4 ms·

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? T

by sosuke 12y ago

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 12y ago
It hurts everyone as the economy shrinks and there's less cash to go around. That's who.
- deleted 12y ago
  [deleted]
- msandford 12y ago
  > 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.
  - ap22213 12y ago
    So, you're saying that you want another Great Depression? That's generally not considered as a positive period of time.
  - Nursie 12y ago
    >>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 12y ago
      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.
- Houshalter 12y ago
  The amount of wealth is constant. Just because there is more cash in the economy, doesn't mean anything if it's worth less. You might see some benefit in the short term but only at the expense of the long term. People, and the economy as a whole, should save/invest for the future as much as possible, rather than only caring about the short term.
- MCRed 12y ago
  Deflation means you can buy the same amount of goods (sustaining the same sized economy) with less money. That less money means you have more surplus money to spend on luxuries. More people will have more disposable income, which likely would mean they buy more goods, and could sustain a larger economy... leading to economic growth. Plus-- the goods you're buying are made by companies who are buying materials at a lower cost, and thus if they lower prices slower than the materials prices are going down due to inflation they have more margin. Businesses as well will have more flexibility, the ones that are borderline now will last longer, might turn things around, etc.
  - Nursie 12y ago
    You're also getting paid less over time. Meanwhile my savings are slowly growing in economic power, even though all I've done is stuff them in an old mattress. New entrants to the labour market can never aspire to have the kind of cash their older peers have put away because work yesterday is valued more than work today. Not a world I want to live in.
lazyjones 12y ago
If you stop the excessive spending, you may actually pay off your debts prematurely. Guess who it'll hurt? The sponsors of the Economist, the banks and wealthy investors who want at least 2-3% interest for nothing (for lending out money they've accumulated in the past, or money they've generated out of thin air in case of banks). It'll likely also hurt some countries that have accumulated far more debt than they could ever reasonably hope to pay back. Debt also motivated by the same entities hoping to make a buck from nothing. I'm not at all afraid. I have no debt and I invest in things that have actual value when used, like real estate. I don't care if prices drop, because it'll still be real estate with practical value.
msandford 12y ago
I think what's really interesting is exploring the dynamics around lowering or raising the interest rate. Lowering it will tend to pull purchases from the future to the present, everything else equal. But -- at least with housing -- all other things aren't equal; lowering the interest rate also drives up property prices. Once something is expensive enough that say, 95% of the population has to finance it, the purchase price is no longer really a consideration. Sure you might sign on a mortgage that ostensibly says you start out owing $300k or whatever, but in reality what you're signing on is an obligation to pay $2k/month for the next 30 years, or until you sell it, go broke and move out, etc. At 10% interest the $2k/mo doesn't have all that large of a price-artifact; it's about $200k. At 4% interest, the $2k/mo price-artifact is $375k. This is interesting and serves to illustrate that lowering the interest rate doesn't really "help" real-estate except to ensure that people aren't underwater in houses they paid too much for. In the non-financing world, a high interest rate means that you get a future-discount by saving your money and buying it later. And a low interest rate means that you get less of a future-discount by waiting to buy. When I say "a high interest rate" I'm talking about the real interest rate, interest minus inflation. The nominal interest rate doesn't matter save for some psychological effects. You can get that by having 10% interest and 4% inflation or 2% interest and 4% deflation, either way the real interest rate is 6%. But when the interest rate is 1% and inflation is 3% then the real interest rate is negative, -2% and you're a fool to save any money at all; everything else equal. This is how lowering the interest rate pulls future purchases into the present. Here's the kicker though: eventually there's less and less future purchases to pull from, and as a result the inflation has to get ever-more severe. As you start to approach spending all your money on debt service, you have less and less ability to take on new debt. And that means that the terms have to get substantially more favorable, and seemingly the only way to do that is to inflate enough to make the old debt less burdensome. Is that an underhanded form of theft? Probably, but it's the legal kind. The "hoarding" argument tends to fall apart if you consider all the things which a person HAS to buy; food, water, clothing, shelter, energy, transportation, etc. It's not as though you can not eat your vegetables because they're expensive for 20 years and then make up for that all at once. Can people make do with less? Sure. One person's "hoarding" is another person's ability to finance a house because the bank has enough savings to make the loan.
