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inflation -vs- deflation, a brief look at the consequences

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September 13, 2009 – Comments (35)

This blog aims to take a look at inflation and deflation in a broad and simple way to make the main points.

Imagine a world in which we had 10% inflation of everything - prices, costs, and wages - every year.  Imagine that in this world you made $100k and were thinking about buying a $200k house.  You buy the house, ...  and incur debt of about 2x your annual salary.   At the moment you have 0% of your annual salary as equity in the home and lets assume you have no savings.

In 1 year you are making $110k, have paid off lets say $2500 of the house, and the house is worth $220k.  Now you have debt of 1.8x your annual salary and have about 20% of your annual salary as equity in the house.  In 5 years you are making $160k, you owe perhaps $180k on the house, and the house is now worth $320k.  Now your debt is now just  1.1x your annual salary (down from 2x) and you have nearly 1x your annual salary of equity in the house.  

This is good.  The inflation of wages, costs, and prices constantly devalues debt (making debt held less of a burden), and creates a savings account in the house (or other assets which hold value -vs- depreciating).  Also your pay is constantly increasing which will have a positive psychological effect as you feel better making $100k than $60k even if your net buying power is the same.  

In this inflationary scenario you have nearly 1x your annual salary of equity in the home, your debt is just over 1x your annual salary, life is probably good.  You may miss the good old days when gas was $0.25  and a new Corvette was $5000, but overall its acceptable.

 

Now imagine a similar deflationary scenario.  Every year costs, prices, and wages drop 10%.  You buy a house, again, thats 2x your salary.  $100k income, $200k house.  The next year you are making $90k, the house is worth $180k, and you've paid off again lets say $10k of the house.  Your debt is now 2.1x your annual salary and you have negative $10k of equity in the home.  

Flash forward 5 years.  You are making $60k, you have paid off $15k.  Your debt is now 3x your annual salary, your house is now worth just $120k and you still owe roughly $180k, you are $60k or an entire years pay underwater.  Probably, you can no longer make your house payment and you face bankruptcy.

You don't have time to enjoy the cheap gas or low prices for a steak dinner, you're broke.

 

This is possibly the most relevant element of inflation -vs- deflation in my view:  debt is far less burdensome in an inflationary environment (assuming again that wages, costs, prices all inflate).  There are other effects as well.

Motivation to spend -vs- motivation to save.  In an inflationary environment people are motivated to spend money now -vs- save it, as the buying power of their savings is constantly lessened.  In a deflationary environment you have little motive to purchase as the cost of something will be lower in the future, and the value of whatever you have purchased will also be lower in the future.  If you knew that a new Corvette was $50k today but would be $75k in 5 years, you would be much more motivated to buy your dream car today than if that car was going to cost $35k in 5 years.  

Inflation creates an intrinsic logical motive to purchase to spend to consume to invest.  Deflation creates anti-motive to do those things as you could buy cheaper in the future, your investments and assets are likely to lose value, and so forth. 

 

The examples above are unrealistic and extreme, of course.  Wages, costs, and prices won't ever move in perfect synchrony.  Its likely that wage inflation will lag price inflation and that this will cause a period of discontent and an economic hiccup.  For example, when gas hit $4.50 last summer, I don't remember anybody getting an automatic raise.  Similarly, when it hit $1.50 late last fall, I don't remember anybody getting an automatic pay cut.  So in the short term, deflation can seem good and inflation can seem bad.  And in either case, not all assets or costs will inflate/deflate the same amount, this will create imbalances that harm some and help others.  For example, the big drop in natural gas prices recently hurts CHK (a seller of nat gas) but helps DOW (a user of nat gas).  

As oil shot up in price last summer, companies like ASH or NCX (NCX is no longer an active ticker) were hurt by the sudden increases in raw material costs.  It takes time to pass those cost increases along to customers.  Similarly, ASH was aided by the sudden drop in prices late last fall (their customers had already been passed some of the higher costs, and another lag exists in lowering costs, etc.). 

 

So changes in the pattern of inflation and deflation are chaotic and typically somewhat troublesome.  Wages are likely to lag inflation (leading to more trouble) and all of this...  but inflation is clearly preferable if one had to choose.  It may well be that some amount of inflation is preferable to stable prices, costs, and wages as well for a variety of reasons including the psychological effect of having your income go up, even if that doesn't bring you more buying power.  

But whether inflation or stability prices is the preferable scenario, I can't see any way around deflation being disastrous for an economy.  It was deflation, not a bank bailout, that caused Japans lost decade(s?).

The dramatic events in the world in the last 12 months are the aftermath of excessive inflation (in housing prices, commodity prices, stock prices) turning suddenly to dramatic deflation (in house prices, stock prices, commodity prices).  The change of course causes tremendous turmoil.  We are likely to face turmoil again in the turn back to inflation.

