question on deflation I've been thinking of - BART? Aaron? Sapiens?

[rabot10]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

I suggest a "lawn mower accident"

and the next time

a "blender accident"

and the next time a "hedge trimmer accident"

and the next time "what? no, nothing in the mail, really ... " (if you are a good liar)

Well she is very good looking and after 24 years of looking at me OMG I have a hard time telling her to stop shopping

[Spartacus]

Thanks for your time Eric - if you have some more time

there's a few loose threads on the Peter Warburton interview screaming for your view.

It's currently 3 posts up from the end of the comments on the interview page

[Sapiens]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

I've been thinking of and trying to argue against something this guy wrote,

http://www.silveraxis.com/index.html

he claims when a debt is written off, that is INFLATIONARY

???

If you mean, when a debt is written off it is INFLATIONARY.

Then it is false.

Writing off a debt is neither inflationary or deflationary unless the act of writing the debt off increases or decreases the number of monetary units.

-Sapiens

[Spartacus]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

???

If you mean, when a debt is written off it is INFLATIONARY.

Then it is false.

Writing off a debt is neither inflationary or deflationary unless the act of writing the debt off increases or decreases the number of monetary units.

-Sapiens

my take was that when a loan comes into existence monetary units are created and at the same time a mechanism is set up to "destroy" these units. You have a plus and a minus, net effect zero.

When the loan is written off, the mechanism to destroy the units disappears but the units don't disappear. The plus remains, the minus "disappears"

Eric's view is that the loan's creation itself is the inflationary event.

[Jim Nickerson]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

Has anyone around here ever wondered how much employee productivity Eric Janszen is costing to the hapless employers of all of the obsessively engrossed iTulip readers?

With all the time we spend (all of us, from the roustabouts to the captains of industry), are spending tunneling and boring through all the topics discussed on this website, it's a wonder any of our employer's get some work out of us. :eek:

If you're getting paid for working and are not working, then you are a thief.

[Spartacus]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

you're trying to simplify the situation by including another transaction?

let's look at all the parties and see how it looks to each. the borrower spends the money by buying something. the recipient of that cash no longer possesses the object or asset but now possesses cash. let's use your example of a home purchase. the home seller now holds cash. the home buyer owns an asset for the moment, the house, and owes a debt. the debt is carried on the bank's books as an asset. the buyer now defaults. he no longer holds the house and let us say the debt is written off. the bank no longer carries the debt as an asset, it carries the house as an asset. the bank then sells the house. let us suppose that the value of the house has gone down, so it sells the house for less than the loan it originally issued. the money used to purchase the house from the bank now disappears into the bank vault, and the bank records a loss on its books.

the buyer paid cash for the house?

so, phew, the original seller has the original cash, the bank has a loss equal to the amount of the original loan minus the value recouped by the foreclosure sale, and the second home buyer owns the house but is out the cash he used to buy it.

the cash used to buy the foreclosed house, which has been put in the vault, plus the loss recorded equals the amount that the original seller pocketed. net change, zero.

This (cash in the bank's vault) ONLY happens in rare circumstances (remember Aaron's near-zero reserve requirements)

IMHO this looks like 3 inflationary events (monetary units created with each house purchase plus new reserves added for the bank to loan against) and one deflationary (the bank taking a loss)

[touchring]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

If the bank could only keep lending (and not tighten up lending standards) when lots of people default then in aggregate it would remain inflationary.

That will be impossible, and fraudulent?

[Sapiens]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

Eric's view is that the loan's creation itself is the inflationary event.

That is correct.

http://www.michaeljournal.org/myth.htm

[Rajiv]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

Things would become even worse in this story if you were to add in leveraging and insurance also managed by Mr. Banker!

[herbkarajan]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

Spartacus, defaults on mortgages is highly deflationary, when the bank turns around and sells the property it will do so at a lower price, and in a process lower the price of all the properties around it. That's deflationary. the next buyer of the defaulted house and the bank will monetize the value of the loan for the original seller, but the banks will take very few losses before curtailing lending. this will cause further asset price deflation, because how many people do you know who can purchase a house with cash.

[grapejelly]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

if money is loaned out, it is at at that moment created through fractional reserve banking.

Then the money is spent.

Okay, so look at the scenarios. If the loan is paid back, that is deflationary. Because the money that was paid into the economy is sucked back out and used to extinguish the loan.

But if the loan defaults, I would argue that is not inflationary or deflationary. The money has already made its contribution to depreciating the already extant currency, e.g. has already inflated.

