
The dangers of deflation - anigbrowl
http://www.economist.com/news/briefing/21627625-politicians-and-central-bankers-are-not-providing-world-inflation-it-needs-some
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jandrewrogers
For those that do not understand why deflation is considered dangerous, let me
describe it this way:

It is effectively like cash earning tax-free interest. And since it is cash,
that "investment" is virtually risk-free because you'll always have the cash.

As a consequence, simply holding cash starts competing with the expected
return of investing the cash in other ways, like real estate, government
bonds, the stock market, or a startup. Relative to some traditional
investments, you might maximize your effective risk-adjusted returns by doing
nothing at all!

This sounds great (at least for people with cash) until you realize that this
"investment" is one of the least productive investments possible. No
infrastructure is built, no technologies invented, no products are created for
customers. While people with cash might be nominally wealthier, there is
greatly reduced investment of cash in things that improve the productivity and
wealth of the entire economy.

Furthermore, real investment is how many jobs are created. Several million
jobs in the United States are paid for with funds from speculative
investments. If it no longer pays to make speculative investments on new
technologies, new startups, or otherwise changing the world, what do you think
happens to those jobs that are tacitly funded by that investment?

Mild inflation, for better or worse, incentivizes anyone with a bit of money
to use that money to fund companies, infrastructure, technology, and jobs that
may ultimately return higher value than the loss to inflation. Yes, if you sit
on your cash in an inflationary economy, you slowly lose wealth. It
incentivizes people to attempt to apply their assets toward productive ends.

Lastly, there is the question of what about people with little or no cash in
an inflationary environment? On the surface, it looks like they get screwed.
In practice, the productivity and technology advances created by the
investment by people with money are often effectively neutral or
_deflationary_. Not only are they more productive at their jobs, assuming they
have one, but the costs of many goods decline thanks to the investment. This
doesn't apply to all goods but it applies to many that almost everyone
consumes. That said, if an economy inflates too fast it can quickly outstrip
the earning potential of the people that operate in it. The flow of money
through an economy has a significant viscosity and in extreme cases that
causes much suffering.

In summary, the reason mildly inflationary economies are commonly preferred by
most governments is that, on the balance, it optimizes incentives to maximize
real investment which not only grows the economy in real terms but has quasi-
deflationary effects for consumers as well. There are always tradeoffs but
this is widely believed to have the "least bad" set of tradeoffs for a
currency inflation/deflation policy.

~~~
yummyfajitas
This is NOT why deflation is bad. If there is a deflation rate D and (nominal)
interest rates R, you can still get a real return of D+R by investing your
money. If you want "risk free" income, you can put your money into AAA fixed
income _just like you would do in an inflationary economy_.

The effects on the allocation of investment in a deflationary world are
mathematically identical to an increase in interest rates. I.e., D=0, R=5 is
the same as D=2, R=3.

The only notable economic effect is that black money can now earn interest
(it's hard to invest black money in fixed income or other such things).

[edit: "Black money" is Hinglish for un-laundered money, i.e. cash profits
from crime.]

The problem with deflation is nominal rigidities, i.e. _sticky nominal wages_
or the _prideful worker effect_. Namely, workers will irrationally refuse to
accept work below their previous nominal wage. People's real productivity
fluctuates, and sometimes goes down. In an inflationary economy, you can wait
a little and not give them pay raises until their real wage drops below their
real productivity.

In a deflationary economy, the problem gets worse over time. Hence you'll need
to fire the workers with wage > productivity, and those workers will refuse to
accept new employment since new offers will have lower nominal wages than
their previous job.

~~~
Retric
No bonds are free of risk. Further deflation can be extremely high with real
world examples hitting 50% per year. Remember at 50% deflation your zero risk
cash is makeing an effective 100% ROI. So those AAA bonds need to make an
effective 100+% ROI or there going to default and nobody with a true AAA
raiting is going to pay that kind of interest. Worse places that had a AAA
raiting often fail in those kinds of shocks.

