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TMFHumbleServant (< 20)

Debt-deflation: Just the beginning?

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October 29, 2009 – Comments (8)

The debate rages on.

Is inflation or deflation the bigger threat? There are lots of people -- lots of smart people -- on both sides of the debate and they present lots of good arguments. One thing that I have not seen -- and maybe I just missed it -- was an analysis using Irving Fisher's debt-deflation framework. So I decided to put one together myself and to inject my understanding of what Bernanke is try to do to stop deflation from taking hold.

The question I keep coming back to, especially as I read more about the situation Japan faced (I'm reading everything I can by Richard Koo, including his book "The Holy Grail of Macroeconomics." Who else should I be reading on the topic of Japan's Great Recession?) is "can we generate enough counter-momentum if the debt-deflation process really takes hold?" I really wonder, even with the power of the printing presses.

And just to make sure I am not being one-sided, I am countering my fears of deflation with "Monetary Regimes and Inflation" by Peter Bernholz, which should arrive next week.

The summary of my presentation below is as follows: debt-deflation is a contraction process and according to the data I collected to populate Fisher's debt-deflation framework, it looks like it is just starting to take hold. Bernanke et al will do everything they can to counteract it, but I still wonder if they can really stop it if it takes hold. I don't know the answer for sure, but deflation is my biggest fear as monetary policy might not be able to stop it.

I would love to hear your thoughts on the topic, so let's get this conversation started. Are you worried more about inflation or deflation? Is the US consumer changing its attitude about debt and consumption and what are the ramifications? What's missing from my argument? And let's discuss what types of investments fit the different scenarios.

To me, the scariest chart (and I believe there are two really scary ones in the presentation) at the very end. I won't spoil it for you. :-)

Without further ado, below is my research on debt-deflation.

Fool on!

Dave

Debt Deflation October 2009                                                                                                                                                                                                                                                                                                                                                                                                          

8 Comments – Post Your Own

#1) On October 29, 2009 at 4:38 PM, Evlampius (84.80) wrote:

cool thank you

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#2) On October 29, 2009 at 8:04 PM, nuf2bdangrus (< 20) wrote:

Deflation is the natrul progress of true capitalism...the lowering of the cost of goods and services through innovative efficiences.  It is the governments who try to inflate via abuse of currency to confiscate wealth.  Yes, deflation will hurt my house...and could wipe me out.  But it is the natural order of things.  Embrace it.

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#3) On October 29, 2009 at 8:27 PM, TMFHumbleServant (< 20) wrote:

@nuf2

I believe there are two kinds of deflation, one caused by increasing the supply of goods that causes prices to fall. This is good for the consumer and can be good for output. Call this "good deflation."

But if aggregate demand falls, then prices fall but output falls as well. Call that "bad deflation."

The problem that Fisher talked about is too much debt causing "bad deflation" to occur. I would not agree that getting to unsustainable levels of debt and having that cause deflation is a natural occurance. How many times in history has it happened? The Great Depression and Japan's Great Recession are two instances.

Could our Great Recession be a third?

Let's keep the conversation going.

Thx!

Dave

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#4) On October 30, 2009 at 9:58 AM, Option1307 (30.35) wrote:

Excellant presentation!

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#5) On October 30, 2009 at 12:36 PM, JakilaTheHun (99.93) wrote:

Deflation is the greater fear.  The reason I say this is that if inflation takes hold, the Feds have the blueprint for keeping it in check.  We've had double-digit inflation before and we saw Paul Volcker completely crush it by increasing the Fed funds rate to dramatically high levels.  This was a vastly unpopular move across the political spectrum but it worked --- even it did create a lot of short-term pain. 

Eliminating deflation is much trickier.  The Japanese failed at that for a really long time. 

That said, I don't believe our situation is quite as bad as Japan's was and our policymakers, despite making a lot of blunderous moves that I have critiqued alot, have mostly done a reasonable job on monetary policy.  

 

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#6) On October 30, 2009 at 1:42 PM, TMFHumbleServant (< 20) wrote:

@Jakila,

I am reading Richard Koo's "The Holy Grail of Macroeconomics" which is about the recession in Japan.

His data points to businesses and households being over-levered and taking 15+ years to repair their balance sheets despite ultra-low interest rates that should have pushed them to borrow and consume.

Will the US go through a similar scenario, just like businesses and households did during the Great Depression, according to Koo?

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#7) On November 01, 2009 at 5:16 AM, benfranc (< 20) wrote:

As long as the U.S. remains the roll as the worlds reserve currency. The U.S. is dynamic enough to monetize it way out of this current situation. 

Relationships are equity and hustle is capital.

 

http://www.reverbnation.com/benfranc

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#8) On November 09, 2009 at 8:59 PM, washcomp (< 20) wrote:

Loved the presentation.   I do have a couple of comments/suggestions.  We now live in a global environment.  It is likely that other parts of the globe will not only recover sooner than us, but also at a faster trend rate.  This could increase commodity prices in the absence of  monetary inflation in the States.  While increased prices are implied by inflation in the US, they may appear due to circumstances outside of our control despite nominal low inflation here.  Cash is king in deflation unless the government decides they need it more than an individual.  There are anecdotes from actions taken in other countries (Brazil, Argentina, Israel, USSR, etc.) in the past which could be interpreted as wealth confiscation.  Both inflation and deflation cause a decrease in standard of living.  It is clear to me that inflation will be unavoidable in the medium/long term future in the US.  It remains to be seen whether we truly enter a deflationary period before our relentless borrowing must be paid off. This is not only true on a governmental basis, but on the personal level as well.  The “American Dream” is interpreted as home ownership.  The cost of homes vs. wages, the low down payments, and so forth enforce a level of general indebtedness which, on a non-emotional basis, is difficult to justify. Jeff

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