If you were Bernanke or whoever is ultimately in charge...  of a country with enormous debt, who's citizens have considerable debt... you would probably want some inflation.  Its power to ease the burden of debt is vast, and I cannot imagine a scenario in which the current situation does not play out to inflation.  The powers that be no doubt want some inflation, and I'm sure they will get it.  Thats not necessarily bad, mind.  If inflation cannot be restored, the consequences to the economy and markets may well be dramatic and unpleasant for the basic reasons given above. 

But in any case, my goal here was to provide a simple overview of inflation and deflation and some of the consequences of each, not to make any kind of market or economic prediction.  I think its clear that avoiding a prolonged period of deflation is critical.  

 

 

 

35 Comments – Post Your Own

#1) On September 13, 2009 at 2:40 PM, alstry (35.99) wrote:

Than why are wages crashing and banks raising interest rates and tightening credit to tens of millions of American families and businesses?

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#2) On September 13, 2009 at 3:00 PM, checklist34 (99.71) wrote:

alstry, i think alot of what we're seeing now is the chaos stemming from sudden changes to the system.  Many things get out of time when there are sudden shocks.

like oil rushes to $150/barrel, wages don't increase to compensate for this inflation immediately...  but the rise in oil prices leads to creation of new jobs that are frequently high in pay (exploration, etc.) and eventually leads tonet total wages rising.  Although for some people this rise in gas prices is a negative as their wages don't ever move up to match.

then the system is shocked (in this case strong inflation suddenly giving way to dramatic deflation) all kidns of wild things happen.  

But the action taken to ensure that we don't fall into a deflationary spiral is, however flawed or imperfect in design or practice, a good idea.

right now wages (if they are crashing, didn't I read somewhere that wages rose recently?) should be dropping as we have experienced a strong deflation.

and as for banks, they are going to have to ... issue less credit in the present and future than in the past for obvious reasons.

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#3) On September 13, 2009 at 3:36 PM, starbucks4ever (94.57) wrote:

You only forgot to mention that in a deflationary environment you will pick that house for $50K, and in an inflationary environment you won't find a fool who'd sell it to you for $500K. Other than that your argument makes sense.

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#4) On September 13, 2009 at 3:38 PM, whereaminow (< 20) wrote:

checklist34,

Are you willing to discuss this piece? If so, I'll present a detailed critique of where you have gone right and wrong, both on the inflation and deflation. 

David in Qatar

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#5) On September 13, 2009 at 3:42 PM, bigcat1969 (90.79) wrote:

At risk of sticking my nose where it shouldn't be, I would like to see that post David in Qatar.

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#6) On September 13, 2009 at 5:19 PM, Option1307 (30.06) wrote:

Fight fight fight!

Just kidding guys, David I'd like to see your rebuttal as well. It's always good to see multiple sides, especially when dealing with such an important, yet difficult, topic.

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#7) On September 13, 2009 at 5:38 PM, whereaminow (< 20) wrote:

Option1307,

LOL, it wouldn't be anything like that.  Checklist34 made some really good points, and I agree with at least two very important issues he raised.  But, in the past, he hasn't been very receptive to what I have to say, so I don't want to waste anyone's time.

David in Qatar

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#8) On September 13, 2009 at 6:23 PM, checklist34 (99.71) wrote:

zloj,

     you are somewhat right about the $50k vs $500k.  whenever one asset class is inflating strongly for a period of time it probably tends to sell at a premium in anticipation of future appreciation.  Certainly this was widely "known" 2-5 years ago about housing prices... it was "known" that they'd go up making them safe "investments".

     And earlier this year stocks of financial companies were experiencing a prolonged period of severe deflation and the market priced them far, far below actual value presumably in anticipation of additional depreciation.

     Opportunity in investment, perhaps, is primarily found in the turnaround from inflation to deflation, or vice versa, in any given asset class.  That statement is just too obvious to be interesting, I guess, but its true.  

good point

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#9) On September 13, 2009 at 6:28 PM, checklist34 (99.71) wrote:

whereaminow,

     counterpoint away!  but I would offer that i'm not legally required to agree.  :) :)

     I think i'm fairly receptive to everybodies ideas, but as you are very very bearish and until recently I was very bullish, we aren't likely to have seen a whole lot of things eye to eye.  :)

CL

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#10) On September 13, 2009 at 8:05 PM, kaskoosek (35.82) wrote:

When high inflation topples the dollar as a reserve currency, expect lower standard of living like the 70s in the US. Much higher import prices including raw materials.

 

Regarding deflation, it corrects the malaise that is stupid consumption and deletes speculators from the system. If we want to wipe out the GSs and morgan stanleys of the world, only deflation will do that. They are the parasites who will keep on sucking the lifeblood of the US economy including the corrupt politicians.

 

By going the inflation route, there will be no reset which we need. Solving the problem of cheap credit with even more cheap credit, does not deal with the structural problems of the US economy.

 

If you default on your mortage some body else will buy it, who saved money and did not speculate. 

