The Boston Diaries

The ongoing saga of a programmer who doesn't live in Boston, nor does he even like Boston, but yet named his weblog/journal “The Boston Diaries.”

Go figure.

Sunday, November 02, 2008

The printing press at the United States Treasury is going full tilt, and investors are still worried about deflation? What are they smoking?

Deflation fears are suddenly rising, as the full impact of the credit crunch hits markets and economies. Small wonder: Plunging commodity prices, crumbling inflation expectations, a soaring dollar, and the onset of a potentially severe global recession are combining to reverse the inflation spike of early 2008.

Via New Mogul, The Coming Deflation Scare

We've already had severe deflation—falling prices—in housing, stocks and commodities this year.

The question is whether that could spill into prices of goods and services across the board, as well as into wages, as the economy worsens.

Via The Mess That Greenspan Made, Investors brace for a case of deflation

Good lord!

Our government masters have dumped over $2,000,000,000,000.00 [in the United States alone —Editor] to prop up our economy and investors are worried about deflation? Do they have no concept of how the economy works?

Okay, scratch that, we are talking about the dismal science and I suspect that no one alive today really understands our economy.

I mean, I get the basics—supply and demand—given a constant supply and an increase in demand, the price goes up (and if it doesn't the market experiences shortages in said item). Conversely, given a constant demand and an increase in supply, the price goes down (and if it doesn't, the market experiences a glut in the item). Pretty basic.

A bit less basic is how the monetary supply affects this, but it's easy enough to point out a few historical examples of vast increases in the monetary supply to see that when the supply of money goes up, so does the price. And conversely, when the monetary supply contracts, there's less money chasing goods and services so the price falls.

I never did understand what was so bad about deflation—heck, it sounds pretty good! Lower prices across the board, my money is worth more, what's not to like?

Plenty, actually. It was quite the education to read about the downside of deflation in the comments to this Reason Magazine article about Ron Paul:

Usually what happens is that nominal interest rates become exceedingly high. With deflation, you get paid to sit on cash—so you need a very high interest rate to induce you to lend it. Deflation pays you to be risk averse and hoard cash—which induces chrinically tight money, and stifles the risky ventures upon whose success technological progress is made.

Tacos, please explain why having my money becoming more valuable over time is a bad thing. It seems preferable to having it worth less over time.

A number of reasons, as it encourages liquid holdings over less liquid ones (such as higher education) and encourages holding liquid currency as opposed to spending it. Currency is hoarded instead of invested, and capital decreases (why by a stock or loan cash when your money will become more valuable just sitting under your bed, without you having to sacrifice liquidity or take on risk?). Deflation functions to increase interests rates, making loans more expensive.

With no one spending or borrowing money, production drops and you move toward recession. Businesses lay off people as the real cost of wages increases while sales decrease, etc, etc, etc. The number of problems caused by deflation is myriad and probably best enumerated elsewhere.

Even Austrian economists [my own views of economic policies tend towards the Austrian school, just for the record —Editor] view deflation caused by contraction of the money supply as bad, so I'm uncertain as to how this is reconciled with non-fiat currency.

If you have an inflexible standard like gold you get deflation and the house you are contractually obligated to pay $2,000 a month to keep is now worth only $1,500 a month using the newly deflated currency. No one can borrow, there is no liquidity and everything comes down like a house of cards. The right answer is a totally free currency market and with no central banks and full disclosure. Let the market set the money supply with no interference from a Federal Reserve.

Indeed. Which makes me wonder why Austrian economists are stuck on the gold standard, since they accept that deflation due to contraction of the money supply is bad for economies (as opposed to deflation due to a drop in prices from increased efficiency, which is good).

Ouch.

So yeah, deflation bad. I get it.

But I still can't see how “investors” are afraid of deflation when governments over the world are printing money as fast as they can and shovelling it to the banks. Perhaps the banks don't trust anyone to loan it out so the money isn't actually getting into the economy like the governments want …

Strange times indeed …

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