PS: Basically, the root cause of that kind of deflation is rolling defaults
contracting the money supply.

~~~
yummyfajitas
If you have a bond which costs $100 and pays $101 in a year's time, and a 50%
deflation rate, then the real return on the bond is 102%. The real return on
cash is 100%.

Inflation or deflation with magnitudes exceeding 20-30% is generally a _very
bad thing_ , and is also not what the article is discussing.

~~~
Retric
The issue is 3% deflation is already bad and can easily spike to 50% vary
quickly.

------
mindslight
Oh goodness no, not _lower consumption_! In 2014 of course we should all be
working full time just to have roofs over our heads, assuaging our stress by
buying toys that we can't even appreciate before they're obsolete or broken.

The myth that inflation is good is one of the greatest lies used to pervert a
seemingly free society into yet another treadmill of sustenance-based slavery.

In a functioning free market economy, most prices should be always decreasing
- _that is precisely what competition is based on!_

But when we fix the CPI, what we get instead is basic necessities still being
optimized ever-lower, while the currency is inflated to make energy costs (the
only true monetary measure) rise to compensate. Collateralizable assets shoot
through the roof as they're used to facilitate the monetary inflation (those
who control access to the proverbial printing press taking a hearty cut), and
we get to our current point where things that used to be owned are now just
rented from banks.

Ask yourself how many people have avoided owning a computer, knowing that
prices are always dropping? How many people have gone hungry, figuring that
food will be cheaper next week?

~~~
gfodor
I think the theory is not so much that people go hungry because food will be
cheaper tomorrow, but that there is a perverse _incentive_ to spend a little
less because you'll be able to get a little more with it later. I'm not sure I
buy this theory but I think it's more about the macro effects of a small tweak
in incentives.

~~~
imaginenore
That theory is complete nonsense.

If you wait a little longer, you can buy a better tablet, a better computer, a
better phone, a better TV with the same amount of money (inflation-corrected
or not). That doesn't stop people from buying all kinds of electronic devices,
even though they get obsolete much faster than their money.

~~~
gfodor
The point is not that it stops people from buying things, but that on a macro
scale it will cause people to delay or dampen their consumption. Sites like
[http://buyersguide.macrumors.com/](http://buyersguide.macrumors.com/) show
this phenomenon exists, the question is how much of an effect it has when it's
a few % yearly discount spread out over _every_ good and service.

------
sosuke
Such a hard thing to reason out in my non-economist brain. The idea that
people won't spend money today because something may be cheaper in the future
is bad? That sounds really close to saving money instead of spending it. Many
of us are in debt up to our ears from spending past our income, on school or
worthless things. We don't buy a car today because we're afraid the car will
cost more next year, the car costs are largely stagnate. We don't buy a house
today because we're afraid it will cost more next year, we buy a house because
a family is growing, we need a place to live, or it will leave the market and
we'll miss it. A top of the line iPhone last year was the same price as a new
one this year, if we wait its for the last years model. We don't wait to buy
food until tomorrow because it might be cheaper. We don't wait to fill our gas
tank until tomorrow, we have to get to work today. We don't wait until
tomorrow to fill our prescriptions, we need them today. I don't wait to pay my
electric or cable bills, I need them today.

Where is it, who, exactly, does this hurt. Who will be sitting on their money,
waiting to buy things they need until tomorrow. Only people who already have
everything they need, and even then they will continue to buy the basics. Who
does this hurt. The roads will continue to be paved, the cities will continue
to function. How does this all break down when a dollar today is worth a
dollar and a fraction of a cent tomorrow.

We weren't all dying when gas was $1 a gallon were we?

~~~
Nursie
It hurts everyone as the economy shrinks and there's less cash to go around.

That's who.

~~~
msandford
> It hurts everyone as the economy shrinks and there's less cash to go around.

Only until prices fall enough that people start spending again and hiring
picks up again.

The idea of an evenly rotating economy where everything is great all the time
has been thoroughly disproven over 100 years ago. To try and manage the
economy to be so is a fool's errand.

Debt has grown ever-so-slightly faster than income for the last 40-50 years
and that means future purchases have been pulled to the present for the last
40-50 years. If history is a guide (and I believe that it is) one of two
things will happen:

1\. People will start to pay down their debt and this will unfortunately
result in hardship as debt-fueled growth stops

2\. The banks will print more money and the party never stops until the party
blows up in an enormous currency crisis

I can't tell you which will happen, but every time we print more money we grow
the systemic risk of total blowup. People who argue that we should be doing
more to prevent climate change while simultaneously cheering money-printing
need to take a good look at their belief systems.