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#11) On September 13, 2009 at 8:18 PM, kaskoosek (35.82) wrote:

By flooding the system with money, you do not solve anything, people will continue to consume. There should be high saving rate so that the trade balance is corrected. Flooding money does not correct this unless we have a total collapse in the purchasing power of the dollar which leads to all kinds of havoc. 

 

More money does neet lead to across the board increases in wages, it leads to higher income disparity. 

 

The solutions are equally bad. One is deflationary, leading to a higher saving rates which we need. Though in the long run will be much better. Higher inflation will definitely lead to dumping of the dollar, short term is better, but long term you have shot yourself in the foot of the dollar looses reserve currency status.

The outcomes are very similair, it is either economic pain now or we pospone to later. This is very similair to 2001, though this time the dollar is goig to get dumped much faster. 

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#12) On September 13, 2009 at 8:27 PM, whereaminow (< 20) wrote:

checklist34,

We've got 40 minutes until Bears-Packers kick off. Let's see if I can put together some quality thoughts with such an important event looming on the horizon!

I am very bearish, on the political economy, but not necessarily on anything else.  I'm a buy-and-hold guy just like most people.  I'm a value investor like so many others.  Where I differ with most bears is that I'm not predicting deflation - and a corresponding market crash.  I believe we'll see stagflation, which is bad for the middle class, poor, and fixed incomes but great for the politcally well-connected  I'm bearish on America in general because I don't see any evidence that the people will demand the freedom necessary to reverse the damage inflicted upon social cooperation that makes an economy thrive.  America is sliding towards a Vulture Economy 

The first element of your post was a theoretical construct of a perfect world of inflation.  If we're going to present a theory, and use that theory as the basis for a policy, the theory must have some value in real life.  It must be verifiable and it must be reflected in reality.  Otherwise we need to disregard the theory and construct a new one.

The theory of perfect inflation is such a theory.  Not only is it unrealistic, it's not even possible. Free market theory makes no grand assumptions.  The idea that people will enter into exchange based upon mutual benefit is irrefutable. Similar is the logic that shows how price formation relies on the subjective evaluations of individual actors.

It's where you criticize the inflation theory that you and I begin to find common ground.  As you note, inflation causes wages to rise slower than other goods.  Keynes noted this as well, and wrote about its implication on union negotiation way back in the 1940s. 

Most people, and academic economists, spend their time searching for the time lag  of inflation. How far behind will wage raises lag consumer prices increases?  We are asking the wrong question here. The real question is "Why do some goods rise in price faster than other? Why do wages rise last?"

The answer can not be found by following a $1 bill as it travels through the economy.  The task is preposterous.  Attempting to follow $1,000,000,000 multiplies the fulitiy.  So what is the solution?

I enjoy math, though not to the extent of some of our friends here at Fool ;)  Math is a logical science.  We know that the shortest path between two points is a straight line.  We didn't have to examine every straight line in history to find this out.  Mathameticians employed logic.  Then, had their discovery not conformed with reality, it would have been disregarded.

We can make some logical deductions about how money enters the economy.  This is referred to as The Cantillon Effect after French economist Richard Cantillon (oddly enough, he was an inflation proponent.)  When money enters the economy, those that get to use it first benefit.  They use it while its purchasing power remains at current levels. Who are the first users?  The government and the politically well-connected.

It's easy to see that under such scenario, government power will increase exponentially with inflation.  I am not the first nor the last person to note this.  We can not ignore the political impacts of inflation, even when making a rudimentary economic analysis.  We do not have a free market.  Government action in the economy (and government-granted monopoly money production is by far the largest intrusion) is a fact of life.  It is a political economy, unfortunately. 

I am also not the first to note that a policy of inflation makes war more likely and is extremely beneficial to the military industrial complex.  The most disturbing aspect of inflation and government growth for me is the growth of American Empire. If one feels that every American war is just, purposeful, and necessary, then they will have no objections to such a scenario.  For those of us, however, that object to American militarism, we view inflation as the condition which makes the immorality of American war possible.  It is still the decisions of individual actors (who may or may not be the President) that send troops to battle. However, there can be absolutely no doubt that a war as unnecessary and unpopular as the Iraq War could have taken place without a printing press.  Inflation and war have a long and sordid history. There is no defense against the historical record.

Now I'll quickly address deflation, as I have to get ready to watch da Bears season opener (c'mon Papa Bear! We need you for this one!)  Deflation can arise in a free market.  Increasing productivity = more goods chasing the same amount of money.  Prices fall.  That is good.  The middle class prospers as it is easy to get ahead. 

Deflationary arising from the pop of an inflationary bubble, however, is extremely painful.  However, there is another element that must be considered.  If you believe, as I do, that purposefully low interests cause a misallocation of capital resources, then you must believe that the pop will eventually happen whether the government wants to avoid it or not.  It's just a matter of time.  The government will avoid it all costs, make no mistake.  For its own survival it must.  i believe that currenly our government has the resources to prevent the big pop.  But it is a fundamental economic fact that resources are scarce.  If they weren't, we could do away with interest rates altogether with no negative consequences. 

