Still confused about Deflationary Spiral or Hyperinflation!?

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Kathy Nestell's picture
Kathy Nestell
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Still confused about Deflationary Spiral or Hyperinflation!?

 

Below is a portion of an article that I came  that primarily focused on the notion of Deflationary Spiral vs Hyperinflation. I have been tending toward the notion of hyperinflation, but was intrigued by the comments in the "Whats Really Happening" paragraph. I would love a Chris Martenson style break down of this article. Can we expect the worst case of Deflation and inflation? and any updated predictions on a time-line?

 

 

Here is the portion of the Article>>>>>

"Lately, I’ve run across a number of articles warning people to prepare themselves for hyperinflation in the United States.  Inevitably, these warnings are accompanied by comparisons to Germany’s Weimar Republic and its infamous bout with hyperinflation in the aftermath of World War I.  But is this really something to be worried about?

To answer that question, we must first understand what hyperinflation is.  In simple terms, hyperinflation is a rapid increase in the general price of goods and services, brought about as a result of a rapidly expanding money supply.

Given the current worldwide credit crunch and subsequent actions by the Federal Reserve, a number of people are predicting a period of hyperinflation for the United States.  These commentators point to the U.S. Treasury, the Federal Reserve, and the massive amounts of “liquidity” each institution is injecting into the marketplace.  Their theory rests on the assumption that in its drive to end the current credit crisis, the federal government is essentially printing money in order to stimulate economic activity.  Since the U.S. dollar is a fiat currency, meaning its sole value is derived from a holder’s faith in the promise of the U.S. government to back it up, no limits exist on how much currency the government can print.  The theory goes that as the U.S. government prints more and more dollars and extends more and more credit, the value of its fiat currency is eroded and the world is flooded with an excess supply of U.S. dollars.  As a direct result, it takes more and more U.S. dollars to purchase goods and services.

Based on these assumptions, quite a few websites are advising readers to be on the look out for hyperinflation and to prepare themselves and their families accordingly.  As such, people are being encouraged to buy gold, silver, and other precious metals as a hedge against hyperinflation.  This is sound advice if the diagnosis of hyperinflation is correct.  But unfortunately, it’s not.

The Real Threat

I know I’ll receive a barrage of emails from well-intentioned people who are convinced our current economic environment is setting people up for a nasty bout of hyperinflation.  But it’s just not true, and in good conscience, I can’t let these claims go unanswered.  United States citizens, and most people throughout the world, should not be preparing for the mythical threat of hyperinflation.  In fact, they should be preparing for the exact opposite.

The real threat of the current financial crisis is deflation – a general decrease in the price of all goods and services as a result of a contraction of the global money supply.  In short, deflation is a net contraction of base money and credit while inflation and hyperinflation are the opposite.

What’s Really Happening…

The hyperinflation argument is built on the faulty premise that the money supply will dramatically increase in the near future, while demand remains steady, thus increasing the general price of all goods and services.  However, if we observe the world around us, we see the exact opposite forces in effect.

This is because the money supply is a total of all currency, coin, and credit in the marketplace.  Take note that physical U.S. dollars a person can actually hold in his hand account for only a small fraction of the money supply.  The remainder of the money supply essentially consists of credit or IOUs held in the form of various financial instruments.  In our fractional reserve banking system, the money supply expands in tandem with the expansion of credit.  Yet, right now, all the indicators are signaling that the days of easy credit are over.  The extension and acceptance of credit is contracting.

Simply put, fewer institutions are willing to lend money, and fewer institutions and individuals are willing (or able) to borrow.  As individuals and institutions default on their debts, the debt instruments (money) decline in value, effectively decreasing the money supply.

While I’ve put this in very simplistic terms, the fact of the matter is that we’re in the midst of a massive global credit crunch, the effective result of which is a worldwide contraction of the money supply.

Furthermore, we’re witnessing a tectonic shift in consumer spending attitudes as people turn away from the recent past behavior of borrow and spend to a more realistic view of work and save.  This means total demand for consumer products throughout the economy is in general decline.

While it’s true that the United States is issuing new currency and coins at an unprecedented rate, this increase in the base money supply (physical currency) is increasing at nowhere near the pace at which credit and consumer demand are being destroyed.  The net effect is deflation.

