Guest Post: If You Want to Help the Poor and the Middle Class, Encourage Deflation

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

If You Want to Help the Poor and the Middle Class, Encourage Deflation

If we step out of the conventional brainwashing about how bad deflation is, we discover it's actually good and it's inflation that's bad.

We have been brainwashed into believing that inflation is good and deflation is bad. The truth is that inflation is good for banks and bad for households, while deflation is bad for banks and good for households.

Since ours is a bank credit system enforced by the Central State, what’s bad for the banks is presumed to be bad for everyone.

This is simply not true. Inflation is “good” for borrowers, but only if their income rises while their debts remain fixed. For everyone with stagnant income--and that's 90% of the nation's households--inflation is just officially sanctioned theft.

The conventional view can be illustrated with this example. Let’s say a household earns $50,000 a year and they have a fixed-rate mortgage of $100,000. If they set aside 40% of their income to pay the mortgage, that’s $20,000 a year. This means they can pay off their mortgage in five years. (To keep things simple, let’s ignore interest.) Let’s say the household’s annual grocery bill is $5,000—10% of the annual income.

If inflation causes all prices and incomes to double, the household income rises to $100,000 and groceries cost $10,000--still 10% of the annual income. In this sense, inflation hasn’t changed anything: it still takes the same number of hours of work to buy the household’s groceries.

We can say that the purchasing power of an hour of labor hasn't changed; whether the hour is converted into $1 or $1 million, that money buys the same quantity of goods and services as it did before the inflation.

But inflation does something magical when incomes rise and debts remain fixed: now 40% of the household income is $40,000, and so the household can pay off the fixed-rate mortgage in only two-and-a-half years.

Why is inflation good for the banks? After all, the mortgage is paid with depreciated money that no longer buys what it used to. Inflation benefits the banks for the simple reason that it enables the household to make its debt payments and borrow more.

Remember that banks don’t just earn profits on interest, they make money on transaction fees: issuing loans and processing payments. The more loans they originate and manage, the more money they make. The more debt and leverage increase, the more money the banks make.

Banks don’t actually hold many of the loans they originate. They bundle the loans and sell them to investors, a process called securitization. The banks bundle the loans into a security such as a mortgage-backed security (MBS) that can be sold in pieces to investors around the world. (Near-worthless mortgages always have a ready buyer: the Federal Reserve.)

The bank made its money when it originated the loan. Future inflation hurts the investors who bought the loan, not the bank. The bank sold the loan and booked the profit. To make more money, it needs to originate more loans. And to do that, it needs consumers who feel richer because inflation has boosted their nominal (face value) income.

It’s all an illusion, of course; it still takes the same number of hours of labor to buy groceries. But this illusion of having a higher income encourages households to borrow more. This is how inflation greatly benefits banks.

But the mechanism falls apart if incomes don’t rise along with prices for goods and services. When incomes stay the same and prices of goods and services rise, the household is poorer-- their income buys less than it did before inflation.

The mechanism also falls apart if interest rates rise while income stays flat. In adjustable rate loans and credit cards, for example, the interest rate can adjust higher; the rate is not fixed.

This is the situation we find ourselves in: 90% of households are experiencing stagnant or declining income, even as inflation raises the cost of goods and services every year. Adjusted for (probably understated) official inflation, the median household income has fallen 8% in the past five years.

Income, Poverty and Health Insurance Coverage in the United States: 2011 According to the Census Bureau, "In 2011, real median household income was 8.1 percent lower than in 2007."

Major expenses like medical insurance and college tuition have been rising at 5% to 6% a year for decades, twice the official rate of inflation.

The Federal Reserve’s policies are explicitly intended to create 3% inflation, as this benefits the banks. But since wages and incomes are declining for 90% of households, the Fed’s policy is stealing purchasing power from households and enriching the banks. The Fed is a “reverse Robin Hood,” stealing from the poor to give to the rich. The Real Reverse Robin Hood: Ben Bernanke and his Merry Band of Thieves (August 31, 2012)

Since we’ve been brainwashed into uncritically believing deflation is bad, we haven’t thought it out for ourselves. Take computers as an example: we can buy more memory and computer power every year with less money. The cost of computers has deflated for decades. Calculated in 2012 dollars, I paid $5,350 for my first Macintosh computer in 1985. Last year I bought a Hewlett-Packard PC for $450, less than 10% of the cost of a computer in 1985, and the PC has 1,000 times the power and memory of a 1985-era computer.

This is deflation in action: our money buys more goods and services every year. How is this bad? If deflation is good when it comes to computers, how does it suddenly become bad when applied to everything else?