I prefer to have the pop now, when we can deal with it.  The history of money and government shows that this will not  be the case.  Our problems will continue to be passed to the next group of statesman.  Eventually, the big pop will come, and it will be much worse.  Again, history shows us this path.  We are following it once again.  This is why I'm bearish.

I have to go, and when I can tomorrow, I'll post more on deflation.  It can be a positive for consumers.  It was great for me while it lasted this year.  I bought way more than I could have.  Of course, I have no debt. That should tell you everything ;)

David in Qatar

 

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#13) On September 13, 2009 at 8:32 PM, kaskoosek (35.82) wrote:

definition of inflation: Stealing money

 

By inflating the money supply the US is actually stealing from the rest of the world. Yes you are right, it doesn't take a scientist to understand that. 

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#14) On September 13, 2009 at 8:33 PM, whereaminow (< 20) wrote:

3rd paragraph from bottom 

purposefully low interests should be purposefully low interest rates

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#15) On September 13, 2009 at 8:37 PM, kaskoosek (35.82) wrote:

Though you are taking some thing for granted. The US gains a lot from SENIORAGE (yes check it in the dictionary), if the dollar falters, the US economy becomes borderline crap. So trying to maintan the purchasing power of the dollar is actually in the interest of the US. Paul Volcker saved the economy back in the 80s.

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#16) On September 13, 2009 at 8:54 PM, starbucks4ever (94.57) wrote:

Good points, whereaminow, but I don't see inflation as a precursor to war. I'd say that wars tend to cause inflation because during the war, the appetites of the Ministry of Piece become almost impossible to control. But it doesn't follow from there that inflation must necessarily cause a war. Case in point: Zimbabwe has not invaded Mozambique so far...maybe they will someday...

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#17) On September 13, 2009 at 8:56 PM, whereaminow (< 20) wrote:

zloj,

No, but they have engaged in quite a war on their own people, sadly.  The point is that the appetite for modern war can only be satisfied through the condition of inflation.  Without it, financing would be impossible.

David in Qatar

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#18) On September 14, 2009 at 8:36 AM, russiangambit (29.33) wrote:

There is too much to talk about when comes to inflation. So, I just give you  a few points:

1. with the unemployement where it is the wages will lag significantly below the inflation level, add to this all the government meddling with the official number. So, inflation will be 10%, reported as CPI of 5% and you'll get salary increase of 3% 2 years later. How is that helping to pay your existing bubble debt?

2.Consumer credit is forzen, so people cannot borrow to support the increasing cost of living and with hihgh inflation banks will demand even higher interest rates which consumers will not be able to pay. That leads to stagflation, as the best possible outcome. Or straight edbubbling of all assets again, 2008 style.

3. Ask any person who experienced an inflation on their own hide - what would they prefer - A) current wage , current debt and falling prices, i.e. deflation or B) high inflation? Believe me, A) is much less painful and less harmful long-term. Inflation kills investments , without investments there is no growth, without growth the futre is very bleak.

4. You can also read my rant about inflation which addresses the moral hazard of it.

Inflation is only good for those corrupt and positions directly at the trough and is very bad for everybody else. Don't fall for it.

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#19) On September 14, 2009 at 1:21 PM, jstegma (29.29) wrote:

kaskoosek - liked the quote about stealing money from the rest of the world.  if that works, then I say let's do it.

whereaminow - interesting thoughts on inflation and war.   I think you have it backwards though.  inflation is usually caused by wars rather than the opposite.  paper currency is valuable because the issuer makes it so, but if the issuer loses a war, the value disappears.  the easiest way to have inflation is to lose a war. 

checklist - I agree with your conclusion that inflation is the outcome that will be chosen.  deflation has typically been more destructive to the economy than inflation.

russian - since when do you get your current wage in deflation?  If that was the case, we'd all vote for it.  that misses the entire point of deflationary problems where the wages decrease against the debt.  you guys can rant about the evils of inflation, but let's not get too happy about deflation as some kind of utopia.  praising the benefits of deflation is totally idiotic.  it's disasterous for the economy.  it might be necessary in some situations, but long term it is entirely unacceptable for investing purposes.

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#20) On September 14, 2009 at 2:42 PM, checklist34 (99.71) wrote:

kask, in essence intentional inflation would, yes, be basically stealing money from not only the rest of the world but americans who save in conservative forms (CDs, treasuries).

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#21) On September 14, 2009 at 2:58 PM, checklist34 (99.71) wrote:

whereaminow:

my initial paragraphs on inflation and deflation were exactly what I said they were:  broad not entirely realistic overviews. 

your post is a good read, but I'd appreciate it if you fleshed out the mechanics of your thoughts instead of just stating them as fact.  I do not really concur that deflation benefits the middle class, as the middle class (if only through ownership of a home or car) faces a necessity of holding considerable debt, more or less.  I know of no debt free middle class couple under the age of 50, and I don't konw how they could realistically accomplish a debt free life.  By renting...  but this forgoes the great savings account that is home ownership over the fullness of time.

