5 ms·

The Rising Threat of Deflation

22 points by MaysonL 16y ago

RyanMcGreal 16y ago
You know it's serious when the American Enterprise Institute and Paul Krugman are saying the same thing.
- MaysonL 16y ago
  Strangely enough, Krugman linked to this AEI piece in his blog.
  - deleted 16y ago
    [deleted]
lowkey 16y ago
It doesn't exactly take a Nobel Prize in Economics to figure out deflation is in the forecast - only access to good data. Since the Federal Reserve stopped reporting M3 Money Supply several years ago, it is a bit harder to come by this data - but not impossible. Take a look at this link and tell me if you can spot the deflation: http://www.shadowstats.com/alternate_data/money-supply-charts http://www.shadowstats.com/alternate_data/money-supply-chart... Banks got bailed out by taxpayers but they are not making loans - hence M3 velocity is collapsing. When the money supply contracts, deflation results. See, economics is pretty simple when you strip out all the fancy words and replace them with good data :)
- stretchwithme 16y ago
  one interesting aspect of inflation/deflation is that neither moves through the economy uniformly. one market can be inflating even while another is deflating Right now, things are definitely deflating if looking at the whole. The loss of hundreds of billions in perceived value definitely removed some of the "currency" people thought was part of total buying power. The currency left over is naturally more valuable and price declines are the result.
grandalf 16y ago
Deflation just means prices are going down. This is a good thing for people who want to buy those things. Of course, after a bubble bursts prices will be lower. No price is intrinsically "good" or "bad". Price is a measure of supply and demand. The idea behind the typical Fed policy of slow inflation is that by constantly adding a bit of inflation, the Fed has something to take away when the economy needs to be slowed. Keep in mind that it is US policy to inflate housing prices, so it's no wonder that after a while it just wasn't sustainable. As a renter I find this practice abhorrent and wish that somehow the brunt of the economic crisis could be foisted upon all the mortgage debtors who thought they were Warren Buffet just before the crash. After the crash billions more were poured into housing in the hope that nobody would realize it was way, way overvalued. I think that most of this is built upon the desire not to have more people walk away so that there is still a remote numerical chance of deeming a the typical mortgage debtor aka "homeowner" credit worthy.
- nostrademons 16y ago
  The problem with deflation is that it tends to be very unevenly distributed. You rarely see prices drop by 5%; instead, you'll see some prices stay the same, and others drop by 25+%, and some even increase. In practice, this means that this is a good thing - if you're one of the people who keeps their jobs. Wages tend to be one of those prices that is least likely to drop; this is known as the "sticky wage problem" and is because employers have found that cutting nominal pay rates almost universally causes bad employee morale. So if you have a 5% drop in aggregate employment expenditures, it usually manifests itself as 95% of employees keep the same salary, and 5% get laid off entirely. Of course, I'm absolutely certain that I'll be in that 95%, right? Because I'm clearly above average. ;-)
- stretchwithme 16y ago
  yeah, we have two contradictory goals with housing: making it more affordable, while simultaneously inflating housing prices. If you removed the interest deduction, the first time buyer subsidies, the capital gains exclusion of $250k and whatever else they do, you'd see an even steeper decline.
  - 16y ago
stretchwithme 16y ago
Deflation is not a threat. Its just prices returning to normal after the collapse of largest bubble in human history. And its not over. Housing prices will be dropping some more now that some of the artificial support has been removed.
- btilly 16y ago
  If deflation was just happening in housing, I might agree. But it is not. The problem is that deflation is happening across the board. The price of food. The price of clothing. The price of furniture. All are affected. Most of those products were not part of the bubble, but all are impacted by changes in the money supply. The real problem comes when people get used to deflation and start counting on it. In that environment people don't think, "I have 10,000 dollars, what can I invest it in?" Instead they think, "I have 10,000 dollars, imagine how much more I can buy with that next year!" And when you kill investment, all sorts of bad things happen. For instance in the short term companies stop growing, stop hiring, and you are likely to get prolonged periods of high unemployment. And in the long term you have reduced productivity.
  - SHOwnsYou 16y ago
    A lot of the decline in prices in food and furniture and other items that have to be transported is due to the oil bubble in 2008. An easy example is milk. It now costs less than in did in 2008 because gas is so much cheaper.
