Paradoxical Deflation coming?

Stardust, To answer the question posed in your first paragraph, yes I would have expected inflation and GDP to explode. So, I see your point.

So far at least it seems that the Fed/government actions have held net deflation at bay and prevented what might otherwise have been a depression. But it is obvious that the economy is not recovering very fast, if at all, and the outlook is rather dismal at present. Perhaps all we have done so far is to buy some time without really fixing anything, and perhaps some problems have been made worse. Certainly the TBTF problem falls in that category. It is easy to criticize in hindsight some of the actions taken at the height of the 2008 financial panic, and certainly some of those things would have been done differently if one could go back and do them again. Now, it seems we are looking at the possibility of a deep, long-lasting, recession that could affect much of the globe.

I don't want to substitute my amateur judgement for that of the experts, and I consider Bernanke to be about as expert in these matters as we are going to find, but I sure would not want to be in his shoes right now.
 
Quote from Swan Noir:

I have not described a contraction of the money supply but rather a dramatic reduction in velocity. Eventually the gobs and gobs of fiat money will drive the value of paper to ... well, the value of paper. But in between here and there deflation of wages, prices and spirit are a real possibility. I believe round 15 will be in the midst of currencies becoming worthless but that may have little to do with rounds 10 or 12.



That is not necessarily deflation. In fact it could be inflation as the prices start to rise. It is a contraction of money supply.
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Technically velocity of money and money supply is the same thing. I guess it depends on which definition of money supply you use i.e. monetarists etc. Then we could get into a debate about broad money what classifies as money supply like M1, M2 etc.

What I am saying is there is a difference between prices which is inflation and deflation and "money supply" or velocity of money as you refer to it as.

The two are different factors. You seem to believe a contraction of the velocity of money is deflation it is not it is a contraction in the velocity of money. It may in fact lead to inflation.

Interesting subject though. The thread was a good discussion.
 
I'm not suggesting that a decrease in velocity is deflation but I am suggesting if every household in America spent half as much of their discretionary income in June as they did in May and then cut that spending in half again in August that cutting of the velocity would result in an immediate economic contraction (one that might well feed on itself) resulting in prices being slashed and American business making every decision based on the deflationary backdrop they faced.

Alfred Hitchcock once opined that if you introduced a gun into a movie that you were obligated to have it fired. In the same sense I believe that significant increases in money supply will at some point result in people spending that money at a frantic pace. Obviously, in order to counteract the inevitable "markdown" in purchasing power of the fiat, people, as the markdown passes certain trigger points, will simply buy things instead of holding paper pushing velocity up dramatically. They will buy four gross of hammers and 60 cases of canned goods as they buy five dozen tires and forty cases of vodka. They will put up temporary structures in their backyard wired with alarms and will have the means to protect their property. They will know hard goods can be bartered. They will not want to engage in the behavior but when they see the $2 hammer become $9 over six months they will know hammers good ... Benjamins bad. But most of all they will know that the Benjamins go down in value (real value ... purchasing power) every month. Then they will see significant decline every week and at some point they will note virtually every day the paper is worth less.

But that does not have to happen in the first, second or even fifth scene of this horror flick. Right now, whether it be rational or not (electricians, bakers and cops generally are uninformed on money supply) people -- those same electricians and others - in many parts of the world, are becoming afraid to spend. All I am suggesting is that behavior like that can tip us into deflation even if the presses are running three shifts. Societies can print it but it is still individuals that decide whether or not to spend it. And even more to the point, when to spend it. The electrician and the cop exercise more influence on velocity than Bernanke and Tiny Tim. Or at least that is what I believe ... lol.

Quote from morganist:

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Technically velocity of money and money supply is the same thing. I guess it depends on which definition of money supply you use i.e. monetarists etc. Then we could get into a debate about broad money what classifies as money supply like M1, M2 etc.

What I am saying is there is a difference between prices which is inflation and deflation and "money supply" or velocity of money as you refer to it as.

The two are different factors. You seem to believe a contraction of the velocity of money is deflation it is not it is a contraction in the velocity of money. It may in fact lead to inflation.