I think the transition phases, from inflation to deflation (ala recently) or vice-versa (ala someday) result in a great transfer of wealth.  Those prepared or ahead of the curve can benefit immensely at the expense of those holding the once-inflating, now-deflating assets or those behind the ball, so to speak. 

If oil shoots to $400/barrel and stays there, wages won't rise for most, and they will suffer.  Automakers selling trucks would suffer, the smart car dealerships would probably boom, and tremendous increase of wages in the oil exploration industry would result in many benefitting considerably.  Real estate prices near oilfields (say northwest north dakota) would skyrocket.  Shareholders of Dow Chemicla may suffer, shareholders of Dawson Geopysical may benefit.  Tremendous transfer of wealth, but perhaps no net loss or gain in the fullness of time.  I haven't thought about that last statement enough to really decide if its practicla or not. 

Assaults on the US for militarism are perhaps overdone.  We have for most of the last century possessed the ability to conquer whatever we've wished, but I'm not aware of us planting a flag anywhere.  In fact, what we have done is perhaps "worse" for us citizens in that we spend alot of $$$ but ultimately don't really bring home compensatory conquested resources the way previous dynasties (i.e., the british for a century or 2) have. 

purposeful low interest rates no doubt reslut in an overallocation of resources to real estate.  today we have rates kept intentionally low to help ease the pain of real estate deflation.  But you can't say they've avoided the bubble popping... 

As a quick thought, purposefully low interest rates probably result in a lower net-quality of investment.  If rates were 15% you'd be dang sure some venture had very good chances of success before venturing... 

I'm rambling here, just typing what I think, and I suppose that will make for a disorganized and ambiguous reply, whereami, but... frankly, low interest rates seem to benefit the middle class the most.  The fabled uber-rich can pay cash, no? 

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#22) On September 14, 2009 at 3:04 PM, checklist34 (99.71) wrote:

kask, i'll read a bit on seniorage.

jsteg, thanks for the input.

gambit.

to you rpoint 1, it may be that inflation won't really rear its head until wages increase, increasing demand (i.e., as in unemployment is already falling).

I don't think that credit is as frozen as blanket statements like that frequently imply (in your point 2.).  It may be de-bubbling, as in people not creditworthy are suddenly without it, but they always should have been.  Lending rates aren't that low, mortgage refis are large, car loans still exist, etc.

in 3.  EVENTUALLY, though certainly not immediately, falling prices must lead to falling wages.  aluminum prices plummet, this is "good" in that cars get cheaper, cans get cheaper, foil gets cheaper, we all save 300 bucks a year or something.  But alcoa then isn't profitable, has to shutter plants, people lose jobs, etc.  This type of price deflation is good for SOME, but bad for SOME.  net, net, i still think inflation is the preferable overall situation.

 

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#23) On September 14, 2009 at 3:14 PM, russiangambit (29.33) wrote:

> This type of price deflation is good for SOME, but bad for SOME.  net, net, i still think inflation is the preferable overall situation

Checklist, ok. Let me try another approach. Does it give you a pause that Wall Street  and FED think that inflation is the preferable solution? Prefrable for who?

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#24) On September 14, 2009 at 3:15 PM, checklist34 (99.71) wrote:

seigniorage...  anybody ever tried to quantify the benefit of this to the US?  as in would it even be remotely material?

 

on a side note...  i have now made vastly more money investing in my lifetime than in any other way, and I once owned a few businesses that employed many and profited their owners nicely. 

I do not subscribe to the conspiracy theoryish anti-rich uber-liberal rolling-stone-magazine kind of trains of thought.  one must let people succeed gloriously to provide motivation for the epic effort it can take to create those jobs and businesses.

BUT, and i've posted this before, ... society must differentiate in my view between productive earnings and zero-sum earnings.  starting that business resulted in manufacturing jobs, net exports, etc. 

buying stocks results in no net gain to society. 

i maintain that a hedge fund manager (possible future profession for me, i tink its interesting) paying the same tax rate as someone owning a manufacturing business is perverse. 

this country needs to encourage production invention, things that build wealth, and stop encouraging things that just transfer it.

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#25) On September 14, 2009 at 3:20 PM, checklist34 (99.71) wrote:

some comments on seigniorage:  http://www.atimes.com/atimes/Japan/KA23Dh01.html

 

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#26) On September 14, 2009 at 3:23 PM, checklist34 (99.71) wrote:

gambit, in general i don't subscribe to the goldman-sachs-controls-my-life school of thinking.  I basically agree Bernanke that avoiding prolonged deflation is fairly critical.

i take enormous issue with wall street, as i mentioned in a post 1 or 2 up from here where i comment on the need for production and not transfer to be best rewaqrded in a society.

but in the end being willing to believe that bernanke wants whats best for the US in th elong term isn't such a stretch.  assuming that his intent is evil, controlled by goldman, and meant to harm the country and it citizens is perhaps a much greater stretch.