  - grandalf 16y ago
    I think you're getting hung up on the idea of a deflationary spiral. We are not anywhere close to that.
piguy314 16y ago
Core inflation is kind of a lie anyway, they basically extract any commodity that they claim has a volatile price and only track ones that don't. What about food and energy prices?
MartinCron 16y ago
What helped me understand deflation was, as with so many things, the Planet Money team from NPR. http://www.npr.org/tablet/#story/?storyId=96993728 http://www.npr.org/tablet/#story/?storyId=96993728
ruang 16y ago
Neither deflation nor inflation are a problem. Instead it is the speed at which they occur. Having prices move to their natural supply/demand equilibrium is a good thing. The problem is if they move too slowly. For example, if I believe a house is worth $100,000 instead of $200,000, I will wait until it reaches $100k before buying. Now whether this happens in 1 day or in 1 decade is the problem. If it happens in 1 day, everyone will start spending again in a matter of months, if not days. If it happens in 1 decade (aka Japan), then people will hold their money until price reaches the natural equilibrium. Thus, the US should stop trying to artificially prop up housing prices. It only delays the inevitable.
- gte910h 16y ago
  The US should allow bankruptcy judges to partially invalidate mortgages, gently reducing the value of homes. As it is now, foreclosures vs overvalued real homes means we have a hideous home buying landscape out there now.
  - grandalf 16y ago
    What will happen to mortgage interest rates if the contract can be easily invalidated by a judge? That luxury (to the borrower) is not free, and will be borne by all other borrowers. Lenders resort to foreclosure b/c they realize that if they give an inch, they will absorb all of the losses. If you invest in something, even if you borrow money to do so, you typically agree to suffer the losses and to profit from the gains.
    - gte910h 16y ago
      Mortgage interest rates are at historic lows.... Even that being the case, that means markets in which risk is low, will have lower interest rates than in markets in which risk is high. So people buying in overheated markets will have another dampening effect on them (ie, interest rates go up when the market get's risky). >If you invest in something, even if you borrow money to do so, you typically agree to suffer the losses and to profit from the gains. Yes, like the people investing in mortgages. Remember, the people lending the money are making an investment. The people buying a house may just be buying a place to live. I actually see what will happen to interest rates with this change being a nice dampening effect on house price speculation, flipping and overheated property markets.
narrator 16y ago
One important thing to realize is that in a credit bubble the price of things like houses, college education, etc increase even as the supply rapidly increases. This is because there is more and more credit available to pay for them from the same constant income stream of the consumer. This increase in credit is caused by the lowering of lending standards and interest rates. This credit is payed for by a continuous stream of income. Once the stream of income is fully tapped and debt service becomes around 30% of income, credit can no longer grow and a deflationary cycle gets going where the prices of those goods that were inflated by credit revert to the prices that they would have commanded had the supply of those goods (housing,education,etc) just been increasing and not the money supply. The "deflation" is the business infrastructure built around constant expansion of debt collapsing. In the end it is healthy as the economy was unreasonably warped towards over-production of credit secured assets. This warping is what has led to the current underconsumption of house-poor and student-loan poor individuals who are unable to spend because they sold their productive years, in the form of debt payments, to the dream of making it rich by overpaying for credit inflated goods. WHEN DOES THIS END? This ends when we reach the end of the K-Wave and prices come back down to levels where the cap rate on renting a house competes well with risky bonds. Even then, you've got the whole multitude of debt laden consumers who need to default on everything so they can have some spending money again. Unfortunately they are not yet out of the woods as higher taxation by our government, in order to pay its debts, is still an on-going problem that will overhang the economy until the massive bulge of government pensioners of the baby boomer era start to die-off and we end the Iraq/Afghanistan wars.
- grandalf 16y ago
  Exactly. Prices are value neutral. When the government decides that housing prices should be higher (applies its own value judgments to prices) it creates a bubble which may then burst, leading to deflation, which of course would be viewed through the lens of this value judgment as "bad". A price is just the nexus of supply and demand and cannot be good or bad.