Not only is deflation good for the household with fixed or declining income, it’s also good for the economy. How many people could afford a computer in 1985? Very few. How many can afford a computer now that they cost one-tenth as much? Almost everyone can afford one, even those households that are officially near the poverty line ($23,000 for a family of four in 2012).

If inflation had driven up the cost of computers while income stayed flat, even fewer people could afford computers, and manufacturers would have a much smaller market.

It’s important to remember that adjusted for inflation, the median income for the lower 90% of wage earners (138 million people) has been flat since 1970--forty years. Only the top 10% (14 million people) actually gained income, and only the top 5% gained significantly (+90%). The only way 90% of the populace can buy more goods and services is with deflation.

Let’s consider a household that earns $1,000 a month that enables them to buy 100 good and services. At 4% inflation, in five years the household will only be able to afford 80 goods and services, because inflation stole 20% of the value (purchasing power) of their income. Those producing and selling goods and services have lost 20% of their market.

At 4% deflation, in five years they can afford 120 goods and services--20% more. If you are producing a good or service, your market has expanded by 20%.

Let’s total the consequences of inflation and deflation. With 4% inflation, households are poorer, as they can buy fewer goods and services, and those producing goods and services see their market shrink by 20%. Inflation is a disaster for everyone but the banks.

With deflation, households’ purchasing power increases by 20% and the market for goods and services also increases by 20%. If productivity rises more than 20% over five years, companies can actually produce and sell 20% more goods and make more profit than they did five years before.

What the banks and their neofeudal enforcer the Federal Reserve want is for households to become poorer but more heavily indebted. They don’t want households to be able to afford more goods and services--they want households to have to borrow more money to buy more goods and services because issuing more loans is how banks make huge profits.

Politicians love bank profits as much as the banks because they collect tens of millions of dollars in contributions (in more honest terms, bribes) from the banks. Politicians don’t care if 90% of American households get poorer every year thanks to inflation created by the Federal Reserve: the 1/10th of 1% live in a completely separate world than the 99.9%.

The banks and their politician partners love inflation because it lines their pockets with tens of billions of dollars in profit. They have worked very hard to convince the 99.9% that inflation is good and deflation is bad, but it’s simply not true. Inflation is a slow, continual theft that robs the hard-working productive members of society and transfers the wealth to the banks and their crony lapdogs, the politicians and lobbyists.

Banks and the Federal Reserve hate deflation because people can buy more goods and services without borrowing money to do so.

If the Federal Reserve’s nightmare comes true and deflation occurs, something else happens that the banks fear and loathe: marginal borrowers default on all their debts. Rather than being easier to pay, the debts become more difficult to pay as money gains value. Marginal borrowers no longer get the “boost” of inflation, so they increasingly default on their loans.

How is it bad for hopelessly over-indebted, overleveraged households to default on all their debt and get a fresh start? Exactly why is that bad? What is the over-indebted household losing other than a lifetime of debt-serfdom, stress and poverty?

The banks have to absorb the losses, and since they are so highly leveraged, the losses drive the banks into insolvency. They are bankrupt and must close their doors.

Note that 99.9% of the people benefit when bad banks absorb losses and close their doors. Only the bank managers, owners and bond holders lose, and everyone else gains as an unproductive, poorly managed bank no longer burdens the economy with its malinvestments and risky bets.

The Federal Reserve’s policy of protecting the wealth and power of the banks while stealing from wage earners via inflation is a catastrophe for the nation and the 99.9% who are not financiers, politicians and lobbyists.

If you want to do something for the poor and middle class, encourage deflation.

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fuu's picture

Deflate Bitchez!

GetZeeGold's picture

 

 

We're printing so much money....deflation is sure to happen!

dlmaniac's picture

 

If we could buy a house at 300K instead of 400K, we'd have 100k freed up so that we could buy perhaps a new car, a new set of furniture, a new HDTV, have a few trips to Carribean and so on. Our standard of living would acutally go up with a lower real estate price.

This is not even Econ-101. It's elementary school common sense, and yet beyond our Ivy League Econ-elites to understand.

 

mayhem_korner's picture

 

 

...umm...only if you had the $400K and weren't planning on borrowing any of it for the house.

redpill's picture

Has Chuck ever written anything under 1,500 words?  Dude needs some Twitter therapy.

Dalago's picture

deflation = purchasing power    It's that easy.

mayhem_korner's picture

 

 

Not if your income falls faster than prices...

Popo's picture

On the other hand,  Deflation obliterates anyone leveraged 100:1    (cough, JP Morgan Chase, cough)

..which is exactly why the megabanks try to convince everyone that deflation is "worse".   Inflation and deflation both suck.  But the latter annihilates banks.