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#27) On September 14, 2009 at 3:36 PM, StopLaughing (< 20) wrote:

With deflation many wages tend to be sticky. They do not go down much but instead the unemployment  goes up. The purchasing power increases for the lucky and the unlucky really get hit.

Inflation on the other hand hurts savers. Keynesian economics has hurt savers as long as I can remember. It ecourages debt either by household and businesses or governments. 

Lets face it Bush, Clinton, Bush and Obama are either out right Keynesians or at least somewhat NeoKeynesian. 

People do not notice slight inflation 1-3 % as it happens on a yearly basis. They do notice it over 10 years but their house is worth more and thier debt is worth less so they for the most part are not in the streets rioting. 

They instead complain about the cost of medical services, education and basics everytime the oil price explodes. However, they do not blame the politicians who caused it all. And they are glad for what appears to be raises. 

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#28) On September 14, 2009 at 3:56 PM, russiangambit (29.33) wrote:

> but in the end being willing to believe that bernanke wants whats best for the US in th elong term isn't such a stretch.  assuming that his intent is evil, controlled by goldman, and meant to harm the country and it citizens is perhaps a much greater stretch.

You misunderstand me. They are not evil, but they are self-serving.The end result is the same.

They are unwilling to acknowledge the reality and make hard choices. Instead they are try to buy time by making all the wrong choices.

I work in IT, I see it all the time on a smaller scale. Hard choices are avoided, short cuts are implemented, as a result the project falls apart down the road. It is human nature. But it has to be mitigated by the fear of consequences. In certain companies there are consequences and in certain companies you never know who is accountable. In such places I don't even try to change it, it is useless, I simply plan for contingencies . Only in case of financials we have the future of the country at stake not 5-10 mil of IT investments. And nobody is planning for the eventual fall out.

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#29) On September 14, 2009 at 5:49 PM, checklist34 (99.71) wrote:

stop laughing, i think thats a good commentary.  and i think, overall, the population is happier in a mild inflationary situation.  I think the mid-late part of this decade was a little ...  heavy on inflation, and that was starting to annoy people.

 

gambit, i'm still willing to believe that Big Ben wants a positive outcome.  and you are certainly right about our short-cycle democratic government:  none of them want to make tough choices, they want to be reelected

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#30) On September 15, 2009 at 9:03 PM, whereaminow (< 20) wrote:

checklist34,

Sorry I'm getting back to you so late. I'm going to address comment #21 for now, as I don't have much time.

I'm sorry but the first two paragraphs.  They have no basis in reality.  There is no example of wages and goods rising simultaneously.  The reason for this is because it can't happen.  It's impossible.  Again, we have to employ logic here.  If we can't, then we should just disregard all learning and go back to clubbing seals for food.  Money does not enter the economy all at once.  It is injected at points and that people that use it first benefit.  That is irrefutable.  If I give you a counterfieted $100 and you spend it, you benefit.  You received a $100 and used it before prices rose.  As it steps through the economy, it devalues everyone else's savings.  Those are the mechanics. That is as simple as it gets. If we choose to deny this as reality, then we must be able to construct a detailed criticism.  If we can't but choose to deny it anyway we are engaging in a sadist's game.

 think the transition phases, from inflation to deflation (ala recently) or vice-versa (ala someday) result in a great transfer of wealth. 

Agreed. History shows us that the purpose of inflation is to redistribute wealth.  Again, I point the readers to The Ethics of Money Production by Jorg Hulmsann, The Mystery Of Banking by Rothbard, and Money, Bank Credit, and Economic Cycles by Jesus Huerta de Soto.  All of these books are available for free on pdf via the Mises Institute.  A Google search will put you in possession of them.

purposeful low interest rates no doubt reslut in an overallocation of resources to real estate. 

I'm sorry but that statement is not only incorrect, its been refuted by nearly every economist, even the mainstream ones.  Even a hack like Krugman and the statist turncoat Greenspan have publicly admitted that low interest rates cause misallocation in the housing sector.  This is beyond refute.

I wrote extensively about deflation here.

Certainly, it would be better altogether if we could avoid the booms and busts brought about by inflationary fractional reserve banking, paper money, and legal monopoly priviledge. In light of the fact that these evil monstrosities aren't going away any time soon, it would be beneficial for society if the busts that they caused at least allowed for a transfer of assets from inefficient to efficient managers. - David in Qatar

"The champions of the fight against deflation usually present six arguments to make their case.One, in their eyes it is a matter of historical experience that deflation has negative repercussions on aggregate production and, therefore, on the standard of living. To explain this presumed historical record, they hold, two, that deflation incites the market participants to postpone buying because they speculate on ever lower prices. Furthermore, they consider, three, that a declining price level makes it more difficult to service debts contracted at a higher price level in the past. These difficulties threaten to entail, four, a crisis within the banking industry and thus a dramatic curtailment of credit. Five, they claim that deflation in conjunction with “sticky prices” results in unemployment. And finally, six, they consider that deflation might reduce nominal interest rates to such an extent that a monetary policy of “cheap money,” to stimulate employment and production, would no longer be possible, because the interest rate cannot be decreased below zero.