In an earlier article, I wrote about the declining value of the U.S. dollar:

“Anyone in touch with the world today knows that the dollar is losing value on an almost daily basis.  The dollar has fallen relative to oil, gold, silver, and every other commodity on the planet.  Although this fall won’t last forever, it’s a clear symptom of an ominous future for the dollar’s underlying value.”

When the above statement was made, the world was near the pinnacle of the largest credit bubble in world history.  The easy extension of credit over the course of several consecutive years dramatically increased the money supply.  Since demand for the dollar remained relatively stable over that same time period, an increase in supply resulted in a lower price for dollars.  In other words, the dollar lost value.  As credit expanded (increasing the money supply along with it), it took more and more dollars to purchase gold, oil, silver, food, gasoline, houses, and just about everything.  Essentially, the world experienced rampant inflation for the greater part of this decade.

The idea that “peak oil” or increased demand or anything other than speculation and a general decline in the value of fiat currency was responsible for $147 a barrel oil is simply dead wrong.  An ounce of gold will purchase approximately the same number of barrels of oil today as it would have purchased ten years ago.  Inflation, caused by the rapid expansion of credit, was the driving force in the rising price of oil – as well as the rising price of just about everything else.

What’s Going On Now…

When the massive credit bubble burst, it led to an immediate contraction of the global money supply – a contraction that is still in the process of unraveling.  This isn’t entirely the result of massive debt defaults, but also the product of a global race to hoard cash in order to service debt and make adequate provision for the future.  Financial institutions are hoarding cash in order to guard against future losses and meet government reserve requirements.  Corporations are hoarding cash as they watch past lines of credit disappear.  And individuals are hoarding cash as they face the prospect of job layoffs as well as mounting debt obligations.  So, not only is the money supply contracting, but demand for cash has increased.

This demand for cash has had, and will continue to have, worldwide  implications.  In an effort to increase their cash holdings, corporations, hedge funds, and individuals have been selling assets.  As a result, we’ve witnessed a general price decrease in just about every asset class.  The price of gold is down.  The price of oil and gasoline is down.  The housing market is down, and the stock market is down.

In such a world, the idea of hyperinflation is almost laughable.  This isn’t an environment that breeds hyperinflation.  It is an environment of widespread deflation.

The Deflationary Spiral

Unfortunately, a deflationary environment is one of the worst economic situations possible.  Consumers, faced with unemployment, or the very real prospect of unemployment, curtail discretionary spending, and the collective result of their efforts is lower profits for many businesses.  Faced with decreased demand and poor cash flows, businesses throughout the economy respond by trimming their workforce.  This, in turn, further derails consumer spending as the jobless are not a reliable customer base for most businesses.  In addition, the gainfully employed cut back on spending and hoard cash in preparation for the next round of layoffs.  And on and on…  The vicious cycle just feeds itself.

This is the same situation which plunged the world into the Great Depression.

So where does it all end?  Unfortunately, government efforts to “fix” a crisis government created in the first place will inevitably fail.  The Federal Reserve Board can cut the discount rate and the fed funds rate.  Other central banks throughout the world can follow suit, and they have.  Governments can guarantee bank deposits, buy up debt obligations, nationalize banks, and run the printing presses night and day.  But in the end, all of these efforts will be futile in attempting to spur economic activity.

Why?

Because, in the end, governments can’t make lenders lend and borrowers borrow.

And until lenders are willing to lend, and borrowers are willing (and able) to borrow, the credit side of the money supply equation will continue to contract, and the economic landscape will continue to deteriorate.

Collapsing debt obligations, rising foreclosures, rising credit card defaults, and rising unemployment are deflationary forces. And these events are not exclusive to the United States.  The credit crisis is worldwide.  Only after the debt bubble fully deflates (i.e. the foreclosures and bankruptcies end), then – and only then – will credit and economic activity expand.  Once that happens, inflation will become a threat once again.  But for the moment, inflation and hyperinflation are no where on the horizon.

That said, we remain in a severe global economic downturn."

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Re: Still confused about Deflationary Spiral or ...

Kathy,

I wondered where this information came from so I backtracked and found it came from this web site:

BrittGillette.Com

A Christian examination of bible prophecy and emerging technology…

http://brittgillette.com/WordPress/?p=92

I'm sorry, but anytime information is provided by an obviously religious web-site it causes me to discount what I'm reading as the information will have a religious bias to it and, therefore, is not reliable in my view.

I'm sure you meant well, but I prefer non-religious, technical anlysis.

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Re: Still confused about Deflationary Spiral or ...

