimulus was issued in the hundreds of billions, it could be done, I just don’t think that it is planned to be. I think the idea was to provide employment in order to sustain the current personal budget.
Guessing that this is where we are headed, in a deflationary episode the levels of profits really don’t matter, far more important is employment, and far more important is the distribution of basic supplies at a sensible price. These two items were critical before and it was extremely difficult to manage for them. Training for suitable skills –suffered from lack of money, time, foundation skills or even prejudice –on the part of several parties. Distribution was not terribly expensive in the US because it had cheap oil and will likely continue to have cheap access for some time. If it doesn’t, then inflation on basics will rise necessarily and when the money is unavailable to buy these and they sit on the shelf, that’s also counts as Deflation. If I had a point, it is that as the situation becomes more critical, the demand for less skilled labor increases but the investment is rarely forthcoming to put it to work...which is a discussion of building up the lower middle class.. a part of which is the concept of universal healthcare. So, tricky ground, but the structural changes to cope with the worst case scenario, if they are targeted for those who need work the most, can really only be conducive to medium term economic growth. One solution to the current situation would be to put labor to work producing basic items near to where the demand exists, i.e. akin to rural industrialization, which we know works well. This can be applied to food and in fact almost everything apart from metals refining. It’s even possible to make synthetic oil distributive. Heck, it even makes sense to tax imports from out of state if it serves to bolster state revenues from corporations who have international low-cost manufacturing bases. If it’s possible to produce Oil, plastics, make goods, work metals and to produce food inside a small town, then profits decrease over the short term, but wealth distribution becomes more equal. And there’s no real question that this is the future- it doesn’t sit well with the large corporations, the threat of terror, or with dubiously- motivated bankers…but this is a necessary part of the squaring of the circle, there isn’t much point in continuing with the current economic system unless you feel that ripping off other peoples faces is the American way, gawdammit. With the ability to detect explosives as fine as it is, the threat of terror is an insufficient deterrent – which leaves the other two – and that’s where the issue is one of the level of necessity for structural changes:
The bankers have just made a level of money on the scale of the entire US housing market; they’ve just been very well-paid. Corporations have the rights to intellectual property which is a tricky item to distribute, license and enforce. For instance, companies could develop a process and then could sell the process, rather than make the product. The model is widespread already, in that this isn’t a dramatic change. The suggestion is that corporations take an active role in farming affiliated production amongst many, many small units, could be an excellent way to restructure GE. Also, that the government stands out of the way and allows these ‘local’ solutions to take shape.
Obviously, I don’t expect the government/banks to do anything helpful; if these changes are to work they would have to be explored by corporate roundtables.
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Fighting deflation? We can fight inflation or deflation?
I found the tone interesting. As if serfs have the power or the potential even to do something like fight inflation/deflation!
The distributio of essential things at a fair price.
Too hopey/simplistic an analysis for this time.
It is different, just not how we'd liek it to be.
This is the most complex economy ever, not a tire.
Inflate, deflate.
More like punctured! Flat.
ORI
http://aadivaahan.wordpress.com
I think the author's point is that this most complex economy ever needs to get less complex in a hurry if it is to survive. Intentionally recreate local economies, with local banks, where producers and consumers can more readily interact with each other. This idea has reared it's head on several other threads. The thought seems to be that we can either do this intentionally, or the predicted social collapse will bring it about simply as a response to the crash. Not likely to happen intentionally. Very few in history have given up their kingdom on purpose.
Yes, correlates nicely with the comparison to Rome's fall posted yesterday. Complexity stifles and kills. Simplicity allows flexibility and change. There are simple solutions, but we are so wrapped up in the complexity of saving sacred cows and unproductive institutions and making everything better by adding layer upon layer of special interest that no one has the power or will to fix things.
We could add value adding labor back in the US at a reasonable cost, but that would require simplification and the displacement of special interests, such as the large banks.