First, in historical fact, deflation has had no clear negative impact on aggregate production. Long-term decreases of the price level did not systematically correlate with lower growth rates than those that prevailed in comparable periods and/or countries with increasing price levels. Even if we focus on deflationary shocks emanating from the financial system, empirical evidence does not seem to warrant the general claim that deflation impairs long-run growth.

Second, it is true that unexpectedly strong deflation can incite people to postpone purchase decisions. However, this does not by any sort of necessity slow down aggregate production. Notice that, in the presence of deflationary tendencies, purchase decisions in general, and consumption in particular, does not come to a halt. For one thing, human beings act under the “constraint of the stomach.” Even the most neurotic misers, who cherish saving a penny above anything else, must make a minimum of purchases just to survive the next day. And all others—that is, the great majority of the population—will by and large buy just as many consumers’ goods as they would have bought in a nondeflationary environment. Even though they expect prices to decline ever further, they will buy goods and services at some point because they prefer enjoying these goods and services sooner rather than later... In actual fact, then, consumption will slow down only marginally in a deflationary environment. And this marginal reduction of consumer spending, far from impairing aggregate production, will rather tend to increase it. The simple fact is that all resources that are not used for consumption are saved; that is, they are available for investment and thus help to extend production in those areas that previously were not profitable enough to warrant investment.

Third, it is correct that deflation—especially unanticipated deflation—makes it more difficult to service debts contracted at a higher price level in the past. In the case of a massive deflation shock, widespread bankruptcy might result. Such consequences are certainly deplorable from the standpoint of the individual entrepreneurs and capitalists who own the firms, factories, and other productive assets when the deflationary shock hits. However, from the aggregate (social) point of view, it does not matter who controls the existing resources. What matters from this overall point of view is that resources remain intact and be used. Now the important point is that deflation does not destroy these resources physically. It merely diminishes their monetary value, which is why their present owners go bankrupt. Thus deflation by and large boils down to a redistribution of productive assets from old owners to new owners. The net impact on production is likely to be zero.

Fourth, it is true that deflation more or less directly threatens the banking industry, because deflation makes it more difficult for bank customers to repay their debts and because widespread business failures are likely to have a direct negative impact on the liquidity of banks. However, for the same reasons that we just discussed, while this might be devastating for some banks, it is not so for society as a whole. The crucial point is that bank credit does not create resources; it channels existing resources into other businesses than those which would have used them if these credits had not existed. It follows that a curtailment of bank credit does not destroy any
resources; it simply entails a different employment of human beings and of the available land, factories, streets, and so on.

In the light of the preceding considerations it appears that the problems entailed by deflation are much less formidable than they are in the opinion of present-day monetary authorities. Deflation certainly has much disruptive potential. However, as will become even more obvious in the following chapters, it mainly threatens institutions that are responsible for inflationary increases of the money supply." - Jorg Hulsmann

Finally, you now know a middle aged man with no debt. Me. My fiancee and I have been debt free for over a year (I have been debt free personally for two years.)  I am 35. I don't own a credit card. I don't have a mortgage.  There are others like me.  We got out of the system.  We made the right choices. We get punished when Bernanke inflates, even living over here in Qatar, as the qatari riyal is tied to the dollar.  It punishes the people that make smart decisions and rewards the politically connected.  It doesn't even save homeowners.  Any gains they make from housing price increases due to inflation is eatin away by the loss of purchasing power of the dollar. As Keynes admitted, it's a mug's game.

The link between inflation and war is only overdone if you haven't seen a young lance corporal dying on the side of the road in baghdad with his legs blown off.

David in Qatar

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#31) On September 15, 2009 at 9:30 PM, whereaminow (< 20) wrote:

purposeful low interest rates no doubt reslut in an overallocation of resources to real estate. 

I'm sorry but that statement is not only incorrect, its been refuted by nearly every economist, even the mainstream ones.  Even a hack like Krugman and the statist turncoat Greenspan have publicly admitted that low interest rates cause misallocation in the housing sector.  This is beyond refute.

Terribly sorry.  You wrote the opposite of what i read.  I've been up for 26 hours.  Probably shouldn't engage in debate right now!  I feel silly.

Will talk to you soon.  Thanks for the good discussion.

David in Qatar

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#32) On September 15, 2009 at 9:38 PM, starbucks4ever (94.57) wrote:

"but in the end being willing to believe that bernanke wants whats best for the US in th elong term isn't such a stretch."

No, it isn't. I also think he is perfectly sincere and wants what's best for the US. The trouble is, he doesn't know anything about the US. He thinks the US consists of several dozen banking executives borrowing at 3%, lending at 6% and playing golf at 3pm.  