Deflation is not asset prices falling.  Deflation is a contraction in the money & credit supply.  There is nothing wrong with deflation but note however deflation is not a reimbursement for inflation. Those who lost wealth during the inflation will not necessarily gain it back during the deflation.

Inflation is an expansion in the money/credit supply.  This is what happens when the gov't prints money.

I like prices falling.  It means my dollar has more purchasing power.  Whether deflation is a good or bad thing really depends on how its managed.  When prices fall it means real wages rise (your pay cheque has more purchasing power) and therefore employers can't afford to pay the wages.  If wages were permitted to fall with deflation then there would be no unemployment.  Also, profitability of a company does not depend on the sale price but on the profit margin.  When a companies cost of business falls and so does the price of its produce then the profits will remain the same.  Also note, loans could be adjusted for deflation just as they are for inflation.  If the interest rate reimburses the lender with more money because of anticipated future weakening dollar a similar change could be made to reimburse the lender with fewer future dollars if the dollar is strengthening.  

The problem with deflation is that the gov't has too many regulations and interference in the market to allow it to happen.  The issue with deflation  is that the gov't has no means to control the economy when it happens.  The gov't only has control in an inflationary environment.  Gov't chooses to inflate its way out of the problems by expanding the money supply via printing money and/or creating more bank credit.

Don't kid your self.  The current gov't policy is very inflationary and when this economy starts to come back on track we will see either very high prices for goods or the gov't will have to increase interest rates to halt the inflation - which will create yet another recession.

Deflation in the money supply also helps the recession to be more rapid.  The recession is the inevitable correction for the malinvestments made during the previous inflationary credit bubble - thanks to the Federal Reserve's policies. Deflation is mistakenly fought during a recession while it should actually be embraced because it actually helps thing correct faster.

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Re: Still confused about Deflationary Spiral or ...

The problem with this line of thinking is with the root cause of hyperinflation. Hyperinflation is not just inflation on steroids. Hyperinflation comes from a lack of confidence in the fiat currency. As long as people are comfortable and confident with the currency they're using then they will trade it freely, regardless of the price of something. Once they lose confidence, however, they consider it nothing more than toilet paper and will trade it as such. Do you know what eventually got the Weimar Republic out of hyperinflation? It was the introduction of a new fiat currency. It was merely the fact that people wanted to and needed to believe in this new currency that it worked. That is all.

It is very important to understand that the dynamics and causes of hyperinflation are different from inflation and high inflation. Once you understand it, you can see how, although we are currently experiencing a bit of deflation, it will ultimately lead to hyperinflation. In fact, throughout history, ALL fiat currencies eventually ended with hyperinflation.

Also understand that just because all of the major retailers are offering major sales incentives to get customers to buy and it appears that goods and services are now cheaper and, therefore, we are in a deflation, this is not really deflation going on but rather liquidation.

There is a great website that does a superb job explaining all of this in more detail. Check out these links from marketskeptics.com:

What is Hyperinflation: http://www.marketskeptics.com/2008/12/what-is-hyperinflation.html

The Dynamics of Inflation and Hyperinflation: http://www.marketskeptics.com/2008/12/dynamics-of-inflation-and.html

How Deflation Creates Hyperinflation: http://www.marketskeptics.com/2008/12/how-deflation-creates-hyperinflation.html

In fact, I would read everything on this site. The author really seems to understand what is really going on and can see the big picture and through the lies and misinformation that are being thrown at us everyday. 

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Re: Still confused about Deflationary Spiral or ...

One other thing.. I have been studying this stuff for about a year now so I am by no means an expert. I read a ton of conflicting information and had a hard time making sense of it all. So I created this quick and easy 3 point system for filtering out those who are full of it and have no clue:

#1 - Whenever someone refers to The Fed as the government or says the government is doing things that The Fed are actually doing they lose credibility. The Fed is not a government entity and only acts in its best interests. The government creates the currency and sells it at manufacturing cost to The Fed. But The Federal Reserve Bank distributes it as it pleases to other banks and creates its own money by making journal entries in a book. Any money it lends to the government must be paid back with interest. If The Fed were a government entity then why pay interest? Do you pay interest to yourself on your own money?

#2 - They lose credibility when they say that deflation is when prices fall or inflation is when prices rise. I guess according to some economic schools of thought this might be true but it makes it very difficult to explain reality when you use these definitions. Inflation is an increase in the supply of money and deflation is the decrese in the supply of money. It's that simple. Everything else that happens such as rising/lowering of prices, unemployment, etc., are all symptoms or the result of the expansion and contraction of the money supply.