"Complexity stifles and kills."
indeed. it also serves as a great hiding place for those that would fleece us.
in "localized" systems, the fleecing is visible, as are the recipients. witness the recent citizen response to the $800K mayor in the Los Angeles suburb.
i agree, that this effect/result will come to pass. intentionally? doubtful.
why should we fight deflation?
Deflation in creditmoney is a good thing...it means less interest going to banksters. It means the destruction of their slavery product.
Neoclassical idiocy.
I would caution the reader to not confuse a decline in the price level of a sector with efforts of the banking system to reduce the amount of money in circulation. For example, we know that when the price of a 100 GB disk drive drops from $200 to $50 that is not "deflation". But we are rightly alerted to question the cause of a drop in the value of residential housing.
There is a lot of noise in all this data. The biggest noise-maker is government itself. What really happened to the real money supply when, for example, the Fed creates hundreds of billions of dollars with the click of the mouse, and trades them for nearly worthless bank loan portfolios?
My answer would be that unless and until that newly created money competes in the market with all the other dollars held in private hands, that trade was "sequestered" from the broader pool of dollars and will not change the level of wages and prices. The net effect of that trade was to allow the banks to greatly decrease the bank's reserve requirements! (or to greatly expand the leverage allowed on what sound reserves it had left) It also socialized the bank's portfolio losses.
But why should we be surprised at this? It must be remembered that the Federal Reserve is a private corporation whose shares are held exclusively by the member financial institutions. We are seeing banks voting their shares in the most massive crony capitalism scheme in human history.
We also know that the Fed is almost unrestrained in both what it is free to do and the scale it is free to operate with. Further, it is free to do it in secret and knowing that most of the details will never be told even to those in Congress who have official oversight.
The Fed must be regularly audited and must be forced to have total transparency.
While I disagree with Friedman on many points, he was mechanically correct by stating, "inflation is everywhere and always a monetary phenomena." I think that von Mises and the Austrians have a more complete understanding of the topic.
I don't know about that. If my neighbor walks away from her house, it sits vacant, going to hell, the other house values still go down. There is still an effect, even though the Fed is holding the bag.
Agreed. My point being that many on this blog, including myself, are alarmed by the vast expansion of the money supply. However, upon closer examination, a lot this "liquidity" is not made available in the banking system for expansion of credit at the consumer level, but is solely used to provide for government to assume the bad debt of banks. It never gets in the hands on anyone who uses it to bid up the price of consumer goods or the wages of the average worker. Therefore, this particular expansion of M3 cannot by itself cause the rapid rise in prices we would normally expect.
i think many here understand that the QE money *is* being used to buy-out the sins of the elites...
it's just impossible to tell how that money will ultimately re-appear, if ever. currently it seems to be buying the 'extend and pretend' scheme that's holding us together right now, but how does that cabbage rot at the end of the season (kim-chee, saur kroute, or just rotten mush...)
interesting thread last week described the FED buying the better part of it (MBS, etc.) then shutting down, outright.
i see that as almost too rational, and not likely without a new FED-like thing to replace it (more global in nature?).
a bit over my head, methinks.
http://www.washingtonpost.com/wp-dyn/content/article/2010/07/29/AR2010072903898.html
By JEANNINE AVERSA AP WASHINGTON -- The Federal Reserve should revive a crisis-era program to buy government debt if the country seems headed toward a bout with deflation, a Fed official said Thursday. James Bullard, president of the Federal Reserve Bank of St. Louis, worries that the United...
1. A painful mix of stagflation and deflation in developed countries.
2. Painful inflation in developing countries.
3. Good times for the ultra-rich, as usual. I wish I were ultra-rich...
Hence the Japanese disease. The QE money still makes it into commodities while private consumers continue to deleverage because lending is stifled by the systemic fragility that prevents banks from taking on further risk.
Or, the higher time preference of a fragile, risk-averse banking system that now only makes profit on spreads nets you inflation in liquid assets like stocks, government paper, and commodities while you see persistent deflationary pressure on the consumer-side as saving (lower time preference) takes hold. All this goes along with a collapsing capital structure (the shrinking economy/loss of jobs from the liquidation of malinvestment) brought on by the peak and subsequent contraction in credit that caused the deleveraging cycle to start off in the first place. Thus, if you are a business that produces and buys real things, Cash is King.