- 12y ago
waps 12y ago
> The idea that people won't spend money today because something may be cheaper in the future is bad? No. Think about what happens to any large organization during deflation. The counterintuitive part here is that every large organisation, including the government, is worth exactly nothing. Now you might think "But Obama sure has a nice little white house, lots of employees, ... that's gotta be worth something". That's true. Those are the assets. Then you have the liabilities. This includes loans that need to be repaid (plus interest), and any remaining capital is effectively loaned to the shareholders (though in practice this will, nearly always, be zero. The exceptions are Apple, Google and Facebook, but there's other major caveats there). Now what happens when you have 11% deflation (making an extreme example, nobody's expecting more than 1.1% at the moment). Before: * Assets(t-1) = What was produced (sold) - what was consumed (yes, even for the government) * Liabilities(t-1) = What was loaned * Worth(t-1) = Assets(t-1) + Liabilities(t-1) = 0 After 11% inflation: * Assets(t) = 0.9 * What was produced (sold) - 0.9 * what was consumed * <> Assets(t) = 0.9 * Assets(t-1) * Liabilities(t) = What was loaned ~= Liabilities(t-1) (Liabilities, especially loans, but many other instruments as well, are not affected by inflation) * Worth(t) = 0.9 * Assets(t-1) + Liabilities = Worth(t-1) - 0.1 * Liabilities(t-1) So there you have it : the organisation (say, the US government), effectively has to pay 10% of it's liabilities without getting anything in return for that. Zero liabilities disappear, nothing gets produced, it's literally money down a black hole. So there you have (way, way oversimplified) the problem. When you have deflation, every organisation that is balanced (assets + liabilities = zero), including the government, every large organisation, ... all their loans effectively increase by the deflation amount. So what would the effect be of 1% deflation : The US government loaned $17 trillion, so every 1% of deflation means raising tax income by 170 billion (or loaning it, worsening the problem quickly) without getting anything in return at all. Note that this is just the primary effect. The fact that every loan suddenly becomes more expensive to repay will have all sorts of indirect effects, like say a housing price crash (because banks can be pretty sure nobody will be able to repay even small loans with low interest rates). Deflation, effectively, is a tax on loans. It will very quickly destroy anyone and anything holding loans, which is to say everyone. Incidentally, fractional reserve banks have a capital buffer of 2%, which means they loan out 50 times more money than they have in capital, all of which will suddenly and simultaneously have problems getting repaid. What do you think will happen to your savings ? Cynics would say, because the effect this will have on governments, they will go to war. Especially the ones that don't control their own currencies. (in other words, a piece of advice : if inflation gets to 0%, you won't get interest on the bank anyway. Get your money and hide it under your mattress before everyone else does)
MCRed 12y ago
The way I look at it, high rates of inflation incentivize debt. If I can borrow at %4 a year (much more than the federal reserve charges, for instance) and then deploy that money productively, I can use the proceeds to pay down the debt with much cheaper money. So, if I thought the rate of return made sense, I could borrow dollars on my credit card, buy Apple, Google or Facebook stock, and then pay back the loan on the dividends or returns from the stocks appreciation. This isn't even necessarily irresponsible if, say, you bought Berkshire Hathaway, which has historically returned >%20. If it continues to do so, even a credit card rate of %13 will give you a %7 spread. This is a simple example of leverage and is effectively the same as trading stock on margin. But, I'm sure everyone reading this realizes the danger- Buffet may die, BRK might flatten, any of those tech companies might not return what I expect. That's the risk of leverage. So, in short, inflation incentivizes the risk of leverage. And that's exactly what we saw in the housing bubble where people with $60k in income were buying 4-5 $120k condos hoping to flip them in a few years.
- msandford 12y ago
  Yeah, leverage is probably one of the best/worst concepts to ever happen. It's why an airline goes bankrupt every few years, and the primary reason why banking crises happen. But leverage is also the thing that allows me to buy a house or a car on credit rather than outright with cash. Leverage is kind-of like guns. I want me to have it because I'm responsible and can handle it appropriately. But I'm not sure that anyone else should be allowed to have it. (I'm personally for arming people more rather than less, but it seems like it'll hit home for a lot of folks)
- wbl 12y ago
  And what was inflation over that time period? Answer: less than 5%, with the target of 2% getting meet a great deal of the time.