[metalman]

Re: question on deflation I've been thinking of - BART? Aaron? Sapiens?

Spartacus, defaults on mortgages is highly deflationary, when the bank turns around and sells the property it will do so at a lower price, and in a process lower the price of all the properties around it. That's deflationary. the next buyer of the defaulted house and the bank will monetize the value of the loan for the original seller, but the banks will take very few losses before curtailing lending. this will cause further asset price deflation, because how many people do you know who can purchase a house with cash.

this topic is covered all over the place here. defaults on mortgages are asset price deflationary but NOT necessarily commodity price deflationary. covered in gruesome detail in this article. he explains...

Financial institutions re-lend their interest and other financial inflows as new loans to finance asset purchases. The result is that net savings do not increase for the economy as a whole. Meanwhile, lending out savings helps bid up asset prices, but does not necessarily promote new tangible investment and employment or increase real wages and commodity prices.

it's really important to distinguish between asset priced deflation and commodity price deflation and a lot of folks here seem to keep mixing them up. apples and oranges in relation to each other. then there is the matter of relative size.

Industry and agriculture, transport and power, and similar production and consumption expenditures account for less than 0.1 percent of the economy’s flow of payments. The vast majority of transactions passing through the New York Clearing House and Fedwire are for stocks, bonds, packaged bank loans, options, derivatives and foreign-currency transactions. The entire stock-market value of many high-flying companies now changes hands in a single day, and the average holding time for currency trades has shrunk to just a few minutes.

the p/c economy is tiny. the fire economy is huge. to understand where the "wealth" is going we need to look at where it came from and the future of asset price and commodity price deflation. the guts of hudson's article...

Despite a falling savings rate, however, the economy never has been flusher with savings and credit. The growth of savings, wealth and net worth is less and less the result of new direct investment in tangible capital formation, but rather the product of rising asset prices for real estate, stocks and bonds. In balance-sheet terms, gross savings are soaring while net savings are zero or negative.

"This growth in net worth occurs despite the fact that most new saving is offset on the liabilities side of the balance sheet by growth in debt. The rise of net worth is the result of savings being lent to borrowers who bid up asset prices by using new loans and credit to buy property and securities, that is, wealth and financial claims on wealth.

Despite a falling savings rate, however, the economy never has been flusher with savings and credit. The growth of savings, wealth and net worth is less and less the result of new direct investment in tangible capital formation, but rather the product of rising asset prices for real estate, stocks and bonds. In balance-sheet terms, gross savings are soaring while net savings are zero or negative.

For one thing, the volume of savings compounds by being recycled into the creation of new interest-bearing debt as savers or financial institutions use their accrual of income, dividends and capital gains to buy more securities, make more loans or buy property rather than to spend this revenue on current output. The growing debt overhead – and the savings that form the balance-sheet counterpart to this debt – bears interest charges that divert income to debt service rather than being available for spending on consumption and direct investment.

read on. what happens now that this dysfunctional system is no longer functioning?

Today’s propensity to save is less than zero as the economy is running into debt faster than it is building up new savings. Keynes did not address this possibility, and indeed it was not a pressing concern back in 1936 when he wrote his General Theory.

Nearly all new fixed capital formation is financed out of retained business earnings, not out of bank borrowing. Banks finance sales, foreign trade, consumer debt and the purchase of property already in place, but hardly ever have they taken the risk of financing new direct investment. Their time horizon is short-term, not long-term.

But in today’s U.S.-centered bubble economy the problem has become more complicated. To the extent that savings are lent out (rather than invested out of retained earnings to purchase capital goods, erect buildings and create other tangible means of production), they divert future income away from consumption and investment to pay debt service. In this respect the growth of savings in financial form (that is, in ways other than new direct capital formation) adds to the debt overhead and hence contributes to debt deflation. This is what occurs with nearly all the savings intermediated and lent out or reinvested by the banks, insurance companies and other financial institutions.

Keynes favored inflation as eroding the burden of debt. Calling for “euthanasia of the rentier,” he saw inflation as the line of least political resistance to wiping out the economy’s debt burden. His idea was that inflation would leave more income available for consumption and for new direct investment. But asset-price inflation works in a different way. Instead of eroding the purchasing power of wealth relative to commodities and labor, it increases property prices without increasing consumer prices or wages. At least this has been the pattern since 1980. Wealth disparities have increased even more than have disparities among income brackets. The net worth for the wealthiest 10 or 20 percent of the population has soared, while the rest of the economy has fallen more deeply into debt and many of its gains have turned out to be short-term.