If the bank loans me money to buy a house and five years later I sell it to my neighbor for $1 more than I purchased it for, have I expanded the money supply? If instead of selling my house to my neighbor, I sell it to the Federal government for $1 more than I purchased it for, does that sale expand the money supply? I think that the answer is neither transaction expands the money supply.
Now, if I default on my house payments and the government pays off the loan (in effect, purchasing my house from me, but at a lower price), how does that transaction expand the money supply?
The vast expansion of the money supply actually happened before the housing crash. It was the expansion of credit that drove up the price of housing and other things. The money being pumped into the economy now is simply the government paying off these loans instead of the debtor. The government then becomes the owner of these assets it paid for. Now - if the government decides to give away these assets at some point (assets it has already paid for), that would be a defacto expansion of the money supply.
So long as the money the Feds put into the marketplace is simply paying back a debt already owed, there can be no expansion of the money supply. It is when the Feds hand out money that is not in any way connected to a prior debt, that the money supply actually expands in terms of increasing purchasing power that can lead to inflation.
I realize this example is an oversimplification, but it gets us into the ballpark.
If assets are not allowed to deflate, the "value" is still circulating in the money supply. Is that an "inflation" pressing against the deflation (one that should not be there)?
The FED is not magically separated from the administration nor congress... The FED prints with a mandate from others, not out of its own volition. Its actors might have get out of jail free cards, but they operate at the behest of others (our political leaders). We simply enable their sorry asses... the whole lot of them.
Whenever you say "the FED gets to do whatever it wants", you need to put a little asterisk there and then a footnote that reads "*so long as we raise the debt ceiling, agree to back certain organizations, and give GSEs enough for its fluff".
The FED is certainly worthy of its reputation, but we've got to give credit where it's due.
while by original (1913) design, what you say is true "on paper", there are many edicts on that same paper that the FED has willfully and independently ignored recently. e.g. apparently, they are not allowed to purchase (uncollateralized ?) stuff like the MBS cruft they own so much of right now.
Mr. Denninger at market-ticker.org has a pretty good bead on their shenanigans. Like him or not, he backs up his facts regarding this kind of stuff.
whether desperate or evil, i'm comfortable that the FED is operating well-outside its original charter at this point.
Agreed. Unconventional crises required unconventional responses.
exactly,
but again, i'm trying figure out if they are being evil or simply desperate.
if they are merely desperate, i still retain some semblance of hope - not much, mind you :^)
Are you arguing form or substance though? My point is that the FED's handlers gave it a blank checkbook, with no oversight, and said "fix it." This is what initiated the most recent lunacy. The FED did not initiate this decision...
Whether or not it keeps with its original mandate is largely irrelevant if we are going to continue to allow it to proceed. At some point, you have to just admit that we have ratified its actions and move on... a little face time with congress and some moderately relevant questioning isn't what I would call a reasonable effort to uncover the truth.
Fine, it might be (certainly is) operating out of the parameters of its charter... but it is doing so with the tacit (and sometimes explicit) acceptance of congress and the administration. Simply put, the FED is not an island unto itself. It doesn't just magically decide to do shit...
The FED did not initiate this decision...
I think the Federal Reserve Chairman and Treasury Secretary came up with the scheme. The Treasury Secretary demanded that Congress give them permission. Congress did. This was not initiated by Congress. It was consented to by Congress. Would be interesting if they had just said no at the initial bluster of the Treasury Secretary. (Remember what Paulson did under Bush?)
So, the administration initiated the decision and congress rode shotgun... so? The whole point is that the FED is not an island unto itself. It doesn't just go AWOL... To a very large extent, it asks permission before acting... we don't need to get caught up in the minutia of its transactions... it's a given it's acting outside of its charter... that's not accepting blame...