~~~
Nursie
>>Only until prices fall enough that people start spending again and hiring
picks up again.

But why would I bother investing capital to hire people to make stuff if I've
got guaranteed returns just by sitting on cash?

~~~
msandford
Deflation is only a scary thing because people have adapted to inflation, and
that has shaped the last 100 years or so of financial history in this country.

It used to be that prices went up, then down, then back up again, then back
down again, etc on a time-scale of a couple of years. Maybe spanning a range
of 4x or so. Because everyone knew that's how things went, they arranged their
affairs to cope and things weren't amazing, but a year or two of deflation
didn't destroy the world.

What we have now are huge asset bubbles that are popping and people at the Fed
are trying to reflate and/or at least slow the collapse down. The problem
isn't that deflation might happen; it's that there were years and years of
asset prices going to more and more unreasonable levels that no sane person
would pay.

How do you clean the slate and get asset prices back to levels that might make
sense from a fundamentals perspective instead of a risk-on, risk-off
perspective? The only thing I can think of is to let them fall to levels where
people would be willing to buy them again. It's either that or a 20 year
inflationary slog to slowly reprice them in real terms.

In other words, at 4% inflation over 20 years if a price doesn't change in
nominal terms it'll lose 55% of its value in real terms. That roughly
approximates it dropping in value 50% in say 6 months nominally, because in 6
months nominal terms are unlikely to diverge from real terms by more than a
few percent.

Which would you rather have? 20 year of Japan or the Great Depression, or a
fairly swift realignment of the economy to the new realities? Either way the
assets have to get repriced once everyone realized that they were priced
horribly, horribly incorrectly.

------
001sky
Might be useful to differentiate asset deflation from other forms. Asset
deflation is neccessary to spread wealth more evenly around the world. Such a
policy is he most "progressive" policy given the current skew of asset
distributions. Its possible to de-link asset vol from job creattion. Look no
further than the recent inflation of asset values and the lack of net-job
adds. So, as it is on the way up...so it is on the way down. The beauty of
variance and volatility is that they are naturally "neutral" terms.

The argument that there needs to be inflationary bias to create jobs is weak
on many levels. This is just one.

------
ArchD
I don't know why people are talking as if deflation is a real thing when
there's a worldwide property bubble going on and property price is a a very
real aspect of the cost of day-to-day living. One must question the CPI
metrics used.

~~~
adventured
It's a fraudulent concern meant to enable more printing.

One of the many psychological toys the Fed & Co. use, just like they regularly
threaten to raise interest rates (for years at this point) to buy more time on
holding down the bubbles they've created without having to actually do
anything.

The reason so many people are afraid of deflation, is they're from the
Keynesian school of economics. They've been brainwashed for two generations to
think inflation is how you grow an economy. No coincidence, the Keynesian
experiment has been a global disaster of epic proportions, leading to the
greatest accumulation of debt in world history; and locally, a 40 year
stagnation in the American standard of living, perpetually high real
unemployment, increased poverty, and increased inequality (because the rich
can shield themselves from inflation, the poor cannot).

Every country in history that has ever attempted to implement a Keynesian
inflation based economy, has failed, with the result being a disaster. Such
examples include the US, Japan, much of Europe and lately China has signed on
to the debt / stimulus / inflation party. Japan is a famous, fake deflation
example. They haven't suffered a penny of deflation in 30 years (an inflation
based asset bubble imploding, is not deflation); if Japan had suffered decades
of deflation, their wages and prices wouldn't be among the highest in the
world.

~~~
Nursie
Yup. Total disasters. Higher standard of living than any humans in history,
but Japan, Europe and the USA are somehow failed economies and total disaster
zones.

What colour is the sky on your planet?