Interesting subject though. The thread was a good discussion. [/B][/QUOTE]
 
One last thing, then I'll shut up. I strongly believe that the Fed, in spite of the large number of tools at their disposal, can not fix this economy --all they can do is to react in a way that they believe best fulfills their mandate from Congress. There are many who see the Fed as "the evil ones", I don't.

(beware, what follows is going to be in the nature of a rant!)
My primary criticism is reserved for Congress, and secondarily for the Executive branch. Congress is still the most powerful of the three branches of the U.S. government. They control the purse strings, and the Constitution even gives them the power to determine what cases the Supreme Court can hear, and what cases they can't! They have power to reverse the decimation of the middle class, the off-shoring of jobs, declining real wages, runaway health costs; to correct and punish malfeasance in the banking sector; stop unaffordable, unproductive and wasteful military spending, the ballooning of the U.S. prison population; to make changes in programs that are obvious failures -- such as the expensive and ineffective "war on drugs"; correct and simplify an absurd income tax system, and to stop the ever worse trampling on both the Bill of Rights and free enterprise.

Solutions --dam good solutions in fact -- are known for every single one of these problems and are in place and operating well in many other countries of the world. Why does Congress over and over again cede power given to it by the Constitution to the executive and judicial branches, like a bunch of lily-livered namby pambies -- why won't Congress get their act together, AND ACT?
 
In a nutshell it is because buying votes is easier than earning them. Everyone over the age of 16 should know that. It is bedrock to understanding real economics.

Quote from piezoe:

One last thing, then I'll shut up. I strongly believe that the Fed, in spite of the large number of tools at their disposal, can not fix this economy --all they can do is to react in a way that they believe best fulfills their mandate from Congress. There are many who see the Fed as "the evil ones", I don't.

(beware, what follows is going to be in the nature of a rant!)
My primary criticism is reserved for Congress, and secondarily for the Executive branch. Congress is still the most powerful of the three branches of the U.S. government. They control the purse strings, and the Constitution even gives them the power to determine what cases the Supreme Court can hear, and what cases they can't! They have power to reverse the decimation of the middle class, the off-shoring of jobs, declining real wages, runaway health costs; to correct malfeasance in the banking sector; stop unaffordable, unproductive and wasteful military spending, the ballooning of the U.S. prison population; to make changes in programs that are obvious failures -- such as the expensive and ineffective "war on drugs"; correct and simplify an absurd income tax system, and to stop the ever worse trampling on both the Bill of Rights and free enterprise.

Solutions --dam good solutions in fact -- are known for every single one of these problems and are in place and operating well in many other countries of the world. Why does Congress over and over again cede power given to it by the Constitution to the executive and judicial branches, like a bunch of lily-livered namby pambies -- why won't Congress get their act together, AND ACT?
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I think the best way to think about deflation and inflation is by reference to the financial process that underlies them. When we see general prices rising to the extent that we can measure that rise with an inflation index, such ast CPI or PCE, there is a a flow of finance that characterizes that result. In inflation we see that money flows out of aggregate fincancial 'assets' and it flows into tangible assets and enterprise expansion. This process is facilitated by expanding private credit and increasing leverage ratios applied by lenders to collateral assets. 'Velocity' is nothing more than expanding private credit. As private credit expands and leverage ratios increase the nominal value of collateral assets, the assets that justify the debt expansion, go up in value. This is how inflation works, this increase in collateral asset value, fuels all the other increase in general prices.

The opposite happens in a deflaiton. In that process, money flows out of collateral assets and into cash or some money substitute, some stash of liquiditity that can hold most of its value. The process is characterised by declining value of collateral assets, declining aggregate credit assets in banks, lower leverage ratios on collateral assets...in short 'deleveraging.' Aggregate bank assets contract and deposits increase. Money flows out of all assets, credit contracts, which means 'velocity' declines and the decrease in value of collateral assets fuels the reduction of all prices generally.

What we see playing out now with the attempt of CBs to fight the deflaiton process with QE and interest rate reduction is the reliance on the operation of Quantity Theory of Money to modulate bank lending and general prices. The result shows that the Quantity Theory of Money does not work the way that our CB economists were taught. Increasing the supply of money in the banking system does not translate into increased bank lending and price change when collateral asset prices have already begun to decline. The necessary velocity context does not exist (positive credit formation) and it cannot be jump started by increasing cash in the banking system. It turns out that inflation requires accelerating credit formation to manifest in price change and that private credit formation is not driven by the supply or cost of money. Private credit formation is driven by the private consensus veiw of whether the promise of future profit that can be possessed after tax is sufficient and certain enought to overcome the risk associated with borrowing or otherwise investing to realize that future profit. That is a fiscal context problem and not a monetary policy problem.

