[Gerben42]

Recent articles about the economic crisis talk about fear for deflation, i.e. people not buying stuff because they wait until it gets even cheaper, falling wages, etc.

Can someone point out to me why one shouldn't battle the deflation with inflation? Suppose the US economy suffers from deflation: Then can the government print say 10^12 USD? This will lower the government debt by this amount, while at the same time making the USD worth less (i.e. people have to pay more for stuff, i.e. inflation is pushed).

And there was much joy

Probably there must be some reason why this doesn't work. Or does it in fact work, but no one is willing to commit political suicide over it?

Just some random idea from a Physicist...

[Fluffy]

Stop this!, I invested in Dollars 2 years ago! .

[P_Marlowe]

Hi,

Deflation - There is not enough money in the market to pay the
goods, or more precise no one is willing to pay the
price for the available products, hence money, which
got invested in those products is lost, but the money
in the bank has still its value.
Inflation - The money in the bank accounts lost its value, but the
value contained in the produced products still exists.

If you fight Deflation with Inflation you basically destroy the value
in the bank accounts and the value of the goods, because the money
the guys get for their products is less worth, than the money they have
invested in the past.
Of course you could say, everyone will loose equally, so it will be a fair
distribution, but the guys who make it barely, will be hit hardest.

The current finace crisis is partially a result of inflation, in the past cheap
money was available, Greenspan lowered the rates to the lowest point
at his days, and only recently the rates rose.
And the result was, that lots of money was in market, nothing to buy for
it, so the derivates got created, in the end we made depts of goods to be
created in the future, and those depts will need to be paid.
Of course at the moment the goods get created, nobody has money to pay
them.

Just some random thoughts of a Mathematician, and non economist.
But the important point is, that money is only worth as much as their
are products / goods behing it to back up the value, else it is only
paper, or stones.

You know the story of the man on the distant island, who collected stones
on the beach, because they were used for payments, as he died he had a
big hill of collected stones, every one said he was a rich man, but he only
owned stones.

With kind regards
Marlowe

[mike777]

"Can someone point out to me why one shouldn't battle the deflation with inflation?"

Basically you do and that is what the USA, Germany, China and the world is doing.

Yes it debases the currency, in this case everyone is doing it so all currencies are debased, some more than others. It does make repaying the debt easier. You repay "expensive" debt with cheap money. Of course this assumes people accept your country's money.


Look at it this way, economists supposedly know how to fix deflation, so lets do it. One problem at a time.

I like the current talk/rumor which is to try and get 30 year fixed mortgages in the USA down to 4-4.5%. Not sure we can but I think it is worth trying to get there.


BTW all the current target talk for deficit spending seems to be around 6% of GDP. Krugman, I think, suggests something closer to 30%. (see early 1940's.)

[Winstonm]

Federal Reserve Chairman Bernanke said in a 2002 speech about deflation that a determined government could always create inflation to defeat deflation - and it looks like we will find out if his theories work in practice.

The Fed has already started the monetization process by buying the paper of Fannie Mae and Freddie Mac. (When the Fed purchases instead of lends is when monetization occurs - i.e., printing money).

As for the dollar, anytime you create an oversupply - either dollars or toothpicks - you reduce the value of the object. But keep in mind that a reduction in value of the dollar is hard on exporting nations like Japan and China, proving once again that there is no free lunch.

[mike777]

"As for the dollar, anytime you create an oversupply - either dollars or toothpicks - you reduce the value of the object. But keep in mind that a reduction is value of the dollar is hard on exporting nations like Japan and China, proving once again that there is no free lunch. "


Yes this has affected them already but in the last month the USA was an export champ as we cut down on our imports.

[Al_U_Card]

Make the Euro (until the yuan is ready) the global currency (that IS why Iraq was invaded, no? Saddam wanted to sell his oil in euros???) and watch the US greenback find its true level....ie about 1/2 of its current value.

[Winstonm]

A somewhat disconcerting phenomenon on the deflationary front occured yesterday and today without a lot of fanfare - OPEC nations and non-OPEC nations combined announced oil production cuts in the neighborhoold of 2.5 million barrels a day - yet oil prices still fell and are falling again today (under $38 a barrel according to Yahoo finance).

Is this real demand destruction?

[Gerben42]

Quote

Basically you do and that is what the USA, Germany, China and the world is doing.

But the national debt is rising because of all this stuff. And my idea was basically to pay off the national debt with money that isn't there, so that things are worth something again with respect to said money.

[y66]

According to Paul Krugman, inflating your way out of trouble works until it no longer works.

http://query.nytimes.com/gst/fullpage.html...756C0A9659C8B63

Edit: This paper goes into more detail: Thinking about the liquidity trap

[helene_t]

Gerben42, on Dec 18 2008, 04:42 PM, said:

But the national debt is rising because of all this stuff. And my idea was basically to pay off the national debt with money that isn't there, so that things are worth something again with respect to said money.

Which kind of money do you have a mind? If the government puts more bank notes in circulation, e.g. by giving them for free to citizens, or by paying for increased gvt expenses, its dept to the central bank increases. If instead it pays with X Commercial Bank cheques, its dept to X Commercial Bank increases.

[Winstonm]

Here is another question or two for the bright minds.

If banks can get FF at 0%, can't they then buy treasuries a little further out on the yield curve, deposit them at the Fed as excess reserves, and collect the additional 0.25% the Fed is now paying on reserves for a guranteed and risk-free return? If so, where is the incentive to lend?

My grasp is the equation: Y=MV stands for Y=GDP M=Money stock V=Velocity.
Question: If velocity falls for example from 12 to 6, the monetary formula says that an increase by double the money stock will correct the problem; however, what happens in the real world if that increase is hoarded and saved? Velocity doesn't change and the money stock being circulated doesn't really change. Doesn't that skew the real-world application of the formula?