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#33) On September 16, 2009 at 12:54 AM, checklist34 (99.71) wrote:

zloj, that was funny, but in the end i think absolute levels of cynicism like that just arne't realistic.

 

Whereaminow:  man, THATS THE POINT OF THE FIRST PARAGRAPHS IN MY INITIAL POST, TO OFFER THE CARTOON VERSION, they weren't meant to be realistic.  small steps in a discussion, small steps in a discussion.  As I noted later and was discussed hereunder by you me and others they cannot move in lockstep.  But in the fullness of time there is a tendency for wages to rise in inflationary environments and fall in deflationary ones, with considerable shifting around of wages.

search "coffee shop intellectual" on this site and check out my story.  one of the ramifications of that story for me is that in my life i've never read an intellectual book of any kind.  I just decided based on that and similar experiences to let my own experiences and ability to think things through lead me to theories conclusions and beliefs.  That noted I am an absolute epic data and information junkie.  So I read Dreman, which is basically a statistical presentation...  So I do thank you forthe references but I have to for now stick with my overall thesis on how to learn chosen more than 10 years ago and just figure it out on the fly and by pondering. 

No worries about misreading my one paragraph.  low rates sends money into real estate because its the only investment you can finance long term, well, that anyone can finance long term.

 

If you ever call a 35 year old "middle aged" again I am going to sue you in a court of law.  I'm 34 and i'm young dammit.  lol

I have no debt of any sort except a 0% loan on 1 car and a 1.9% loan on another one.  My other cars are cash paid.  at 0% you're a moron not to take it is my view.  

But anyway, my circumstance is unique.  

And I too owe an apology because I  meant "middle class".  To own a home as a middle class couple requires debt, plain and simple, and as thats most everybody I stand by my inflation beats deflation comments from above.

I'll read your longer part on deflation a bit later.

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#34) On September 16, 2009 at 1:49 AM, checklist34 (99.71) wrote:

i'll take issue with jorg on a couple of points.

first, to say that production remains constant in a deflationary shock is clearly not born out by very recent history.

second, to say that widespread bankruptcies and a banking crisis is, without limit, not a net loss for society ...  assumes some infinitely rich entity backing the money that the banks had lent.  i.e., FDIC guarantees.

 

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#35) On September 16, 2009 at 11:31 AM, whereaminow (< 20) wrote:

checklist34,

first, to say that production remains constant in a deflationary shock is clearly not born out by very recent history.

This depends on whether we agree on the definition of deflation.  The classical definition is a contraction in the money supply.  The money supply steadily decreased in a mostly free market from 1871-1900 and America made a spectular productivity leap.   The deflation of the early 1930's did not go over well however.  Rothbard and a recent macroeconomist have made the case that the most important factor in turning the recession into the Great Depression was the government's refusal to allow wages to fall. This is contrary to Friedman and Keynes. 

Regarding the now-conventional explanations of the Great Depression, such as widespread bank failures and the severe contraction of the money supply, Ohanian points out that these two events did not occur to a significant extent until mid-1931, which was two years after the implementation of Hoover's industrial labor market policies.

Moreover, Ohanian argues,

any monetary explanation of the Depression requires a theory of very large and very protracted monetary nonneutrality. Such a theory has been elusive because the Depression is so much larger than any other downturn, and because explaining the persistence of such a large nonneutrality requires in turn a theory for why the normal economic forces that ultimately undo monetary nonneutrality were grossly absent in this episode.

The conclusion of Ohanian's paper is quite — one is tempted to say "hardcore" — Rothbardian.

The Great Depression that quickly superseded and distorted the benign recession-adjustment process was not in any sense caused by monetary deflation but by government-induced nominal wage rigidities, which of course can be temporarily circumvented by surreptitiously reducing real wages via unanticipated monetary expansion. Thus writes Ohanian:

I conclude that the Depression is the consequence of government programs and policies, including those of Hoover, that increased labor's ability to raise wages above their competitive levels. The Depression would have been much less severe in the absence of Hoover's program. Similarly, given Hoover's program, the Depression would have been much less severe if monetary policy had responded to keep the price level from falling, which raised real wages. This analysis also provides a theory for why low nominal spending — what some economists refer to as deficient aggregate demand — generated such a large depression in the 1930s, but not in the early 1920s, which was a period of comparable deflation and monetary contraction, but when firms cut nominal wages considerably.

Second point,

second, to say that widespread bankruptcies and a banking crisis is, without limit, not a net loss for society ...  assumes some infinitely rich entity backing the money that the banks had lent.  i.e., FDIC guarantees.

It must logically follow from this statement that resources are not scarce.  There is no infintely rich entity.  The FDIC is you and me, and we are not infinitely rich, despite what the socialists say.  If the socialists are right, then we can do away with interest rates, savings, profit/loss, everything. Just put it all in a scrap heap and let the people take whatever they way, a la Saint-Simon.

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