1-Jul-10 News -- World economy in deflationary spiral

[vincecate]

We don't know how big the deflationary hole is at any given time, [...]

Yes, I think this is the really hard question, how much deflationary pressure is there? I don't think the "notional value of derivatives" with numbers like $60 tril or $100 tril is the right ballpark. Since all of those derivatives only have a real value of a few trillion they could be bought up and destroyed for a couple years worth of Fed printing.

I think it is some finite amount, like less than $4 tril, that will soon be overpowered by the ongoing money creation needed because of the deficit. They will need to keep making more new money every year, so it just has to overpower any finite deflationary pressure at some point. The deflation in the great depression is very logical to me since they had $2.5 paper money for every $1 worth of gold in the Fed, as people took their gold out there would be less money. But even the great depression, deflation only lasted a few years till they went off gold. Starting with a fiat currency I think we won't ever have significant price deflation. The really hard question to me is just, "When does the inflation start?".

[thomasglee]

...even the great depression, deflation only lasted a few years till they went off gold. Starting with a fiat currency I think we won't ever have significant price deflation. The really hard question to me is just, "When does the inflation start?".

When does the inflation start is exactly the right question in my opinion. As I've mentioned on many occassions, I'm a neophyte at understanding economics, but I've been doing a LOT of reading and research lately and it does seem that the question isn't if we will have inflation, but when. Sure, we might experience deflation first, but at some point inflation HAS to set in. Since the beginning of the creation of the currency system, every fiat currency has failed at some point and that creates inflation. As one author said in a book I just finished reading, "it's going to be a roller coaster ride. We will likely see deflation, closely followed by inflation and then more deflation before finally reaching a level of hyper-inflation". The question is how fast will these cycles move? Will they be slow and drawn out or will they come on the heals of each other?

[Higgenbotham]

There's one distinction in this discussion that I am not sure about. At one time, a few months before the crisis, one of the Fed governors said that the Fed can provide liquidity to the banks, but not capital. I'm not sure if the cash that was swapped for the $1.2 trillion in mortgages can be used as capital or not. I believe he said that only Congress could authorize it to be used for anything other than liquidity.

[vincecate]

When does the inflation start is exactly the right question in my opinion.

The 1930s deflation was in this funny $2.5 paper money for $1 worth of gold bogus standard. Since they paid out $1 worth of gold for $1 worth of paper but were supposed to keep only $2.5 paper for every $1 worth of gold they had to contract the money supply as people took out real gold.

Has there ever been similar deflation under a under pure fiat paper money, in any country? I don't know of any and don't expect there is any.

So if there has never been substantial deflation under a fiat money system it seems wrong to expect substantial deflation in the US when it is under a fiat money system. Just a question of when substantial inflation starts.

[vincecate]

There's one distinction in this discussion that I am not sure about. At one time, a few months before the crisis, one of the Fed governors said that the Fed can provide liquidity to the banks, but not capital. I'm not sure if the cash that was swapped for the $1.2 trillion in mortgages can be used as capital or not. I believe he said that only Congress could authorize it to be used for anything other than liquidity.

Any fractional reserve system is bound to run into liquidity troubles. If deposits are claimed to all be "available on demand" but really the money is loaned out for 20 years then if too many depositors want their money at the same time you have a "bank run" and liquidity trouble. So any country using fractional reserve banking really needs a central bank that can print money to "provide liquidity" when there is trouble. But the central bank is not supposed to be giving a bank money if it is not solvent (more assets than liabilities) or it will risk not being able to get the money back and so inflating the currency. But the current problem was not just liquidity, it was really solvency. Bernanke is just pretending it is liquidity and also helping the banks make money. Would not be surprised if he has broken laws.

See these sections:
http://pair.offshore.ai/38yearcycle/#solvency
http://pair.offshore.ai/38yearcycle/#banks

[Higgenbotham]

But the central bank is not supposed to be giving a bank money if it is not solvent (more assets than liabilities) or it will risk not being able to get the money back and so inflating the currency. But the current problem was not just liquidity, it was really solvency. Bernanke is just pretending it is liquidity and also helping the banks make money. Would not be surprised if he has broken laws.

That's the way I was looking at it. If the mortgage backed securities the banks were holding were illiquid, then a value for the securities needed to be established based on some objective criteria, as it was known the underlying fundamentals were deteriorating. Instead, it's my understanding that Bernanke simply termed them illiquid and took them off the hands of the banks at face with no haircut. In essence, he was recapitalizing the banks. If that's not true, then the banks should have been able to take the mortgages back from the Fed at face once the liquidity problems abated.

[vincecate]

Instead, it's my understanding that Bernanke simply termed them illiquid and took them off the hands of the banks at face with no haircut. In essence, he was recapitalizing the banks. If that's not true, then the banks should have been able to take the mortgages back from the Fed at face once the liquidity problems abated.

