A discussion on deflation from TAE

[GliderGuider]

More fascinating stuff from the very smart lady at The Automatic Earth.

Stoneleigh and Aaron Krowne battle deflation

The following is part of an on-going conversation between Aaron Krowne (who runs The Mortgage Implode-O-Meter) and Stoneleigh on the subject of deflation. It began 3 days ago when Aaron sent me an email reacting to Stoneleigh's recent article The unbearable mightiness of deflation. Civilized and well-argued discussions are a welcome delight.


Aaron: many good points. The way I understand it is that deflation is only happening in the financial economy, not the real economy.

Stoneleigh: Deflation is a monetary phenomenon - the contraction of money and credit relative to available goods and services. It is either happening or it is not. Price falls in nominal terms are a lagging indicator of deflation as a price driver, but there are other price drivers as well, such as wage arbitrage, scarcity, substitutability (or lack thereof) etc. Price movements have no explanatory or predictive value in their own right as they are the net result of many factors that vary for different goods and services.

Deflation will eventually cause prices to fall almost across the board in nominal terms, while leaving them less affordable than they were before due to the collapse of purchasing power. Purchasing power will collapse as access to credit disappears and the ability to earn an income decreases drastically with skyrocketing unemployment. Lack of purchasing power will come from most people having no money. Those (very) few who have preserved their purchasing power in liquid form will find everything is very cheap indeed once we are further into a deflationary spiral.

Aaron: Many assets (i.e. cars, foreclosed houses) are transitioning from one economic sphere to the other. In the real economy (where they are bought outright, not financed), these goods have lower prices. But that doesn't mean "prices are falling" in the same sense as it would for a cup of coffee or your monthly power bill or health insurance -- and in fact all these prices are going up.

Stoneleigh: Prices will fall, but as prices lag a deflationary contraction, many prices have not fallen yet. We have not yet seen the impact of credit tightening on price support for many things, but it is coming. Already we are seeing credit limits cut, cards withdrawn, borrowing against property cut etc. All that will have an effect, especially as it has very much further to go. The market is temporarily rallying at the moment, as we said it would in March, but once the sucker rally is over, the decline will begin again and the impacts will be increasingly obvious.

Much more at the link

Stoneleigh has the home court advantage, of course. However, Aaron obviously either doesn't get or is unwilling to accept the implications of the fact that inflation/deflation are monetary phenomena and that DEBT IS MONEY.

[notesdev]

1. small quibble

Money (as currently implemented) is debt, but debt is not necessarily money.

[GliderGuider]

2. Could you explain that a little further?

As stated, I disagree.

http://www.youtube.com/watch?v=vVkFb26u9g8

[notesdev]

3. explains

Money is a portable, exchangeable store of value. Its essential nature does not require debt; a gold coin, for example, is money, but is not debt.

A Federal Reserve Note (FRN), on the other hand, IS debt. The essential nature of debt is that it is a promise to pay, and the origin of the FRN is as a promise to pay in silver or gold the equivalent value stated on the note. This in turn was backed by the gold standard, which meant that the denomination of FRNs had to be limited by the amount of gold available to pay the promises the notes represent.

Of course, then we have the FDR devaluation/gold seizure, Nixon's closing of the gold window, and various other bits of hanky-panky that got us to where we are today; which is, that a FRN is now a promise not to pay anything.

[discocrisco01]

4. The Fed is a scam

The federal reserve is a scam

[GliderGuider]

5. I'm confused

You seem to be saying that money is not necessarily debt, but debt is necessarily money. I would agree with that formulation, BTW.

I'm speaking in an abstract sense here, not with reference to any specific institutions or activities in the financial arena. A consumer loan from a bank -- especially within a fractional reserve financial system -- "creates" money by the issuance of debt. That debt may be backed by nothing but an implicit agreement to ignore the empty reality of the situation, but given that agreement as the initial assumption the store of value called "money" is expanded nonetheless.