Dalago's picture

mayhem_kornerIt depends on where you think the price/wage spiral begins.  So... no.  Price of goods will react first then wage updates happen after earnings are reporting.  So price is a leader and wages are a lagging indicator.

petridish's picture

Jee-zus--did you read the article??  They understand it PERFECTLY.  It's idiot Americans who don't understand.

tbone654's picture

Bernanke understands... played by Peter Falk in this clip...

http://www.youtube.com/watch?v=j4wY-3zkv6Y&feature=relmfu

11:00 minute mark to end

mayhem_korner's picture

 

 

Inflation/deflation is not the key thing...the key thing is purchasing power.  This article way oversimplifies things in trying to make the argument that the relationship between inflation/deflation and purchasing power is so straightforward. 

ACP's picture

Exactly. A constant dollar would be best for everyone, in fact. Especially those in the middle class, who need to save and plan for some years down the road.

Kinda like the entire period between 1790 until the creation of the Federal Unreserved, where inflation was almost nil.

Edit: The period of highest inflation during that time was during the civil war, which was followed by a period of deflation, back down to "equilibrium."

pods's picture

The biggest scam of inflation is that it is set up to extract the productivity increases over time.

Good should become cheaper over time due to increases in productivity and competition.  With a positive rate of inflation, you are basically stealing the value due to inccreases in productivity.  

Although computers are an extreme example, IMHO, it illustrates the effect.

But overall, as you become more productive, goods are cheaper to make and thus will be able to be sold at a lower price for the same profit.

Competition allows that price to move down.

But you cannot have purchasing power increases or a higher forward value for your currency in a credit money system. It won't work.

Hell, the Federal Reserve was set up due to the fact many companies were self-financing at the turn of the century. Banks were losing their influence.

Usher in the panic of 1907, banking reform committee, a quick sojourn to Jekyll Island and voila, the recipe for enslavement was perfected.

pods

odatruf's picture

Computers are a very bad example because the role of innovation in technology is unlike almost anything else. If autos followed that model, we would all be paying ten dollars to drive Rolls Royces and Porches.  If houses did, we would all be paying $100 to buy 2,000 sq ft urban lofts or 4,000 sq ft McMansions is the burbs.

 

Steaming_Wookie_Doo's picture

I'd put it to you that innovation has been stifled in other industries (but I do get your point). Heck back in the 70's there was talk of a carburetor that provided 100mpg efficiency. Not to mention other energy-related tech that has been silenced. We've been paying a huge premium to have petro-domination continue in the economy. Imagine the cost of anything if we weren't paying a massive wedge of income to petroleum, and could employ low cost energy-- I'm thinking more of water as fuel, zero point energy, not Al Gore's stupid mercury filled light bulbs.

Anusocracy's picture

You're not accounting for the difference in labor, materials, and regulations in your comparisons.

Also, people have a preference for smaller electronic gadgets and larger cars and houses.

 

blunderdog's picture

    followed by a period of deflation

Yeah, and you know what they CALLED that "period of deflation" at the time?

"The Great Depression."

Of course, historians' perspectives changed after the 1930s, so it was renamed in the history books. 

Maybe in another 50 years we'll be calling what's going on NOW "The Great Depression" and the '30s period will become "The (previously believed to be) Great Depression."

Not that it matters much--the more important issue is the decades of widespread misery that result from the economic cycle.  If there were any kind of simple solution to THAT, someone would've found it by now.

ACP's picture

I mentioned the Civil War, not WW2.

But in the latter case, the Fed had distorted the markets so much that "equilibirum" was far, far below what most people could have imagined at that time.

blunderdog's picture

Back to History class...

After the Civil War was what we now call "The LONG Depression."  It occurred before the Fed came into existence.   You referred to it as a "period of deflation," which is all well and good considering you weren't trying to survive through it. 

At the time it was occurring, however, people called it the GREAT Depression, because they didn't have the advantage of knowing what was coming 60-70 years later.

Interesting, too--what comes 60-70 years after the "Great Depression" of the '30s?

I don't put much stock in simplistic wave analysis--two dimensional analysis is only effective for extremely simple relationships--but I DO think the reason history rhymes so often is because human behavior at any given time is heavily influenced by people's age. 

A human lifespan (in theory) would be a useful yardstick to plot against historical cycles if you want to understand why and how things happen over and over again.

Anusocracy's picture

"but I DO think the reason history rhymes so often is because human behavior at any given time is heavily influenced by people's age. "

I would guess that it has more to do with whether the Idiocracy Meters or the Evilometers are in the plus or minus range.

Humans are domesticated animals that can go feral.

blunderdog's picture

The "idiocy"/"evil" *needle* hasn't moved in at least a thousand years.  It's the *scale* that's been jumping all over the place.

avidtango's picture

I've heard (many times) Ron Paul speak about inflation vs deflation in terms of the money supply which, in the end, affects purchasing power.  He has asked the same question as many others.  "Why is it so bad to pay $2 for gas rather than $4."  Someone asked about wages and he opined that a strong currency actually went much further with a low wage than inflating prices go with a higher wage.   There is, to put it bluntly, no limit on the up side. 