22 points by MaysonL 16y ago

RyanMcGreal 16y ago

You know it's serious when the American Enterprise Institute and Paul Krugman are saying the same thing.

MaysonL 16y ago
Strangely enough, Krugman linked to this AEI piece in his blog.
- deleted 16y ago
  [deleted]

lowkey 16y ago

It doesn't exactly take a Nobel Prize in Economics to figure out deflation is in the forecast - only access to good data. Since the Federal Reserve stopped reporting M3 Money Supply several years ago, it is a bit harder to come by this data - but not impossible. Take a look at this link and tell me if you can spot the deflation: http://www.shadowstats.com/alternate_data/money-supply-charts http://www.shadowstats.com/alternate_data/money-supply-chart... Banks got bailed out by taxpayers but they are not making loans - hence M3 velocity is collapsing. When the money supply contracts, deflation results. See, economics is pretty simple when you strip out all the fancy words and replace them with good data :)

stretchwithme 16y ago
one interesting aspect of inflation/deflation is that neither moves through the economy uniformly. one market can be inflating even while another is deflating Right now, things are definitely deflating if looking at the whole. The loss of hundreds of billions in perceived value definitely removed some of the "currency" people thought was part of total buying power. The currency left over is naturally more valuable and price declines are the result.

grandalf 16y ago

Deflation just means prices are going down. This is a good thing for people who want to buy those things. Of course, after a bubble bursts prices will be lower. No price is intrinsically "good" or "bad". Price is a measure of supply and demand. The idea behind the typical Fed policy of slow inflation is that by constantly adding a bit of inflation, the Fed has something to take away when the economy needs to be slowed. Keep in mind that it is US policy to inflate housing prices, so it's no wonder that after a while it just wasn't sustainable. As a renter I find this practice abhorrent and wish that somehow the brunt of the economic crisis could be foisted upon all the mortgage debtors who thought they were Warren Buffet just before the crash. After the crash billions more were poured into housing in the hope that nobody would realize it was way, way overvalued. I think that most of this is built upon the desire not to have more people walk away so that there is still a remote numerical chance of deeming a the typical mortgage debtor aka "homeowner" credit worthy.

nostrademons 16y ago
The problem with deflation is that it tends to be very unevenly distributed. You rarely see prices drop by 5%; instead, you'll see some prices stay the same, and others drop by 25+%, and some even increase. In practice, this means that this is a good thing - if you're one of the people who keeps their jobs. Wages tend to be one of those prices that is least likely to drop; this is known as the "sticky wage problem" and is because employers have found that cutting nominal pay rates almost universally causes bad employee morale. So if you have a 5% drop in aggregate employment expenditures, it usually manifests itself as 95% of employees keep the same salary, and 5% get laid off entirely. Of course, I'm absolutely certain that I'll be in that 95%, right? Because I'm clearly above average. ;-)
stretchwithme 16y ago
yeah, we have two contradictory goals with housing: making it more affordable, while simultaneously inflating housing prices. If you removed the interest deduction, the first time buyer subsidies, the capital gains exclusion of $250k and whatever else they do, you'd see an even steeper decline.
- 16y ago

stretchwithme 16y ago

Deflation is not a threat. Its just prices returning to normal after the collapse of largest bubble in human history. And its not over. Housing prices will be dropping some more now that some of the artificial support has been removed.

btilly 16y ago
If deflation was just happening in housing, I might agree. But it is not. The problem is that deflation is happening across the board. The price of food. The price of clothing. The price of furniture. All are affected. Most of those products were not part of the bubble, but all are impacted by changes in the money supply. The real problem comes when people get used to deflation and start counting on it. In that environment people don't think, "I have 10,000 dollars, what can I invest it in?" Instead they think, "I have 10,000 dollars, imagine how much more I can buy with that next year!" And when you kill investment, all sorts of bad things happen. For instance in the short term companies stop growing, stop hiring, and you are likely to get prolonged periods of high unemployment. And in the long term you have reduced productivity.
- SHOwnsYou 16y ago
  A lot of the decline in prices in food and furniture and other items that have to be transported is due to the oil bubble in 2008. An easy example is milk. It now costs less than in did in 2008 because gas is so much cheaper.
- grandalf 16y ago
  I think you're getting hung up on the idea of a deflationary spiral. We are not anywhere close to that.

piguy314 16y ago

Core inflation is kind of a lie anyway, they basically extract any commodity that they claim has a volatile price and only track ones that don't. What about food and energy prices?

