Situation X: runaway DE-flation

Originally posted by nixie_nox

What kind of circumstances would start de-flation. What events have to fall in place?

Financial panics are not primarily financial, but emotional. As an analogy, think about when you reach "the crest" on the stock market. You know when the high price occurs? It happens when every last "bull" (person who thinks the market should go up) has bought every last share of stock he can afford. At that point, there is literally no more buyers, and things begin to go south.

Likewise, the bottom of a stock market occurs when the last "market bear" (person who believes that stocks will go lower) sells his last share. Then there is literally no more sales pressure, and the bulls take the market, driving it up.

Likewise, when the average consumer decides that prices will be lower, or that it isn't safe to spend money today, you begin to see disinflation pressure.

I've said before, if you study the market from the summer of 2000 to about 2003, you'll see mild disinflation. Credit terms (not the government "prime rate" but actual advertisements) are the best way to measure it. At that point, Ford was offering "zero precent interest for the life of your loan. (!) That is disinflation, at least with car prices.

If there is a real war, or people feel worried enough about the future they quit spending money.

In the depths of the depression, when FDR made his famous speech about "the only thing we have to fear . . . is FEAR itself!" He also said in the same speech, "get out there and SPEND, america!" He was trying to stop the deflationary spiral that had begun actually in 1928 with farm prices. It didn't stop until at least 1933, and probably 1934.

But in sum, every panic or bubble is at it's core an emotional, rather than an economic, experience.

So when you ask about what financial events . . . my response is, emotional events will cause it, and not the numbers.

every time.

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(Bump)

I'm bumping this thread, to note that French Prime Minister Sarkozy basically accused the head of the ECB, J.C. Trichet, of causing "deflation" by ramping up the value of the Euro with continual interest rate hikes

Article from Bloomberg.com

Basically, if a nation (or union) offers a better interest rate, then investors will flock to it, creating demand for its currency. Thus, the Euro goes up in value vis-a-vis the US dollar.

But this increase in euro-value means that euro-denominated goods (french wine, etc.) is now more expensive to Americans and the world, which lowers exports in the EU.

This is turn drives up the currency.

Pretty soon, investors save euros rather than spend them, because they know the value will increase over time without risk.

This is the scenario that started my thread . . . .

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reply to post by dr_strangecraft


As near as I can tell (and this macroeconomics stuff is like voodoo) in a fractional reserve system, deflation occurs as the supply of money shrinks. One way this can happen is when throughout the entire economy there is more debt (money) being destroyed by the repayment of interest created by past credit than there is debt (money) being created by issuing new credit.

Federal taxes are another way for deflation to occur. If we ever had a time when the government was taxing people but not taking out loans constantly (meaning the deficit was shrinking) then we would have a situation where the money (debt) supply was shrinking instead of growing.

Point #1 is a precarious balance and point #2 is an unlikely occurrence. #2 actually helps protect us from #1 - we would probably be experiencing the beginning of deflation due to the housing loan bubble collapsing if it weren't for the huge loans being taken out to pay for the war in Iraq.

Jon

Not arguing with you, Voxel, by any means. Just want to point out a few things, to help folks decide which side of the question they want to take.

Originally posted by Voxel

in a fractional reserve system, deflation occurs as the supply of money shrinks.

This is strict monetarist theory; that is, the value of the currency is purely a function the amount of supply. Of course, in the real world, demand is constantly changing, and technically immeasurable. Kind of like the Heisenberg uncertainty principle in physics.

I have argued, on ATS and elsewhere, that the actual money supply is far less important than the public's perception of the "adequacy" of the money supply.

I can point to periods of inflation, where the government actively destroyed currency, and inflation increased, as in the beginning of Greenspan's term.

Suffice it to say, in economics, as in all realms of public life, that perception is more potent than reality.

Federal taxes are another way for deflation to occur. If we ever had a time when the government was taxing people but not taking out loans constantly (meaning the deficit was shrinking) then we would have a situation where the money (debt) supply was shrinking instead of growing.

This sort of Keynesian, the idea that government can control in (dis)inflation rate through taxation, where tax is a tool for economic engineering, and not merely revenue.

It's usually viewed as the antithesis of monetarism.

Not that either statement is wrong; just that the advocates of either theory are usually at war with each other.

Personally, I think group psychology yields far more insight into market behavior than pure economics can hope to.