The point is, we keep running deficits and call upon the FED for help... not the other way around... Ben doesn't just magically print hundreds of trillions of dollars because he has a wild hair in his ass one day... that's not how it works...
If Congress had actually decided to follow the will of its constituents, we would be balls deep in deleveraging, knee deep in food rationing, and ankle deep in blood. It's coming... we just had to make a detour along the way.
Excellent post....
Complexity will be our downfall in the end. The simplicity of crashing demand brought about by the sheeple waking up to the reality of the situation may right the ship eventually.
Now anxiously awaiting the helicopters to rain worthless paper upon countryside.
trav7777
You are correct you don't need to attach interest to your medium of exchange, BUT that is what humans do, or at least to this point in history that is the norm.
With that said, once you start a system doing just that, you don't just call timeout when it starts to collapse do to math of it's own weight. A price will be paid, a balloon payment from hell which will be paid in bodies.
At this point not much else can be done... some slow down of the rate has been achieved... eventually collapse and liquidation of the non-performing assets.
"Obviously, I don’t expect the government/banks to do anything helpful; if these changes are to work they would have to be explored by corporate roundtables"
The author is confused, there is nothing the government can do other than effect the rate of collapse slightly. Unless there is true Wizard of Oz it's over.
A balloon payment from hell and 535 little pricks running around
Plenty of unfunded liabilities need to be liquidated this time.
Thats not a short note.
Obviously, I don’t expect the government/banks to do anything helpful; if these changes are to work they would have to be explored by corporate roundtables.
I know it's uncool to wax positively about giant corporations but think of the opportunity they have right now to co-opt some traditional government social functions (and power) and become quasi-states themselves. Imagine if a company of Wal-Mart's size decided to forgo much of their corporate profits and executive payouts for a decade in an effort to gain political power through fierce employee loyalty and the lavish employee provisions that would require.
The corporation wouldn't pay their employees a whole lot more maybe but they would provide for them, incrementally at first, in ways that would eventually prove hard to walk away from: healthcare, education and all kinds of in-house domestic, legal, financial and everyday services. When they are ultimately confronted by the government the corporation could say: "hey, you guys are in pretty sorry financial shape. We will take the entitlement liabilities you owe/will owe these people off your hands if you just leave us alone and let us do our thing...we'll save you money." The state/feds will go for it, thinking more of the short term instead of the long like they always do and slowly, if done right, employees will find themselves voting overwhelmingly in tandem with their corporate management and otherwise carrying the company banner. Also remember that corporations now have recent, Supreme Court protected free speech rights.
The corporation would end up becoming the de-facto government in many ways for many more people if/because those people think they're getting a better deal. This is already sort of happening in less significant ways, mostly on the higher end at companies like Fidelity or Google and probably many others. Hell, it's already happened with SEIU. The key for corporations is to make it work at the lower end because that's where the numbers and thus the power are. Is this spooky and fascist? Yeah maybe but if you don't like it you vote with your feet - something that isn't as easy with the Federal government.
I'm not advocating this necessarily and it's not a world in which I personaly would thrive but I think it could happen given current circumstances.
Nope. The only way those functions will be implemented is if by necessity through normal competition. The alarm bell has already been sounded and corporations now have the mandate to increase cash position (as much as possible on the taxpayers' dime) as well as distribute out cash at risk to the largest principal actors (probably not shareholders). Through the deleveraging process, large companies like walmart will gain political clout just by keeping the doors open, as more and more people become increasingly desperate for but few, dwindling jobs at the same time state and local governments decrease payrolls as well as entitlements and incentives.
That's plausible too. We'll see. Maybe the government will have to start defaulting or delivering short on entitlements first. I still stand by my assertion that the SEIU is already accomplishing much of what I've outlined.
http://www.youtube.com/watch?v=IIq0F3sZQFw&feature=related
In attempting to "Reflate" the economy through the financial markets, the Fed and world central banks have unleashed a vicious calculus that A) has not stopped employment, wage, real estate and retirement asset deflation and B) has given birth to a tidal wave of inflated paper assets that have raised the cost of living and staying in business, hastening the death of the middle class.
