On April 19 Ton Zylstra put me on the spot about why I think that inflation is not the problem and I did my best to explain myself. I should have waited for Illargi at The Automatic Earth: July 5 2009: The unbearable mightiness of deflation
As we have consistently explained here at The Automatic Earth, inflation is an increase in the supply of money and credit relative to available goods and services, while deflation is the opposite. Deflation, moreover, is aggravated by a collapse in the velocity of money. Price movements are lagging indicators of monetary changes, but are also subject to a number of other drivers, such as scarcity and substitutability (or lack thereof).
For this reason, price movements alone have no explanatory or predictive value. For instance, we have lived through a highly inflationary credit expansion over the last couple of decades, but prices have not reacted consistently. Some have risen, as one would expect, but others have fallen, due, for instance, to the effects of global wage arbitrage. For prices to fall in nominal terms during inflationary times, they must be going through the floor in real terms.
Deflation would be associated, at least initially, with prices falling across the board, as the collapse of purchasing power would drastically reduce price support for virtually everything. In a deflation, people sell anything they can, in order to pay down debt, to meet margin calls and to cover the cost of living, once access to credit is cut off and earning an income becomes very much more difficult. This is a recipe for prices falling by perhaps 90% in nominal terms, but for goods and services to become simultaneously much less affordable, as purchasing power would be falling even faster. In other words, in real terms, prices rise (i.e. affordability decreases).
He points to all the things that financial wizards have used as money over the last few years, like asset backed securities, credit default swaps etc and says yes, those things have been a hidden, but real, part of the money supply.
In a defaltion, the value destruction hapopens at a greater rate than fiat money can be printed to fill the void and since the fairy dust money supply is in the hundreds of trillions, it only takes a small rate of destruction to beat any printing press.
But the collapse of credit money (or debt money which is what I prefer) is happening at more than slight rates which is why sales of anything that is not mandatory have fallen off the cliff, taking jobs and people's homes with them.
Which is not to say that some things don't get more expensive in real terms. If you ability to earn, either through loss of the job or reduced working hours, is falling, then even prices that don't fall become harder to pay and if the prices of things you don't need to buy are falling like a rock, making the overall cost of living appear to fall, it makes no difference if you have had to shift to an economic strategy of not buying anything that you can do without for another month.
That strategy is reinforced when you see that if you can make those shoes, clothes, iPods or whatever last a bit longer, their replacement WILL cost less that it does now.
Then we come to the much vaunted increase in savings rates. It looks good on paper but since people are now desperately paying down debt, they can save 10% of their money from now till they die and still have not a cent in the bank. That matters becase if we are having to revert to payign for stuff out of income, we need a banking system that retains our savings and accumulates the capital so that it can be invested, but if all our saving activity does nothing more than pay down debt that needs tio be extinguished, there is no capital being accumulated for investment.
And for a long time to come, no bank that will lend and nobody willing to risk borrowing. As Illargi points out in his piece, falling interest rates are as meaningless as falling prices, what matters is the real cost of borrowing and we are close to that being a nominal; zero but, because of the destruction of credit, in fact even zero is not enough.
If zero interest rates had been enough to stimulate borrowing, japan would not have been in deflation since 89. They ain't.
Time to walk the dogs.
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