[P_Marlowe]

Gerben42, on Dec 18 2008, 10:42 AM, said:

Quote

Basically you do and that is what the USA, Germany, China and the world is doing.

But the national debt is rising because of all this stuff. And my idea was basically to pay off the national debt with money that isn't there, so that things are worth something again with respect to said money.

Fine.

But how do you pay for the things you need from today onward?

They wont sell the stuff for yesterdays prices, if the money you
offer lost its value, the price will explode, you may pay of your
old, dept, but in the meantime you will have accumulated new
dept at a higher level.

And sometimes your depts are not denominated in the currency
of your country, sometimes the dept are in another currency,
if your money looses value, the exchange rate just goes up.

With kind regards
Marlowe

[DrTodd13]

As Helene pointed out, the government can't simply "print" money and reduce its debt because our government is essentially not in the business of "printing" money. The privilege has been handed to the Federal Reserve and their constituent banks and even they have to abide by an asset to money ratio. Where do they get the assets? Mainly treasury bills. So, to increase the money supply the government has to go into more debt, not less.

Money is also created when banks loan out money and money is destroyed when loans are paid off. So, people now are paying off their loans but fewer new loans are being taken out. Therefore, the supply of money is going down and this is deflation. That is why they are desperately trying to drive down interest rates to get people to acquire more debt. I saw a paper written a few years back by a federal reserve board member but not the chairman. The paper argued that soon the standard method of spurring growth would fail because you can't lower interest rates lower than 0 (they are now at 0.25%!!!!) and so he was suggesting various ways of creating new money rather than new loans spurred on by lowering of the interest rate.

[Winstonm]

Well stated, Dr. Todd.

Michael Shedlock has a financial blog and he has been on top of this cycle for a long time - he emphasizes that it is the destruction of debt that is the driver of this deflationary event.

The trouble with Fed monetary policy is that you cannot force banks to lend and you cannot force consumers to borrow. When you run an economy that is dependent upon debt expansion, this becomes a problem.

[Al_U_Card]

And here I thought that it was an economy of WEALTH CREATION...(guess it depends on who is benefitting from the money:debt ratio)

[mike777]

Keep in mind if you are saving money, how do you do that?

In practice you save money by investing the money. In simple terms, you are loaning the money out. (checking or savings accounts, cd's, etc.)

Keep in mind if you repay your debt, not save. The person who gets the money back has to do something with it. In practice they invest it. For banks, yes, while the paid back loan destroys/decreases an asset, the cash back creates/increases an asset, cash.


Look at what banks are doing today. They are making loans, many loans. They are also buying up assets(banks) on the cheap.

The fed continues to flood the system through open market operations, buying back government debt and flooding the banking system with cash.

I think if you can get rates down to 4-4.5% you will see a massive wave of refi's. I checked today and was offered 5.1% with reduced refi fees, not zero cost.

As for cars, I see numerous offers for zero% loans.

I get many offers of new credit cards in the mail.

In other words the loans are out there.

[DrTodd13]

mike777, on Dec 18 2008, 09:28 PM, said:

For banks, yes, while the paid back loan destroys/decreases an asset, the cash back creates/increases an asset, cash.

I don't think this is correct. The interest on the loan would be an asset but the principle of the loan simply vanishes into nothingness. If what you are suggesting were true then fractional reserve would have no power. Banks could loan to each other and then immediately pay it off and then count that as an asset on which to loan more against. They could do this in an automated fashion and increase their assets without limit. It is enough of a moral evil the way it is, please don't give them any more ideas.

[mike777]

DrTodd13, on Dec 19 2008, 12:46 AM, said:

mike777, on Dec 18 2008, 09:28 PM, said:

For banks, yes, while the paid back loan destroys/decreases an asset, the cash back creates/increases an asset, cash.

I don't think this is correct. The interest on the loan would be an asset but the principle of the loan simply vanishes into nothingness. If what you are suggesting were true then fractional reserve would have no power. Banks could loan to each other and then immediately pay it off and then count that as an asset on which to loan more against. They could do this in an automated fashion and increase their assets without limit. It is enough of a moral evil the way it is, please don't give them any more ideas.

I did not suggest what you write.


What I did say was if you have an asset, loan of 10,000 and it is repaid with 10,000 cash the net is zero not decrease amount of assets on the balance sheet.

Now of course Cash is not working/earning as the loan was.

But this is a minor point of my post. Again the main one is that banks are lending and my hope is that getting 30 year loans down to 4-4.5% is a good first step in recovery.


btw in general interest on a loan is not an asset on the balance sheet.
example, if I loan out one dollar and you promise to pay me one dollar back and 3 dollars in interest over 30 years, the 3 bucks are not an asset.
How banks create money is I loan out one dollar but make you put some of it on account with me.....I then reloan that account money out again....again I keep a portion of that new loan on account and reloan it out....repeat process.......I create money. Granted I did start all of this with just one buck.

With mortgages, I loan out one dollar and you promise to repay me one dollar and 3 dollars of interest. I then sell that loan for 1.01 to FNMA and reloan out the money...repeat process.

[DrTodd13]

You have to pay the piper sooner or later. Unnaturally low mortgage rates is part of what got us into this mess. Interest rates below their natural level necessarily create malinvestment. All malinvestment has to work its way out of the system at some point and it is never pleasant. The solution to this problem is not to create an even bigger bubble that also has to pop. Anything other than dismantling the FED and limiting the government's ability to modify the supply of money is rearranging deck chairs on the Titanic.