The Double Whammy Economy is in full flower as illustrated by these contradictions: Capacity utilization has remained at sub-recessionary levels for a prolonged period of time, but raw material costs are at boom-time levels and challenging all time highs. There's an oil and nat gas glut and gasoline demand is at depression levels, and energy prices are already at pre-recession boom-time levels, on the launch pad to bubble levels. Real final sales are depressed, yet stock market indices are near pre-recession peaks.
Rather than squeezing small businesses and the middle class, the operative term is dismemberment.
Spending less does not mean more discretionary spending. It means paying off existing debts and saving more. Spending less means little or no revenue growth for businesses, which results in wage and salary cuts, which reinforces the loop. Take a hard look at how many companies have cut wages and salaries over the last few years. From Microsoft to Federal Express we've seen corporate wide cuts, and in many other cases we've seen corporate wide salary freezes.
Your assertion that spending less on necessities means more discretionary spending is flawed from the start because you have failed to account for other factors at play, thus the rest of your missive is suspect because it is based on flawed assumptions.
+1.
After reading so many glowing posts above, I was starting to think I might be the only one who thought that.
http://www.thedailybell.com/1250/UK-Stagflation-Now-It-Begins.html
Bank of England Governor Mervyn King has warned that high inflation will continue to erode earnings power through next year as the economy faces the threat of 'stagflation'.
GOT GOLD BITCHES?
We have blown massive financial debt bubbles for years to prevent the previous bubbles from popping resulting in debt deflation. The amount of debt is enormous. I have read on the order of $54 trillion in the US alone. Deflation will come with a vengeance sucking money out of the 99 % of society who do not have access to the elite's solid assets. The sucking will come from mortgages, credit cards, student loans and auto loans. It is a massive tax on everyone taking away from demand. The only way to resolve this mess will be debt repudiation. Banks and financial companies will be forced to take haircuts. If not, the system will collapse from lack of any demand.
Greyzone, you are focussing on the demographic who are unable to accumulate savings: these will most likely to shift discretionary income into debt deleverage. That is a function of the decades, perhaps, of financal miseducation. How can you assert that a decrease in personal indebtedness is a malinvestment for the economy? Doesn't that strike you as putting the donkey before the cart?
DOW daily chart posted at blog, showing two megaphone wedges . . .
http://stockmarket618.wordpress.com
This is an important topic, but the original post is very difficult to read and its logic is very hard to follow.
I only understood one fundamental point to be that the administration ought to be considering how to make it possible for everyone to get by on less, by lowering costs (which I took to mean decreasing taxes, regulation, etc.). If this was the point, I agree.
I also think that the best take on the inflation/deflation debate is from the Austrian school.
Debt moritorium is the only solution. Charge off mortgages that have been bailed out. We spent enough money to already payoff everyone's mortgage. Why are we forced to pay it twice/thrice?
Wages and housegold incomes are going down or sideways verses core inflationa/currency devaluation. "A dollar buys a nickel's worth." As the middle class, those folks that rebuilt the planet after WW2, is destroyed by offshoring and retirement, the macro economy will de-evolve faster. Food prices will take up a larger portion of your monthly income - as an example, compare the cost of feeding your family from a grocery store one night and the cost of feeding the family off the Dollar Menu. Fast food corps have already seen over the horizon. Gas and transportation will edge up making everything else more costly and we haven'y even started WW3 yet. After the smart meters are installed you will find yourself pre-paying for water and electricity and find it turned off in minutes if the late fee isn't debited. Better start looking at how American families lived before 1950, because we are going down because we don't making anything anymore. Except Debt of course.
Even a year ago, I wanted to give the smartest guys in the room the benefit of the doubt. Regrettably, it seems things are not going to turn around until some of these beasts are swinging from lamp posts. The money worshipers are going to have to nuke Mr. Soetoro in order to get their police state, counter the Persians, and get their next JFK/RFK martyr replacement. I hope Hillary at least has the sense to turn the economy back on.