by sosuke 12y ago

Nursie 12y ago

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

deleted 12y ago
[deleted]
msandford 12y ago
> 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.
- ap22213 12y ago
  So, you're saying that you want another Great Depression? That's generally not considered as a positive period of time.
- Nursie 12y ago
  >>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 12y ago
    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.
Houshalter 12y ago
The amount of wealth is constant. Just because there is more cash in the economy, doesn't mean anything if it's worth less. You might see some benefit in the short term but only at the expense of the long term. People, and the economy as a whole, should save/invest for the future as much as possible, rather than only caring about the short term.
MCRed 12y ago
Deflation means you can buy the same amount of goods (sustaining the same sized economy) with less money. That less money means you have more surplus money to spend on luxuries. More people will have more disposable income, which likely would mean they buy more goods, and could sustain a larger economy... leading to economic growth. Plus-- the goods you're buying are made by companies who are buying materials at a lower cost, and thus if they lower prices slower than the materials prices are going down due to inflation they have more margin. Businesses as well will have more flexibility, the ones that are borderline now will last longer, might turn things around, etc.
- Nursie 12y ago
  You're also getting paid less over time. Meanwhile my savings are slowly growing in economic power, even though all I've done is stuff them in an old mattress. New entrants to the labour market can never aspire to have the kind of cash their older peers have put away because work yesterday is valued more than work today. Not a world I want to live in.

lazyjones 12y ago

If you stop the excessive spending, you may actually pay off your debts prematurely. Guess who it'll hurt? The sponsors of the Economist, the banks and wealthy investors who want at least 2-3% interest for nothing (for lending out money they've accumulated in the past, or money they've generated out of thin air in case of banks). It'll likely also hurt some countries that have accumulated far more debt than they could ever reasonably hope to pay back. Debt also motivated by the same entities hoping to make a buck from nothing. I'm not at all afraid. I have no debt and I invest in things that have actual value when used, like real estate. I don't care if prices drop, because it'll still be real estate with practical value.

msandford 12y ago

I think what's really interesting is exploring the dynamics around lowering or raising the interest rate. Lowering it will tend to pull purchases from the future to the present, everything else equal. But -- at least with housing -- all other things aren't equal; lowering the interest rate also drives up property prices. Once something is expensive enough that say, 95% of the population has to finance it, the purchase price is no longer really a consideration. Sure you might sign on a mortgage that ostensibly says you start out owing $300k or whatever, but in reality what you're signing on is an obligation to pay $2k/month for the next 30 years, or until you sell it, go broke and move out, etc. At 10% interest the $2k/mo doesn't have all that large of a price-artifact; it's about $200k. At 4% interest, the $2k/mo price-artifact is $375k. This is interesting and serves to illustrate that lowering the interest rate doesn't really "help" real-estate except to ensure that people aren't underwater in houses they paid too much for. In the non-financing world, a high interest rate means that you get a future-discount by saving your money and buying it later. And a low interest rate means that you get less of a future-discount by waiting to buy. When I say "a high interest rate" I'm talking about the real interest rate, interest minus inflation. The nominal interest rate doesn't matter save for some psychological effects. You can get that by having 10% interest and 4% inflation or 2% interest and 4% deflation, either way the real interest rate is 6%. But when the interest rate is 1% and inflation is 3% then the real interest rate is negative, -2% and you're a fool to save any money at all; everything else equal. This is how lowering the interest rate pulls future purchases into the present. Here's the kicker though: eventually there's less and less future purchases to pull from, and as a result the inflation has to get ever-more severe. As you start to approach spending all your money on debt service, you have less and less ability to take on new debt. And that means that the terms have to get substantially more favorable, and seemingly the only way to do that is to inflate enough to make the old debt less burdensome. Is that an underhanded form of theft? Probably, but it's the legal kind. The "hoarding" argument tends to fall apart if you consider all the things which a person HAS to buy; food, water, clothing, shelter, energy, transportation, etc. It's not as though you can not eat your vegetables because they're expensive for 20 years and then make up for that all at once. Can people make do with less? Sure. One person's "hoarding" is another person's ability to finance a house because the bank has enough savings to make the loan.