#3 - The last one is when someone states the future based on what everyone else is already saying or based off of current, static information. Imagine a weatherman standing out in the rain saying, "Our forecast calls for rain." We intuitively know that weather changes and just because it is raining right now does not mean that it is going to rain tomorrow. I want to know what lies in the future and the rain right now doesn't tell me that. There are other indicators that will tell me what I want to know and I want to listen to the guy that is anaylzing barometers all of the country looking for patterns and changes in air pressure. What if the weatherman says, "I see clouds coming, therefore it is going to rain." You know that there are other, more important things to consider when predicting rain than spotting clouds. The same is true with the market gurus and the media. Just because we know that there are foreclosures and bankruptcies going on right now which are decreasing the money supply does not mean that we are headed for deflation. Deflation is what is happening now, not what is going to happen. If you're going to tell me that we're headed for deflation then back it up with some sort of facts.

 

Use these 3 items to quickly and easily tell the sheep from the shepards.

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Re: Still confused about Deflationary Spiral or ...

the first reaction i had to this article was keelba's third point of his post, and that is you cannot make your assumptions of the future based on what has happened, what is happening... but you make your prediction of the future based on what will happen. what this article leaves out is the simple fact that govt's are stimulating their economies with a multi-trillion dollar cattle prod. that is the future, base your assumptions of inflation, dis-inflation, deflation, reflation based on that premise.

 

obviously the article has merit and were the govt to continue it's current course without fiscal stimulus it may prove correct (or close to it), but at the very best the article is a good snapshot of the current deflationary environment.

 

i am not 100% in the hyper-inflation camp and i am looking for good info to tell me that we will see steady 2-3% inflation by 2010 but it's just not out there.

 

keelba, the three point ananlysis is well done.

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Re: Still confused about Deflationary Spiral or ...

Sam,

I am with you on the religious bias thing. I intentionaly left out th e part about how the writer ties this meltdown to a one world antichrist yada yada yada stuff. It just so happened that on my search for hyperinflationary reasoning, I was link to this article. Perhaps I should have focused more on just the paragraph in question.

Even more specificly this phrase... While it’s true that the United States is issuing new currency and coins at an unprecedented rate, this increase in the base money supply (physical currency) is increasing at nowhere near the pace at which credit and consumer demand are being destroyed.  The net effect is deflation.

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Re: Still confused about Deflationary Spiral or ...

Kathy,

I think the question you raise is a valid one. I for once would like to hear a well reasoned argument against the position of the article you posted. The issue of inflation/hyperinflation vs deflation seems to be the key for trying to prepare for the future. I have followed this site for months and used to be a paid subscriber. I think this site is a great information source for people and that Dr. Martenson is doing a very valuable and noble deed in providing this information. However, lately I have found this site and many of its main contributors have become very biased in certain directions. Hyperinflation being one of them. It has become almost to the point of "group think" or maybe "believers" (a term used in a post yesterday I beleive). There seems to be little real debate on the main issues anymore. Maybe because people on this site seem to find the solutions obvious - but as a non-expert I do not. I think the author of this article makes many good points and I have seen other articles like it but I have not seen what I would consider a sound rebutal to it.

I think the three point analysis is a good one (and I think the article in question passes all 3 points) but I would add a couple more things to look out for:

- I do not give much credibility to articles or comments or websites that only look at a particular issue from one side. That is, there is not a consideration that their opinion could be wrong or they do not provide rebutals to counter arguments.

- I also give almost zero credibility to articles that are unsourced or comments that do not have a real name attached to them. In that vein could you provide the authors name or a link to the original post.

Thanks,

Will

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Re: Still confused about Deflationary Spiral or ...

Keelba-

Your observation #1-

I agree, though there's much more to it, of course.

Your observation #3-

I agree generally, but also opine that even though history doesn't always repeat, if often rhymes.

Your observation #2-

If you continue to use this measure for establishing credibility, you will never truly understand the situation adequately to make well-informed decisions, in my opinion.

There are different definitions of inflation and deflation. Here are 2.

Definition A-Inflation is an increase in money supply and deflation is a decrease in money supply is one used by some, but not all, economists, especially those confined to the quite comforts of cloistered academic halls. This definition requires no additional thought or analysis to comprehend and as such is popular among sycophants of the Austrian school and their feeble-minded followers. This definition is more accurately called "Money Inflation" (or "Deflation").