~~~
jazzyk
I think the poster above is talking about the trends, not the absolute level
of wealth. The standard of living in the US has been stagnant (even declining,
for the lower-middle class) since 2000. Japan has been stagnant since the
real-estate bubble burst in the 80s.

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ap22213
All this pro-deflation talk makes me feel like I've walked into a Christian
Science convention.

~~~
001sky
Are you really that proud of the status quo? lets see, we'll take a bunch of
bank acounts, pay zero interest, and only let rich people & corporations
borrow without abandon to finance their acquisition (er, corner) the market in
all real-assets? Sounds like a great plan if your biz modle if f(n)% of asset
inflation.

~~~
pdkl95
Pointing out that deflation is a bad is not necessarily a statement of support
for any aspect of the current system. Staying away from deflation is good; the
other parts are another matter and need fixing in several ways.

~~~
001sky
deflation is a bad is a hypothetical, and the arguments for and against are
not trivially dismissed. your trading book matters more than any theory. since
the analysis is so fact depenedent, there is no simple right answer.

------
Cacti
The problem with deflation is that, if you're trying to control the money
supply, and your control is based on printing money, and you have deflation,
you lose control. The figurative "pushing on a string," you have nothing left
to leverage. You can't go below 0.

It's really more of a power/control issue than anything. The _entire point_ of
centralized banking is to _cause_ inflation, just not enough that it becomes
an issue.

------
vijayboyapati
The reason that political establishments have always been biased against
monetary deflation can be found in the manner in which wealth transfer occurs
under inflationary and deflationary environments.

During an inflationary credit expansion, wealth is transferred from the public
in general to the earliest recipients of the newly created credit money. In
practice, the earliest recipients are interest groups with the strongest
political connections to the state and, in particular, the state institutions
that control monetary policy (i.e., the Federal Reserve in the United States).
Importantly, the wealth transfer that takes place during an inflation is
hidden and largely unrecognized by the majority of the population. The
population is unaware that the supply of money is increasing and the attendant
rise in prices, ostensibly beneficial to business, initially

"produces [a] general state of euphoria, a false sense of wellbeing, in which
everybody seems to prosper. Those who without inflation would have made high
profits make still higher ones. Those who would have made normal profits make
unusually high ones. And not only businesses which were near failure but even
some which ought to fail are kept above water by the unexpected boom. There is
a general excess of demand over supply — all is saleable and everybody can
continue what he had been doing." In an inflationary environment, wealth
transfer proceeds insidiously and is masked by a perceived prosperity. The
unmasking finally occurs at the end of the credit boom when the market's
tendency to clear prior losses takes hold. Failed businesses are liquidated
and their capital is transferred, usually through bankruptcy, to creditors who
must acknowledge losses on these misguided investments. Unemployment soars and
social unrest replaces the former sense of euphoria attending the credit boom.
Professor Hülsmann summarizes the differences between the transfers of wealth
occurring under inflation and deflation as such:

"In short, the true crux of deflation is that it does not hide the
redistribution going hand in hand with changes in the quantity of money. It
entails visible misery for many people, to the benefit of equally visible
winners. This starkly contrasts with inflation, which creates anonymous
winners at the expense of anonymous losers. … [Inflation] is a secret rip-off
and thus the perfect vehicle for the exploitation of a population through its
(false) elites, whereas deflation means open redistribution through bankruptcy
according to the law."

And here lies the answer to why the state prefers a policy of controlled
inflation. Only in an inflationary environment can state largesse be conferred
to the politically well-connected without raising public ire. The widespread
and visible transfers of property through bankruptcy that must take place
during a deflation are often politically destabilizing and thus highly
unappealing to any regime. A sense of injustice grows within the population as
banks are saved from the folly of their misguided investments with taxpayer-
funded bailouts, while debtors with no political clout have property seized in
bankruptcy.

* [http://mises.org/daily/4974/The-Politics-of-Deflation](http://mises.org/daily/4974/The-Politics-of-Deflation)