I recommend Extraordinary Popular Delusions and the Madness of Crowds. by Mackay. The first section details the financial collapse of England and France respectively in the 1720's. The section on tulipomania is also considered a classic.

Thanks for posting, and sharing your input. I learn something from everyone.

Originally posted by dr_strangecraft
Not arguing with you, Voxel, by any means. Just want to point out a few things, to help folks decide which side of the question they want to take.

Hey like I implied, I am only an amateur economist at best. I am just tying to understand both the science and the scam. I thoroughly enjoy this discussion.

Originally posted by dr_strangecraft
I have argued, on ATS and elsewhere, that the actual money supply is far less important than the public's perception of the "adequacy" of the money supply.

I agree with you that the supply of money isn't the sole factor that determines the direction of "flation" but I do feel it is largest factor. I feel that the effects of a changing supply of money creates changes in the price of goods and services that trigger a change in public perception of the supply's adequacy.

I was saying earlier this week to a friend that the rate of inflation is obviously visible if you take the time to look. At a fast food "restaurant" by my home, a particular large value meal combo used to cost $6.14 back in 2000 today it costs $8.09. There has NOT been a 30% increase in average wages over the same period so the public has to start feeling the inflation soon. Eventually, the public's buying habits will change and the larger issues inherent in inflation will begin to have obvious effects on society - until the deflation kicks in.

Originally posted by dr_strangecraft
I can point to periods of inflation, where the government actively destroyed currency, and inflation increased, as in the beginning of Greenspan's term.

But the government isn't the only participant in this game. While the gov. may have been actively destroying currency, the banks at the time where probably issuing large loans.

I don't know much about the economy during the end of the Reagan era (I was a youngin' at the time) but from what I understand there was a lot of government borrowing during his whole term with the deficit going from $700 billion to $3 trillion. That is kind of the opposite of "destroying currency" as you mentioned but I am prepared to be educated on what exactly you were referring to.

Originally posted by dr_strangecraft
This sort of Keynesian, the idea that government can control in (dis)inflation rate through taxation, where tax is a tool for economic engineering, and not merely revenue.

It's usually viewed as the antithesis of monetarism.

Not that either statement is wrong; just that the advocates of either theory are usually at war with each other.

Personally, I think group psychology yields far more insight into market behavior than pure economics can hope to.

I tend to think that it is a precarious balance. The creation of credit through the various instruments of debt creation, both personal and governmental, and reduction of credit through various methods affects the economy at least as much as public perception.

Because there exists a multi-year lag between cause and effect in macroeconomics, there exists the notion that public perception is the large driving force behind economics. I just wonder how much the changes in public perception are motivated by earlier changes in the machinations of the Fed. and the entire credit system.

Originally posted by dr_strangecraft
I recommend Extraordinary Popular Delusions and the Madness of Crowds. by Mackay. The first section details the financial collapse of England and France respectively in the 1720's. The section on tulipomania is also considered a classic.

Thanks for posting, and sharing your input. I learn something from everyone.

I must check out that book, I have made a note of it. Thank you for starting this topic. I'm just an arm-chair observer trying to understand this stuff myself.

Jon

Originally posted by Voxel

I agree with you that the supply of money isn't the sole factor that determines the direction of "flation" but I do feel it is largest factor. I feel that the effects of a changing supply of money creates changes in the price of goods and services that trigger a change in public perception of the supply's adequacy.

emphasis added by strangecraft

I just want to point out that particular phrase, "creates changes in the price of goods."

How does the price of a doughnut go up? Isn't it when the baker says to himself, "hey, I could probably charge an extra penny, and make the price fifty-one cents a doughnut, and people would buy just as many of them . . . ."

And then the customer says, "what the hell? Oh well, a penny is basically dead weight in my pocket anyhow. Screw it--I'm hungry."

In other words, the FREE MARKET PRICE OF GOODS is determined by both the buyer and seller, when they agree on a price.


That, right there. That agreement on price; that is the public perception of the economy. Averaged out over billions of decisions by millions of producers and consumers. Every price that someone pays is a meeting of the minds between producer and consumer.

The actual number of dollars matters less than the mood of that baker, and the consumer, when they each decide what to charge or pay in the transaction.

That's why I say that the public mood is far more important than the actual number of numbers. If the consumer is frightened, he won't buy a doughnut, even if he has thousands of dollars. And the baker won't sell, if he decides those dollars won't have value tomorrow.



P.S.: The Gutenberg project has a copy of volume one of "extraordinary popular delusions online here.


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