Definition B-Inflation is prices going up and deflation is prices going down is a definition commonly used by people that actually do real work for a living and shop for their daily bread, etc. This is more accurately called "Price Inflation" (or "Deflation")

A primary practical and even theoretical problem with Definition A is that it ignores the whole concept of velocity of money,

Velocity of money is a measure of how fast money moves through the economy. In simplest terms, velocity of money is GDP divided by the money supply.

If velocity goes into the gurgler, because GDP is in free fall, from a practical point of view does it really matter what the money supply is doing? Money supply can go through the roof, but you could still end up hungry and in the dark. 

Right now, we are witnessing "Money Inflation" i.e. the money supply is going up; combined with "Price Deflation", i.e. prices are going down, for almost every type of product and service.

The reason for this state of affairs is that the velocity of money is collapsing. More and more people are simply putting their money in their mattress, so to speak. Banks are doing the same and becoming reluctant to loan, except to the US Treasury, at least in the USSA.

So, my suggestion is to separate "Price Deflation" from "Money Deflation" and vice versa in your own mind.

Also, anyone that refers only to the phrase "inflation" or "deflation" without adding the descriptors "money" or "price" either doesn't have a clue what they are talking about, or is trying to trick you.

Best regards,

POTUS

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Re: Still confused about Deflationary Spiral or ...

POTUS,

Money velocity is limited when the money supply is not expanded.  Even inflation due to credit expansion via fractional reserve banking has a limiting effect on price increases.  However, a larger money supply supports larger money velocity.  Think of it like a bubble or balloon.  You inflate a balloon to expand it or make it larger.  You expand or inflate the money supply to make it larger.  You don't expand prices - prices rise.  Prices rise as a result of higher money velocity, which is supported by an inflated money supply.  You raise interest rates to take money out of circulation, to shrink the money supply. This reduces money velocity.  This is how price inflation is regulated.  Interest rates don't regulate money velocity.  They regulate the supply which feeds the velocity.

Also, all prices in the economy can't rise without the expansion of the money supply.  If there are fewer / limited dollars changing hands at a particular rate then only so much money can buy the goods for sale.  If a particular good goes up in price because of shortage (say bad weather created a bad crop) then the money spent on expensive food cannot be spent on other products.  This will force down the prices of other products in order for them to be sold.  Otherwise they won't be sold.  Overall the average prices will not rise.  Therefore this really isn't price inflation is it.  However, if the money supply is expanded to make credit available to buy all the goods, including expensive ones, then prices will be sustained or will rise.

The modern definition of inflation - as an increase in prices - is a Keynesian redefinition in order to hide the cause of price increases.  This is because the purpose of the Federal Reserve is to create continuous money inflation, for their efforts to maintain full employment, while controling/preventing price inflation.  However, it's an oxymoron to have continuous money supply expansion and no inflation.  Therefore it's convenient for them to redefine inflation to be the result, not the cause.  The cause, in their world, can be blamed on something else like the weather or Saudi Arabia.

I wouldn't  go discounting the Austrian school.  How many books by Rothbard or Mises have you read?  The Austrians predicted the housing bust and the dot-com bubble and are the only ones able to explain the cause of the great depression, while the Keynesians thought everything was fine.  The Keynesians and FDR's new Deal is what turned the 1930 recession into a great depression.  If the Keynesians truely understood economics and the cause of the business cycle then they wouldn't have allowed a 2nd credit expansion in a decade to create the economic crisis we are in today.

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Re: Still confused about Deflationary Spiral or ...

POTUS,

I don't think calling anybody, or any group 'feeble minded' is particularly helpful....

Then I must take you to task when you say;

"Right now, we are witnessing "Money Inflation" i.e. the money supply is
going up; combined with "Price Deflation", i.e. prices are going down,
for almost every type of product and service."

Money supply is not yet going up.....  it's in fact going down.  At least that is how I perceive it.  Why?  So many organisations and individuals are defaulting on their debts that these debts are either written off, or devalued.  This trend is also accelerating.  That disappearing money didn't exist of course, it's not 'folding stuff', much of it I think was electronic....  but it used to appear on balance sheets, and now it doesn't.  Pooof.

So I think we are seeing deflation.  Right now, I certainly cannot think of anything going up, it's a buyer's market.  Man, all those sales.....  and I haven't got any money!