And when one considers the criminal methods used in computing inflation you want to scream.

whatsinaname's picture

I agree with the headline - did not read the article.

Prices need to come to reality based on real GDP growth not headline inflation related growth.

mayhem_korner's picture

 

 

The only way prices will come to reality is if you eliminate fiat currency.  Currency needs to be backed by something(s) physical, tangible, scarce and needed and act as a conduit for the barter system that underlies. 

MachoMan's picture

We've tried that before...  we screw it up like everything else...  we need a lot more than just a seemingly more stable system to avoid runaway prices.

LMAOLORI's picture

 

 

"If You Want to Help the Poor and the Middle Class"

So funny is this a comedy skit?

 

Fed Up: Bernanke Declares War On The Poor,Elderly,Middle Class


Bernanke Buoys Big-Bank Stocks

 

LawsofPhysics's picture

wait what? Wages actually matter?

Sudden Debt's picture

Have you every heard that a wage increase doesn't stimulate a employee to work harder?

IT'S COMPLETLY TRUE!

just a sidenote... It's completly true when that person makes more than 350.000$ a year.

Employers like to fence with the first line of that well known fact and always tend to forget to tell the second. Because it mostly only applies to themselves...

backhandtopspinslicer's picture

IF IF IF IF IF IF IF IF IF IF

GetZeeGold's picture

 

 

Crap it's stuck again......just kick it.

 

Rylie's picture

If you aunt had balls she'd be your uncle.

Cognitive Dissonance's picture

"If we step out of the conventional brainwashing about how bad deflation is, we discover it's actually good and it's inflation that's bad."

Clearly you have missed a few programming session Charles. Please report to your nearest FEMA camp for re-education.

<Don't make us send in SWAT to assist you.>

Budd aka Sidewinder's picture

If everybody files bankruptcy then everybody starts over with the same FICO score, no?

levelworm's picture

Guys, seriously? Deflation? How about 1931 again?

GetZeeGold's picture

 

 

Dude.....that was the Germans They screw everything up.

 

Those guys are paying 50 year old Greeks to retire on the beach wearing nothing but speedos.....they're batshit crazy!!!

10mm's picture

The horror of such a sight.

Terrorist's picture

In 1930 21% of the labor force was in agriculture. Add support services and you can understand...

Dr. Engali's picture

Making the assumption that anybody in power wants to help the poor and middle class make the whole post moot.

mayhem_korner's picture

 

 

If the rate of borrowing exceeds the rate of income growth (individual level) or real production growth (aggregate), buying power is reduced.  That's it.

Rolling in the "class" angle just turns this piece into rhetoric.

DaveyJones's picture

smart enough to run the machines, dumb enough to accept the conditions

Good old George

MachoMan's picture

I think the author walks a tenuous tightrope with the notion that our expanding credit system does not account for a significant portion (if not all) of the cost availability of items like personal computers and their components.  The demand, research, development, and resource extraction pulled forward through our credit system are all inescapably intertwined with the prices of goods.  Price deflation in one sector cannot be used as a lynch pin for the virtues of deflation...  [NOTE: this is not even deflation...  inflation and deflation occur through an increase or decrease in the money supply...  if the author's version of deflation is correct, then we have simultaneous deflation and inflation...  no].

Is the absence of massive credit expansion good for the common man?  Sure...  good point.  But is the withdrawal of credit, at a time when credit has been massively expanded and banks have been backstopped no matter what, a good thing?  Is it necessarily going to lead to anything that won't naturally occur when the levee breaks, so to speak?  Will the common person actually be better off in the interim by maintaining the status quo?

dolph9's picture

It's all about the housing, student debt, and (to a lesser extent) auto debt sectors.

They want you to keep on paying that mortgage and student debt forever, for a lifetime.  And they will keep you alive on food stamps to do it.

They want to turn you into a debt slave rather than take any loss whatsoever. 

There are only two ways out:  either people default en masse, or people refuse to take on debt, en masse.  A few people doing these here or there won't make a difference.

DaveyJones's picture

"the only way to win the game is not to play"

it's incredibly simple

and it probably scares the shit out of them

that's why they constantly scare the shit out of us

ptoemmes's picture

Wife and I just paid off the mortgage - early.  Yeah!  You would not believe - maybe you would - how much push back/resistance we got from the bank (not even a TBTF bank) to do that.  They even "routed" us to their re-finance department.  Finally, we had to threaten them - just so we could get it paid off.  Waiting to see if they clear the mortgage and deed.