Right.

[Higgenbotham]

We don't know how big the deflationary hole is at any given time, [...]

Yes, I think this is the really hard question, how much deflationary pressure is there? I don't think the "notional value of derivatives" with numbers like $60 tril or $100 tril is the right ballpark. Since all of those derivatives only have a real value of a few trillion they could be bought up and destroyed for a couple years worth of Fed printing.

I think it is some finite amount, like less than $4 tril, that will soon be overpowered by the ongoing money creation needed because of the deficit. They will need to keep making more new money every year, so it just has to overpower any finite deflationary pressure at some point. The deflation in the great depression is very logical to me since they had $2.5 paper money for every $1 worth of gold in the Fed, as people took their gold out there would be less money. But even the great depression, deflation only lasted a few years till they went off gold. Starting with a fiat currency I think we won't ever have significant price deflation. The really hard question to me is just, "When does the inflation start?".

I don't think $60-100 trillion is the right number at the present time. $6 trillion might be in the ballpark and the holes might be pretty well defined at present, but the problem I see with the derivatives is that $6 trillion number or whatever it is can be unexpectedly magnified by the derivatives very rapidly and change location from balance sheet to balance sheet, wreaking all kinds of havoc.

Back before the Lehman fiasco, the same thing was being discussed on this forum. It doesn't seem like much has changed.

[vincecate]

The 1930s deflation was in this funny $2.5 paper money for $1 worth of gold bogus standard. Since they paid out $1 worth of gold for $1 worth of paper but were supposed to keep only $2.5 paper for every $1 worth of gold they had to contract the money supply as people took out real gold.

Has there ever been similar deflation under a under pure fiat paper money, in any country? I don't know of any and don't expect there is any.

So if there has never been substantial deflation under a fiat money system it seems wrong to expect substantial deflation in the US when it is under a fiat money system. Just a question of when substantial inflation starts.

After the US demonitized silver (gold only instead of bi-metalic standard) there was like a 1.8% deflation for 20 years.

The German Mark had a short 1-year deflationary period in 1920 before the hyperinflation. The government was printing money fast and still the value went up by 50% compared to other currencies. The following article says that deflation leads to hyperinflation in fiat currencies:

http://www.marketskeptics.com/2008/12/h ... ation.html

The US Great Depression deflation was like 3 years at 10% per year:
http://en.wikipedia.org/wiki/Deflation# ... _deflation

Japan seems a most peculiar long term deflation with fiat money. Not sure how much they really just borrowed money from their citizens and how much new money was created. For the moment I feel this is some kind of exception that I don't understand yet, or maybe it is headed for hyperinflation and just not reached yet.

So let me modify my question. Has there been any pure fiat currency that had substantial deflation (like more than 3% per year and more than 1 year) that did not lead to hyperinflation?

[OLD1953]

...My understanding is that whenever there is a shortage of anything (especially products and/or services) it leads to an INCREASE in cost. If the government implements the controls you postulate, wouldn't that create, for lack of a better term, a black market for those services at inflated prices?

Price controls cause shortages precisely because they distort markets. For instance, in this case, medical providers wouldn't be able to increase charges. If they could, whatever specific good or service would become lucrative and producers and suppliers would enter the market eventually stabilizng.

Many times grey and black markets emerge b/c of rationing. But almost all industries are regulated and medicine more than most; so it would be marginal. The people who are imposing this upon the country won't be affected. They will either get preferential treatment in the system or are wealthy enough to go on a "medical vacations" to Costa Rica or the like.

Don't leave out synthetic "legal" monopolies or monopolies in effect, such as the AMA. The AMA controls (owns in fee simple, really) the state medical boards and the state medical examiners, and that gives them control over how many people can enter the medical profession. Bar associations run in much the same fashion. Many/most of the professional trades are covered by similar groups. For that matter, try being elected without joining one of the two competing "unions", Democrat or Republican.

Shortages are usually synthetic in this modern world. And if more people realized that, there would be a huge drop in what you pay for professional services, in the USA.

GDP - GNP whatever you want to call it, it's a rubber ruler. And damn near meaningless. Plus, many items are counted twice - like my paycheck. When a contractor gets paid, a check is cut to the contracting company, and that adds to GDP. The company pays me, and that adds to GDP. I spend the money, and that adds to GDP. But GDP would be lower if I was paid directly, right?

Add in differences in pricing - I go to a dentist in the USA get a filling, insurance pays 50 and I pay 50. I go to a dentist in Hungary, and I pay 25. Hungary's GDP rises by 25$. BUT IT'S THE SAME FILLING!

If I fill a prescription in Italy, it will cost me about 10% of what it costs in the USA. Does that mean the drugs are only 10% effective?

GDP is not a very meaningful concept in terms of what it purports to represent.