Just as well.  I mean do I REALLY want to participate in the Matrix..?

Mike 

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Re: Still confused about Deflationary Spiral or ...

"The problem with deflation is that the gov't has too many regulations and interference in the market to allow it to happen."

I don't think this is right.  The problem with deflation is that there isn't enough money in the conomy to pay interest on debts, and so people/organisations default.

Re-inflation in the future won't help this time around, because we will not have enough energy to propel the next necessary wave of economic growth needed to pay interest on debts.  The debts can NEVER be repaid, hence my insistance they should just be canceled.

We have hit the wall, and there's no getting out in my opinion.  We need a reboot, just to implement the necessary sustainable future we need to ensure any kind of civilisational survival.

Mike 

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Re: Still confused about Deflationary Spiral or ...

Damthematrix,

Here's the current inflation of the money supply.  See the Hockeystick. There ain't no deflation!

 

http://research.stlouisfed.org/fred2/series/RESBALNS

 

http://research.stlouisfed.org/fred2/series/BOGAMBSL

 

 http://research.stlouisfed.org/fred2/series/EXCRESNS

 

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Re: Still confused about Deflationary Spiral or ...

Potus, I agree with your comments about the velocity of money, however, find the concept to be very advanced for the novice. Most people use the term inflation to mean price inflation and not money inflation. You can usually tell by the context that they use it. You suggest to add the descriptors of price or money in front the terms but in my mind, there is still only one definition for inflation and deflation. For "price inflation" I prefer to refer to this as the "cost of living". The cost of living is going up, the cost of living is going down. That makes it much easier for people not so advanced in economic study to understand. You obviously have a strong grasp of economic theories but my goal was to help those not so knowledgeable as yourself.

 Bearing, I recently studied FDR and the depression and think you may have a few facts mixed up. I'll go back and doublecheck but I think you may want to do the same. If I recall correctly, FDR was a staunch supporter of a balanced budget and for years try to keep it so. He was prodded for many years during his term by Keynes to start deficit spending but refused to do so. It wasn't until the country was faced with war that FDR finally conceded and started deficit spending. I'll go back and check again but I'm pretty sure that's how it happened.

 Finally, the graphs above are what I am referring to when I speak of inflation. There should be no doubt that we are experiencing a period of high inflation. There is liquidation going on all over the world and deflation on top of that but the charts above clearly show that the money supply is increasing like it hasn't in our country for hundreds of years. The only question in my mind is if the government is going to be able to keep the public's confidence in the dollar up through all of this and eventually halt the inflation. I have my doubts. Finally, when you consider the chairman of The Fed's (Bernanke's) comments about his determination to prevent deflation and you should not doubt the increase of the money supply.

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Re: Still confused about Deflationary Spiral or ...

keelba,

Check out this paper.  It does a great summary.  I won't go into details.  Remember, FDR went off the gold standard in 1933 and inflation was so bad he had to confiscate gold and devalue the dollar by 40%.  His election campain was pro free market and laissez faire, but once sworn in his tune changed.  He continued on Hoover's path of interfering with the economy by introducing things like minimum wage, unions, Smoot Hawley Tarriff, created the NRA and the Glass Steagall act.

 

http://www.mackinac.org/article.aspx?ID=4013

http://www.mackinac.org/article.aspx?ID=4026

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Re: Still confused about Deflationary Spiral or ...

WOW......  if you didn't think things were going pear shaped before viewing this, then nothing will change your mind...

HOWEVER, how do you know if these figures include defaults?  I wonder if it's possible to fund a graph showing the value of defaults.......

I also wonder how much of that hockey stick is electronic, ie virtual, non-existent?

If banks actually have so much money in reserve, why are they not lending?  Why not even to each other?  I still don't feel like I'm satisfied, there must be a lot more we haven't been told....

Thanks for the charts.  They are amazing.

Mike 

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Re: Still confused about Deflationary Spiral or ...

bearing01-

I don't intend to respond to all of your comments; it would bore most readers. Most of what you have typed is hardly worth resonding to anyway, so I will limit my remarks to a few of your more curious comments.

Quote:

Money velocity is limited when the money supply is not expanded

I guess I should have been more specific in describing "velocity", so here goes, straight from the typical textbook-

V*M=P*Q, where V is velocity of money, M is the amount of money in circulation, P is the average transaction price and Q is the quantity of transactions. (P*Q can also be referred to as Gross National Product or Gross Domestic Product.)