~~~
MCRed
Or put another way, with inflation government can promise and raise funds for
political programs that help win elections, that they would not be able to
pass if they had to raise taxes (or cut other programs) to pay for.

~~~
anigbrowl
True, but that's not necessarily a zero-sum decision. Use that money for
subsidies or handouts, it's certainly wasted and hihgly inflationary. Use it
to build a port or some similar infrastructure, and it generates significant
real (rather than just nominal) economic activity.

------
dnautics
Maybe not constantly being egged on to consume might have good effects, for,
say, the environment.

------
ww520
Deflation is only bad for fixed interest rate debt bearer. Adjustable interest
rate debt goes lower along with deflation. The only problem for adjustable
rate is that it can't go lower when interest rate reaches 0 and deflation rate
keeps going down. To fix that, allows interest rate to go negative. That means
the principal of the debt goes down faster.

If everything is floating down with deflation, it's not too bad. For the fixed
rate debtors, well they made a calculated risk that inflation will go up.

------
djyaz1200
Anyone who is worried about deflation in the US right now is a moron. We
printed (we actually don't even bother printing it we just change numbers in a
database) more money since 2008 than in the entire history of the country. The
Fed owns over a quarter of the whole bond market.
[http://www.forbes.com/sites/robertlenzner/2013/11/25/the-
fed...](http://www.forbes.com/sites/robertlenzner/2013/11/25/the-fed-has-been-
cornering-the-treasury-market-for-the-past-four-years/)

~~~
w4
And yet inflation has barely cracked 3% since the proverbial printing presses
started up, and has bounced around at <2% for the past few years. Hence the
cause for concern: we pulled an unprecedented amount of currency out of thin
air, and the result was below average inflation.

~~~
adventured
In fact inflation is running closer to 7% to 8% right now.

You're of course referring to the current bogus CPI, which was put into effect
in the 1990s to hide the real rate of inflation.

It conveniently leaves out nearly every major source of inflation a person
would actually want to measure.

~~~
w4
>You're of course referring to the current bogus CPI, which was put into
effect in the 1990s to hide the real rate of inflation.

Let's just assume this is true. CPI, as currently measured, has been in place
since ~1996. One can thus safely assume CPI would reflect the alleged
inflationary effects of QE on price levels, regardless of how accurately it
measures the actual rate of inflation, since it represents a measurement of
_some_ consistent snapshot of the total rate of inflation throughout the
entirety of QE.

But CPI shows no change in the rate of inflation due to QE, and even more
curiously, tells us inflation is currently lower now than pre-QE. Regardless
of your opinion of its measurement of "real" inflation, the fact remains:
there has been no uptick in price levels due to QE (startup valuations aside,
hah!), despite the intuition that it ought to have resulted in substantial
inflation. Hence, cause for concern.

EDIT: And I say all of this as someone who was horrified of inflation back
when the Fed first started QE. So far, I appear to have been worried about the
wrong thing.

~~~
djyaz1200
The whole QE program MUST be inflationary. It don't make any rational sense
that a government could just purchase trillions of dollars worth of it's own
debt with synthetic money and not have some inflationary impact (your initial
fear). So what then? How is that massive force just being absorbed with no
consequence? I don't know, I don't think anyone knows. I could speculate. It's
likely that in a global economy China's artificially devalued currency allows
us to print money without real inflationary consequences for us? Could be the
dollar has become the de facto world currency and with this much wider
circulation the system can absorb much more inflationary pressure than
previously thought. Could be that this system is controlled more by behavioral
economics than economics. Maybe people just believe a dollar is worth about X
and that's very sticky until it isn't. This last idea is the scariest. Our
government is just like a big bank. The value of the dollar is subjective and
I believe serious inflation won't come in an incremental fashion, it will come
in a black swan tidal wave. I could be wrong and I seriously hope I am!! I
just don't think it's prudent to say, well we all thought (rationally and
rightly) QE was going to cause inflation because it's so obviously an
aggressively inflationary policy... then since it didn't we just turn the page
and say oh well... glad that didn't blow up the dollar. We need to understand
why that didn't have an effect.