12y ago

waps 12y ago

> The idea that people won't spend money today because something may be cheaper in the future is bad? No. Think about what happens to any large organization during deflation. The counterintuitive part here is that every large organisation, including the government, is worth exactly nothing. Now you might think "But Obama sure has a nice little white house, lots of employees, ... that's gotta be worth something". That's true. Those are the assets. Then you have the liabilities. This includes loans that need to be repaid (plus interest), and any remaining capital is effectively loaned to the shareholders (though in practice this will, nearly always, be zero. The exceptions are Apple, Google and Facebook, but there's other major caveats there). Now what happens when you have 11% deflation (making an extreme example, nobody's expecting more than 1.1% at the moment). Before: * Assets(t-1) = What was produced (sold) - what was consumed (yes, even for the government) * Liabilities(t-1) = What was loaned * Worth(t-1) = Assets(t-1) + Liabilities(t-1) = 0 After 11% inflation: * Assets(t) = 0.9 * What was produced (sold) - 0.9 * what was consumed * <> Assets(t) = 0.9 * Assets(t-1) * Liabilities(t) = What was loaned ~= Liabilities(t-1) (Liabilities, especially loans, but many other instruments as well, are not affected by inflation) * Worth(t) = 0.9 * Assets(t-1) + Liabilities = Worth(t-1) - 0.1 * Liabilities(t-1) So there you have it : the organisation (say, the US government), effectively has to pay 10% of it's liabilities without getting anything in return for that. Zero liabilities disappear, nothing gets produced, it's literally money down a black hole. So there you have (way, way oversimplified) the problem. When you have deflation, every organisation that is balanced (assets + liabilities = zero), including the government, every large organisation, ... all their loans effectively increase by the deflation amount. So what would the effect be of 1% deflation : The US government loaned $17 trillion, so every 1% of deflation means raising tax income by 170 billion (or loaning it, worsening the problem quickly) without getting anything in return at all. Note that this is just the primary effect. The fact that every loan suddenly becomes more expensive to repay will have all sorts of indirect effects, like say a housing price crash (because banks can be pretty sure nobody will be able to repay even small loans with low interest rates). Deflation, effectively, is a tax on loans. It will very quickly destroy anyone and anything holding loans, which is to say everyone. Incidentally, fractional reserve banks have a capital buffer of 2%, which means they loan out 50 times more money than they have in capital, all of which will suddenly and simultaneously have problems getting repaid. What do you think will happen to your savings ? Cynics would say, because the effect this will have on governments, they will go to war. Especially the ones that don't control their own currencies. (in other words, a piece of advice : if inflation gets to 0%, you won't get interest on the bank anyway. Get your money and hide it under your mattress before everyone else does)

MCRed 12y ago

The way I look at it, high rates of inflation incentivize debt. If I can borrow at %4 a year (much more than the federal reserve charges, for instance) and then deploy that money productively, I can use the proceeds to pay down the debt with much cheaper money. So, if I thought the rate of return made sense, I could borrow dollars on my credit card, buy Apple, Google or Facebook stock, and then pay back the loan on the dividends or returns from the stocks appreciation. This isn't even necessarily irresponsible if, say, you bought Berkshire Hathaway, which has historically returned >%20. If it continues to do so, even a credit card rate of %13 will give you a %7 spread. This is a simple example of leverage and is effectively the same as trading stock on margin. But, I'm sure everyone reading this realizes the danger- Buffet may die, BRK might flatten, any of those tech companies might not return what I expect. That's the risk of leverage. So, in short, inflation incentivizes the risk of leverage. And that's exactly what we saw in the housing bubble where people with $60k in income were buying 4-5 $120k condos hoping to flip them in a few years.

msandford 12y ago
Yeah, leverage is probably one of the best/worst concepts to ever happen. It's why an airline goes bankrupt every few years, and the primary reason why banking crises happen. But leverage is also the thing that allows me to buy a house or a car on credit rather than outright with cash. Leverage is kind-of like guns. I want me to have it because I'm responsible and can handle it appropriately. But I'm not sure that anyone else should be allowed to have it. (I'm personally for arming people more rather than less, but it seems like it'll hit home for a lot of folks)
wbl 12y ago
And what was inflation over that time period? Answer: less than 5%, with the target of 2% getting meet a great deal of the time.