Velocity is therefore not limited by money supply, by that definition and that equation, which are those in most common usage.

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If a particular good goes up in price because of shortage (say bad weather created a bad crop) then the money spent on expensive food cannot be spent on other products. This will force down the prices of other products in order for them to be sold. Otherwise they won't be sold. Overall the average prices will not rise.

Ok, if that logic is correct, then average stock market prices should never go either up or down without the money supply also going up or down, right? By simple observation my stock market price statement is laughably wrong. Price inflation or deflation of stock market values can and do act independently of money inflation or deflation. So do food price inflation; house price inflation; all types of price inflation.

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However, it's an oxymoron to have continuous money supply expansion and no inflation.

Huh? It may be an oxymoron to you, but its a fact of life today throughout the world. Today we have money inflation (continuous money supply expansion) and price deflation (prices collapsing everywhere we look). Thank you for proving my basic point about the different definitions of inflation and how important it is to be precise in how the term(s) is used.

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The Austrians predicted the housing bust and the dot-com bubble

Non-Austrians also predicted both bubble/busts.

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....and are the only ones able to explain the cause of the great depression

Nonsense. Both Marxism and Kondratieff Cycles can be used to explain the causes of the great depression, for example. There are more economic theories in the world that just the Austrian and Keynesian Schools.

http://en.wikipedia.org/wiki/Economic_schools_of_thought

 

Best regards,

 

POTUS 

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kemosavvy
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Posts: 254
Re: Still confused about Deflationary Spiral or ...

why are banks not lending to each other? it's my opinion, and the opinion of countless others, that the worse is yet to come as banks trickle out the losses and go hat in hand to paulson. i think we have seen this play out in the past few days, where banks have announced huge losses, and 1-2 days later TARP injects funds and they are immediately sterilized, or soaked up to meet capital reserve requirements. almost as if it were a coordinated effort. alot of money has changed hands but the banks are still in the same poor health as before. it's a zero-sum game, except now the taxpayers are backing the bad debts.

 

my question to the group is this, it's widely known that the fed is increasing the monetary base significantly (a closer look at the figures for the st. louis chart shows a 2333% increase in nov '08) velocity of money has decreased as the economy as a whole is waiting for a direction to head in, therefore the money is being saved and at the same time defaults are destroying money, obviously we are in a deflationary time. what are the possible outcomes and what is the likelihood, (chapter 20, good students)?

So, i see two outcomes, 30-70 odds, 4-5 years out. number one, our economy accelerates and the printed money actually has value, consumers are gainfully employed and begin spending again, small to low inflation that's kept in check by FOMC. secondly, our economy goes negative or remains flat and this printed money works it's way through the system and the tipping point of the population realizes that inflation eats at their savings and the population begins buying assets in a bid to fend off erosion of their assets, prices skyrocket, increased velocity, hyper-inflation.

 

 

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POTUS
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Re: Still confused about Deflationary Spiral or ...

Damnthematrix-

Here is another chart, M1 of the USA. As you may be aware, M1 is one of several measures of the amount of money available to be spent. There is some controversy about M1 vs the other M's (M2, MZM and especially M3), but it does clearly show that the money supply is increasing. Other central banks around the world publish thier own M1 information and generally, M1 is increasing everywhere.

The charts bearing01 provided are related to the Federal Reserve Bank's balance sheet entries and deposits on hand.

The "hockey stick" referred to in those charts is primarily related to the Federal Reserve Banks inexplicable, mind numbing decision to pay banks interest on their excess reserves, clearance reserves and the like.That began in October 2008. As the charts show, about $750Billion got sent to the Fed by banks almost immediately.

In the face of lack of liquidity in the interbank lending markets at the time this new Fed policy was adopted the decision was truly, truly moronic and no doubt helped contribute to the turmoil in financial markets then. Further, unpredictable, chaotic reverberations are likely as banks unwind these positions, in my opinion.

That bone-headed Fed policy only lasted from approximately 6 October to 16 December 2008, when the Fed adopted their "Zero Interest Rate Policy" and simultaneously recognized the stupidty of their interest on reserves policy.

Link-

http://www.federalreserve.gov/newsevents/press/monetary/20081216d.htm

As bearing01 noted, the charts he posted have absolutely nothing to do with "deflation", or "inflation" for that matter.