The reason that excess reserves spiked when the Fed pumped up cash in the banking system is becuase there was no demand for private credit that could be underwitten based on declining collateral asset values. Where there is no demand pull through for the excess cash it has no place to go but back to the Federal Reserve. The only time you see a build of excess reserves in the banking system is when the system is in a deflationary process.

When you begin to understand how this works you see money supply is the same as private credit supply. When private credit contracts you have deflation and only when it expands can you have inflation. There is no paradox when you see how it works.
 
Quote from Ed Breen:

I think the best way to think about deflation and inflation is by reference to the financial process that underlies them. When we see general prices rising to the extent that we can measure that rise with an inflation index, such ast CPI or PCE, there is a a flow of finance that characterizes that result. In inflation we see that money flows out of aggregate fincancial 'assets' and it flows into tangible assets and enterprise expansion. This process is facilitated by expanding private credit and increasing leverage ratios applied by lenders to collateral assets. 'Velocity' is nothing more than expanding private credit. As private credit expands and leverage ratios increase the nominal value of collateral assets, the assets that justify the debt expansion, go up in value. This is how inflation works, this increase in collateral asset value, fuels all the other increase in general prices.

The opposite happens in a deflaiton. In that process, money flows out of collateral assets and into cash or some money substitute, some stash of liquiditity that can hold most of its value. The process is characterised by declining value of collateral assets, declining aggregate credit assets in banks, lower leverage ratios on collateral assets...in short 'deleveraging.' Aggregate bank assets contract and deposits increase. Money flows out of all assets, credit contracts, which means 'velocity' declines and the decrease in value of collateral assets fuels the reduction of all prices generally.

What we see playing out now with the attempt of CBs to fight the deflaiton process with QE and interest rate reduction is the reliance on the operation of Quantity Theory of Money to modulate bank lending and general prices. The result shows that the Quantity Theory of Money does not work the way that our CB economists were taught. Increasing the supply of money in the banking system does not translate into increased bank lending and price change when collateral asset prices have already begun to decline. The necessary velocity context does not exist (positive credit formation) and it cannot be jump started by increasing cash in the banking system. It turns out that inflation requires accelerating credit formation to manifest in price change and that private credit formation is not driven by the supply or cost of money. Private credit formation is driven by the private consensus veiw of whether the promise of future profit that can be possessed after tax is sufficient and certain enought to overcome the risk associated with borrowing or otherwise investing to realize that future profit. That is a fiscal context problem and not a monetary policy problem.

The reason that excess reserves spiked when the Fed pumped up cash in the banking system is becuase there was no demand for private credit that could be underwitten based on declining collateral asset values. Where there is no demand pull through for the excess cash it has no place to go but back to the Federal Reserve. The only time you see a build of excess reserves in the banking system is when the system is in a deflationary process.

When you begin to understand how this works you see money supply is the same as private credit supply. When private credit contracts you have deflation and only when it expands can you have inflation. There is no paradox when you see how it works.
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Hi Ed

Can you see the point I am making earlier in this thread that there is a difference between money supply increases and inflation and deflation, namely the price of goods. So many people assume the two are the same that is not necessarily the case. Remember the global factor and the impact that has on prices of goods?
 
Morganist, I got your point but I don't think it explains the process nor does it help with making useful definitions for these words. You must remember Milton Friedman's famous and generally accepted definition of 'Inflation:'

"Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output."

Most people disregard the second phrase in that definition. It reduces well to 'too much money chasing too few goods." Do you see how it rely's on the Quantity Theory of Money in its assumptions and how it disregards the role of credit as a transmission mechanism between changes in money supply and changes in the general price structure? You comments ignore the role of credit as well.