In calling for “euthanasia of the rentier” Keynes pointed to the desirability of preventing the diversion of income into the purchase of securities and property already in place. He hoped to restructure the stock market and financial system so as to direct savings and credit into tangible capital formation rather than speculation. He deplored the waste of human intelligence devoted merely to transferring property ownership rather than creating new means of production.

"Today’s financial markets have evolved in just the opposite direction from that advocated by Keynes. New savings and credit are channeled into loans to satisfy the rush to buy real estate, stocks and bonds for speculative purposes rather than into the funding of new direct investment and employment. Matters are aggravated by the fact that financial gains are taxed at a lower rate, thanks to the growing power of the financial sector’s political lobbies. This prompts companies to use their revenue and go into debt to buy other companies (mergers and acquisitions) or real estate rather than to expand their means of production.

don't believe him? fred posted this...



nuff said.

and so on. i'd re-read hudson's piece before reading anything else on asset price and debt deflation. i don't agree with hudson's solutions but man, oh, man does he got the problem friggin pegged. he explains how it all works and what is going to happen. he's nuts to sit in bonar cds. the ONLY way this can play out is a dollar crash.

Perception of this problem leads central bankers not to raise interest rates and take the blame for destroying financial prosperity by pricking the bubble. Instead, they try to keep it from bursting. This can be done only by inflating it all the more. So the process escalates.

he wrote this years ago. how's this for accurate prediction?

When interest charges exceed rental income, commercial borrowers hesitate to use their own money or other income to keep current on their debts. The limited liability laws let them walk away from their losses if markets are deflated, leaving banks, insurance companies, pension funds and other financial institutions to absorb the loss. Sell-offs of these properties to raise cash would accelerate the plunge in asset prices, leaving balance sheets “hollowed out.”"

The potential credit supply is limited only by the market price of all existing property and securities. The process is open-ended, as each new credit creation inflates the market value of assets that can be pledged as collateral for new loans.

Until bubbles burst, they benefit investors who borrow money to buy assets that are rising in price.

Asset-price inflation would be a rational long-term policy if economies could inflate their way out of debt via capital gains. The solution to debt would be to create yet more debt to finance yet more asset-price inflation. This dynamic is more likely to create debt deflation than commodity-price inflation, however. It is true that a consumer “wealth effect” occurs when homeowners refinance their mortgages by taking new “home equity” loans to spend on living, or at least to pay down their credit-card debt so as to lower the monthly diversion of income for debt service. If this were to lead to a general inflation, interest rates would rise, prompting investors to shift out of stocks into bonds. Foreign investors and speculators bail out, accelerating the price decline. This threatens retirement funds, insurance companies and banks with capital losses that erode their ability to meet their commitments.

ok, on to the punch line...

Can the debt and savings overhead be supported indefinitely?

Richard Price’s illustration of the seemingly magical powers of compound interest is a reminder that many people saved pennies (and much more) at the time of Jesus, and long before that, but nobody yet has obtained an expanding globe of gold. The reason is that savings have been wiped out repeatedly in waves of bankruptcy.

The reason is clear enough. When savings, lending and “indirect” financial investment grow by compound interest in the absence of new tangible investment, something must give. The superstructure of debt must be brought back into a relationship with the ability to pay.

that's starting to happen now... my emphasis...

Financial crashes occur much more quickly than the long buildup. This is what produces a ratchet pattern for business cycles – a gradual upsweep and sudden collapse of financial and property prices, leaving economies debt-ridden. Many debts are wiped out, to be sure, along with the savings that have been invested in bad loans – unless the government bails out savers at taxpayer expense.

Financial crises are not resolved simply by price adjustments. Almost all crises involve government intervention, solving matters politically.

Financial lobbies also have gotten law-makers to adopt the “moral hazard” policy of guaranteeing savings. Debtors still may go bankrupt, but savings are to be kept intact by making taxpayers liable to the economy’s savers. Ever since the collapse of the Federal Savings and Loan Insurance Corporation (FSLIC) in the late 1980s a political fight has loomed over just whose savings are to be rescued. Unfortunately, the principle at work is that of “Big fish eat little fish.” Small savers are sacrificed to the wealthiest savers and institutional investors.

there is some legislation to bail out home owners but the REAL bailouts will go to the banks. careful shorting them!

here's where we're headed...

Throughout history societies that have polarized between creditors and debtors have not survived well. Rome ended in a convulsion of debt foreclosure, monopolization of the land and tax shifts that reduced most of the population to clientage.