All those charts are really showing is the results of banks moving money around, shell game style, from one pile (idle money ) to another (risk-free lending to the Fed). The "hockey stick" in those charts will almost certainly collapse now that the Fed's ill-concieved policy on excess reserves has ended.

 Best regards,

 

POTUS 

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bearing01
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Joined: Sep 8 2008
Posts: 153
Re: Still confused about Deflationary Spiral or ...

POTUS,

You made a good point.  Increasing the money supply does not necessarily increase velocity.  It's the perceived change in valuation that changes money velocity.

From your equation for considering the quantity  theory of money:

V*M=P*Q

If the number of goods/service produced (Q) are constant in the short run due to flexible wages, prices & full employment and also money velocity (V) is relatively constant in the short run, that would suggest increasing the quantity of money (M) will cause an increase in prices (P).  But it is well known that this quantity theory of money is crude, and so is this equation.  Just as the quantity of oil helps determine its value per barrel, the quantity of money supply helps determine the value of the dollar.  But the dollar's change in value is not directly proportional to a change in the quantity of the money supply
(as per the VM=PQ equation).  Its not the present quantity but by expectations concerning the future quantity and/or the stability or solvency of the gov't that determines the expected future valuation for the dollar.  If people believe the value of the fiat dollar is worthless then it won't be as accepted!

But regardless of what the money velocity is, when there are more
dollars chasing fewer goods it will bid up prices.  When tomorrow's
prices are expected to be higher (because of anticipated weaker
dollar), people will rush to buy the products today while prices are
low.  This increased velocity of money bids up the price.  As prices
get too expensive the money velocity will decline as their dollar holdings decline.  Unless people have access to more dollars (credit) to spend today.  Take for example the increase in purchasing of oil to store on tankers because of the current oil futures contango.  That's increasing the money-oil trade velocity.  If loans are taken out (expansion of credit) for those purchases then overall money velocity will be sustained as long as interest rates and storage prices keep the investment attractive. 

As for money velocity, money moves through the economy because it is exchanged for goods.  Therefore, money velocity can increase only if the exchange of volume of goods increase.  But an increase in money velocity does not necessarily mean a proportinate increases in prices.  On stock market days where traded volumes are high the prices can still end lower at the close.  Sometimes on light trade volume days the prices often rise.  Therefore, money velocity does not cause stock or commodity prices to rise.  It is the change in perceived underlying valuations of the commodities or stocks (or the dollar in the case of a gold trade) that can also create a change in velocity.  If Citibank reports it is bankrupt, it is the rapid valuation change that produces an increase in the velocity of money while holders dump their stocks.  Velocity of exchange will remain high as long as there is a large difference between perceived value and current price.  This exchange will continue until the price works its way down to the new valuation. 

As for stock prices and quantity of money supply, it's not necessarily related.  However, if people have more dollars they may prefer to spend more of their surplus money on their stocks.  Just like rich people are willing to spend more money on expensive things than middle class people.  I own a few stocks that have very light trade and all it takes is one or two trades to bump the price up 20% or more.  All it takes is one trade where one is willing to buy the stock at a much higher price and there is a seller for that price. Immediately the stock price jumps to that new level.  If a company has 10 million stocks and one trade occurs where 5 shares trade at $20 above the last trade,  the company isn't immediately worty $200 million dollars more.  Likewise, if holders of all 10 million stocks try to sell their shares on one particular day the stock price would plummit to near zero.  On paper each stock may appear worth $50/ea, but that's only because there aren't many sellers at that price and the last trade was at $50.  Just like the housing market.  When not many houses are for sale they typically go for higher prices.  However, when everyone is trying to sell the house the prices plummit.

Another point I'd like to make.  In my previous post I did not say that an increased money supply increases money velocity.  I said it supported it.

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stan.chucks
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Posts: 21
Re: Still confused about Deflationary Spiral or ...
bearing01 wrote:

Here's the current inflation of the money supply.  See the Hockeystick. There ain't no deflation!

my understanding is that in our fractional reserve system the money supply is made up of federal reserve money "printed" plus the money lent into existence by the comercial banks. For every dollar printed by the federal reserve the banks can expand the money supply by a maximum factor of 10 (i.e. they are required to have a reserve at the fed of 10%). In the present climate when the banks loan book is going bad they are reducing this factor by increasing their reserves relative to their loans. These graphs therefore do not (I think) tell us that the money supply (at this stage) is increasing. It certainly demonstrates the capacity for money supply increase once the banks get a renewed taste for risk.

Stan

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