The issue of inflation is currency specific...we are talking about how monetary policy effects the general price structure in a discrete domestic currency and economy. At least we talk about that way in the U.S....other countries are effected by our monetary policy becuase we are the reserve currency so you import our mistakes, and you make your own mistakes as you react to them. The U.S. Fed casued the Asian monetary crises of the lata 1990's because it conducted a monetary policy that was too tight for the Asian economies that had tied their currencies to our dollar. Our economy could absorb the mistakes because of size and diversity; thiers could not...it destroyed the Agentine peso peg. You cannot internationalize the idea of inflation as a monetary phenomenon; when you do that you simply confuse the issues with supply demand imbalances, exchange ratio's and multiple monetary echo's from the reserve currency. The whole issue is further complicated becuase monetary uncertaintity creates risk in long cycle capital investing which inturn results in a lock of capacity for long cycle goods, particularly in energy and mining, so that the lack of investment casued by accumulated bad monetary policy shows up in a lack of capacity that creates supply and demand volatility. The issue becomes so attenuated that you can't parse out the disparate causes of the price behavior.

In any case, in a fiat currency the Quantity Theory of Money does not work and this is the basis of all developed world CB monetary policy. We are in a deflaton casued by malinvestment in realestate compounded by financial technology that has caused a credit contraction and general bank insolvency. The CB's of the world are trying to paper over it, but they can't.
 
Quote from Ed Breen:

Morganist, I got your point but I don't think it explains the process nor does it help with making useful definitions for these words. You must remember Milton Friedman's famous and generally accepted definition of 'Inflation:'

"Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output."

Most people disregard the second phrase in that definition. It reduces well to 'too much money chasing too few goods." Do you see how it rely's on the Quantity Theory of Money in its assumptions and how it disregards the role of credit as a transmission mechanism between changes in money supply and changes in the general price structure? You comments ignore the role of credit as well.

The issue of inflation is currency specific...we are talking about how monetary policy effects the general price structure in a discrete domestic currency and economy. At least we talk about that way in the U.S....other countries are effected by our monetary policy becuase we are the reserve currency so you import our mistakes, and you make your own mistakes as you react to them. The U.S. Fed casued the Asian monetary crises of the lata 1990's because it conducted a monetary policy that was too tight for the Asian economies that had tied their currencies to our dollar. Our economy could absorb the mistakes because of size and diversity; thiers could not...it destroyed the Agentine peso peg. You cannot internationalize the idea of inflation as a monetary phenomenon; when you do that you simply confuse the issues with supply demand imbalances, exchange ratio's and multiple monetary echo's from the reserve currency. The whole issue is further complicated becuase monetary uncertaintity creates risk in long cycle capital investing which inturn results in a lock of capacity for long cycle goods, particularly in energy and mining, so that the lack of investment casued by accumulated bad monetary policy shows up in a lack of capacity that creates supply and demand volatility. The issue becomes so attenuated that you can't parse out the disparate causes of the price behavior.

In any case, in a fiat currency the Quantity Theory of Money does not work and this is the basis of all developed world CB monetary policy. We are in a deflaton casued by malinvestment in realestate compounded by financial technology that has caused a credit contraction and general bank insolvency. The CB's of the world are trying to paper over it, but they can't.
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I would go further on Friedmans definition of inflation. But even so I think there is still an aspect you are missing in relation to foreign impacts on currency and values. I feel money shifts it doesn't move slowly like bubbles it moves quickly like a current from one place to another. It might have a strong current in one direction for a long time then suddenly shift. When that shift happens the currency value and inflation is affected in strong ways that the existing definitions of inflation and deflation and existing money circulation theories do not explain.

This is the thing I have been trying to explain and relate it to the use of currency as an investment vehicle and the economic stabalising factors that make a currency an investment vehicle. Depending on these factors the money supply can change in one way and the level of inflation or deflation can go in the unexpected opposite direction to what is anticipated.

I think you have to look at what it is that makes people believe a currency has value and what underpins that factor that determines currency values and the ability to purchase goods from external sources. Even the mighty US is dependent on foreign goods to reduce prices in its domestic market. Any underlying macro economic stabilising factor and any thing that impacts that will have an impact on the currency to buy those goods and will impact the currency value regardless of domestic monetary policy.

You see there are simply too many factors that impact prices on the international stage for them to be controlled on a domestic level in the long run. Money supply or velocity of money in one domestic economy cannot win against the global factors that determine either supply or demand.

Has this been food for thought?
 
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