[Spartacus]

Coming full circle, Now to extend this to DEFLATION

What causes the actual DEFLATION

the usual ideas I've held so far are obviously wrong.

1. no new loans
1a people unable to borrow
1b banks not willing to lend

2 writing off of debt

by itself neither 1 or 2 "destroys monetary units", so doesn't cause deflation - just a reduced inflation, as money that would otherwise have been created is not created

Can I accurately say that during the US great depression dollars actually were destroyed as
1. banks went bankrupt
2. existing loans were required to be paid off
3. real fractional reserve requirements constacted the money supply

How could such a thing happen today? At the moment then I'm leaning toward
1. greater demand for dollars as people try to pay back loans instead of declaring bankruptcy

combined with
2. no growth in supply to meet the demand - which would happen if the banks refuse to lend.

this time around 2. would only happen because banks go back to conservative lending practices. 2 would not happen because banks are going bankrupt and it would not happen because of the reserve requirements

[renewable]

Re: Coming full circle, Now to extend this to DEFLATION

My very limited understanding of the inflationary effect of defaults is this:

When you get a mortgage, the bank gives you a bundle of money for you to make the purchase. This money goes into the economy and is inflationary (more bits of paper).

The bank magicks this money out of the next twenty years of your working life, out of your future salary. You earn your money out of the economy over the decades, where it goes back to the bank - this is deflationary (less bits of paper).

These two flows of money largely cancel each other out in the long run. The problem comes in the event of default, where the defaultor doesn't end up taking the paper back out of the economy and returning it to the bank. The 'deflationary' part of the deal/seesaw doesn't happen, tipping the transaction into an inflationary one.

Is this mostly correct, or am i completely barking up the wrong tree? :confused:

[bart]

Re: Coming full circle, Now to extend this to DEFLATION

Can I accurately say that during the US great depression dollars actually were destroyed as
1. banks went bankrupt
2. existing loans were required to be paid off
3. real fractional reserve requirements contracted the money supply

Sort of... and a fuller picture is in the following two charts. There's little question that non Fed member banks going under and things like the Smoot Hawley tariff law also contributed to it, but they occurred well after 1929.

Overly simply perhaps, but deflation is the opposite of inflation... and this chart shows that the money supply (as measured by M2 and M3 with a 10 year moving average) actually was growing slower & slower starting in about 1926, and was "dis-inflating".





Fractional reserve requirements, as measured by the monetary base (the light blue line), actually dropped as the Fed started pumping it in 1930. M3 was also not growing at all in 1929 since the Fed was in restraint mode. M1 (cash & checking accounts, roughly) was mostly negative starting in 1928 too.
Put that together with the concept of lags (it takes a while for money additions or subtractions to actually affect the economy), and it's the largest single cause of the Depression in my opinion.

The rate of credit expansion (the dotted line) didn't start to slow until early 1930... at least on an annual change rate basis.

How could such a thing happen today? At the moment then I'm leaning toward
1. greater demand for dollars as people try to pay back loans instead of declaring bankruptcy

combined with
2. no growth in supply to meet the demand - which would happen if the banks refuse to lend.

this time around 2. would only happen because banks go back to conservative lending practices. 2 would not happen because banks are going bankrupt and it would not happen because of the reserve requirements

1. I'm unsure what you're driving at on demand for dollars. Going back to a basic key definition, deflation is less money than goods, and demand is a relatively minor factor in my opinion.



2. I can't imagine a situation where banks would downright refuse to lend, but more conservative practices have been under way for about six months per the Fed's Senior Loan Officer survey,
( http://www.bullandbearwise.com/OfficerSurveyChart.asp ), and the same thing happens during every recession.

Also keep in mind that reserve requirements are quite low now, and there are also plans afoot for the Fed to actually pay interest on required reserves... and that reserves can also be borrowed at the discount window, etc. (about 5% of them are actually borrowed as of the last few months too, for what its worth).

The chances of mass bankruptcies of banks is pretty small too - the primary mission of the Fed is to protect the system, and Bernanke is on record numerous times about not letting another Depression happen. I'm unaware of any banks today that are not members of the Fed too.
Do note though that there's fairly likely to be at least one high profile bank get into serious trouble and get rescued and bought out, and that something like the RTC part deux will be formed too.

Finally, "money" is a fluid concept and "money supply" today should include both various measures of credit and even derivatives too... and no one currently even attempts to measure them all, although the FDI does indirectly address the area as do my M3 + various credit measures charts.