MartinCron 16y ago

What helped me understand deflation was, as with so many things, the Planet Money team from NPR. http://www.npr.org/tablet/#story/?storyId=96993728 http://www.npr.org/tablet/#story/?storyId=96993728

ruang 16y ago

Neither deflation nor inflation are a problem. Instead it is the speed at which they occur. Having prices move to their natural supply/demand equilibrium is a good thing. The problem is if they move too slowly. For example, if I believe a house is worth $100,000 instead of $200,000, I will wait until it reaches $100k before buying. Now whether this happens in 1 day or in 1 decade is the problem. If it happens in 1 day, everyone will start spending again in a matter of months, if not days. If it happens in 1 decade (aka Japan), then people will hold their money until price reaches the natural equilibrium. Thus, the US should stop trying to artificially prop up housing prices. It only delays the inevitable.

gte910h 16y ago
The US should allow bankruptcy judges to partially invalidate mortgages, gently reducing the value of homes. As it is now, foreclosures vs overvalued real homes means we have a hideous home buying landscape out there now.
- grandalf 16y ago
  What will happen to mortgage interest rates if the contract can be easily invalidated by a judge? That luxury (to the borrower) is not free, and will be borne by all other borrowers. Lenders resort to foreclosure b/c they realize that if they give an inch, they will absorb all of the losses. If you invest in something, even if you borrow money to do so, you typically agree to suffer the losses and to profit from the gains.
  - gte910h 16y ago
    Mortgage interest rates are at historic lows.... Even that being the case, that means markets in which risk is low, will have lower interest rates than in markets in which risk is high. So people buying in overheated markets will have another dampening effect on them (ie, interest rates go up when the market get's risky). >If you invest in something, even if you borrow money to do so, you typically agree to suffer the losses and to profit from the gains. Yes, like the people investing in mortgages. Remember, the people lending the money are making an investment. The people buying a house may just be buying a place to live. I actually see what will happen to interest rates with this change being a nice dampening effect on house price speculation, flipping and overheated property markets.

narrator 16y ago

One important thing to realize is that in a credit bubble the price of things like houses, college education, etc increase even as the supply rapidly increases. This is because there is more and more credit available to pay for them from the same constant income stream of the consumer. This increase in credit is caused by the lowering of lending standards and interest rates. This credit is payed for by a continuous stream of income. Once the stream of income is fully tapped and debt service becomes around 30% of income, credit can no longer grow and a deflationary cycle gets going where the prices of those goods that were inflated by credit revert to the prices that they would have commanded had the supply of those goods (housing,education,etc) just been increasing and not the money supply. The "deflation" is the business infrastructure built around constant expansion of debt collapsing. In the end it is healthy as the economy was unreasonably warped towards over-production of credit secured assets. This warping is what has led to the current underconsumption of house-poor and student-loan poor individuals who are unable to spend because they sold their productive years, in the form of debt payments, to the dream of making it rich by overpaying for credit inflated goods. WHEN DOES THIS END? This ends when we reach the end of the K-Wave and prices come back down to levels where the cap rate on renting a house competes well with risky bonds. Even then, you've got the whole multitude of debt laden consumers who need to default on everything so they can have some spending money again. Unfortunately they are not yet out of the woods as higher taxation by our government, in order to pay its debts, is still an on-going problem that will overhang the economy until the massive bulge of government pensioners of the baby boomer era start to die-off and we end the Iraq/Afghanistan wars.

grandalf 16y ago
Exactly. Prices are value neutral. When the government decides that housing prices should be higher (applies its own value judgments to prices) it creates a bubble which may then burst, leading to deflation, which of course would be viewed through the lens of this value judgment as "bad". A price is just the nexus of supply and demand and cannot be good or bad.