Friday, October 15, 2010

Twelve zeros

The DOW was down again today on news of weak retail sales and a low core inflation number and that has Ben Bernanke worried. He was out beating the drum again for more Quantitative Easing (that’s “printing money” for you English speakers). The Fed Chairman has his hair on fire over the idea that we will drop over the edge into a deflationary spiral. His determination to do something about it is making him less than popular with some people on Wall Street.

Most investors want to see a lot more free money since that will drive up the market but the ones that are sitting on trillions in cash waiting for the market to crash so they can buy for literally pennies on the dollar are steaming. They are calling Bernanke clueless and they are giving dire warnings about hyper-inflation. They are predicting runaway government since Congress doesn’t need to pay its bills with Bernanke printing money.

These critics (who are really just shills for people holding USDs) point to Bernanke’s admission that he is really in uncharted territory when it comes to printing this much money (he didn‘t put in such plain English). Of course the Weimar Republic of Germany comes to mind, they added 12 zeros to the Mark in just three years.

As scary as hyper-inflation sounds the opposite or deflation is the wealth destroyer for us peasants. Deflation works great for the wealthy, especially if they are prepared for it in advance by accumulating trillions in cash. If you have a mortgage or other debt, making your payments after a round of deflation has devastated the economy then becomes impossible and you find out the difference between being a peasant and a serf.

If the Fed is successful in creating inflation then the corporations holding that 3 trillion in cash will have no choice but to spend it and that could be good thing if it doesn’t get out of hand. That is of course the 64,000,000,000,000,000 dollar question (64 quadrillion dollar question) that’s the 64 thousand dollar question after you add 12 zeros for inflation. I heard a little guy down at the beer hall who says he knows who is to blame and he gave me this great brown shirt.  www.prairie2.com

11 comments:

Anonymous said...

"Deflation works great for the wealthy, especially if they are prepared for it in advance by accumulating trillions in cash. If you have a mortgage or other debt, making your payments after a round of deflation has devastated the economy then becomes impossible and you find out the difference between being a peasant and a serf."


I still don't understand why deflation is bad for those with debt. The amount of debt does not change under deflation, just like it does not change under inflation. The 10,000 you owe on a car you still owe under deflation. Its just that the 10k could buy more now than it could a year ago so in that sense its a greater debt when you compare what you could have bought with that debt. Inflation otoh will make the money you actually do have (iow not tied up in debt)today worth that much less tomorrow. So you are not only burdened by debt but also by the increase in costs of everyday goods that you cannot avoid buying. And none of this brings out the very real practice of wage deflation that has been carried out over the last two plus decades as well which has also further increased debt levels.

Inflation occurs due to sharp increases in the money supply (the fed printing more money out of thin air) which further devalues the dollar. This is a bad thing as it doesn't free up the credit market and causes people to need to borrow at an even greater rate as the money they do have does not go as far.

Deflation occurs naturally and did for over 150 years in the US from the late 1700's to the early 1900's as greater efficiency is attained in production and the price of production cost drops substantially coupled with an increase in consumer demand and ultimately even greater profitability.

That is unless manipulated to do the opposite though inflationary monetary policy being pushed by the fed to prevent a natural and well deserved deflation that Americans should be seeing due to the record worker efficiency increases over the last couple decades and the outsourcing of manufacturing to 3rd world slave labor.

I guess I should feel like a chump this month making the final payment on my mortgage after years of scrimping and saving and extra payments which allowed me to payoff a 30 year mortgage in 10 but somehow I don't.

prairie2 said...

deflation and inflation refer to the amount of money in circulation and not to prices. Prices can be driven up or down by the money supply as it screws up the economy. If you owe money and the amount of money you receive in income goes down due to deflation you will effectively be paying back more than you borrowed. With inflation you pay back less than you borrowed. This assumes that in either case that you don't lose your job or your business entirely.

Anonymous said...

I hate to monopolize your time but you are losing me on your description of inflation and deflation on a couple of parts. I really would like to have a better understanding so perhaps if you could provide a hypothetical example of inflation and deflation with numbers resulting in what you described above it would help clarify it for me.

For example, how does the amount of money you are receiving go down due to deflation? I can see a income source like social security being affected but how does that affect the average working stiff? Conversely how do you pay back less on a debt with a fixed rate during a period of inflation, once again excluding fixed income sources that may be pegged to inflation/deflation levels? It would seem that the actual amount of the debt is constant, the only thing in flux is what the dollar can currently buy which for several generations has been going steadily down.

On another tangent I have also read that we are already going through a period of deflation of sorts because despite the record amount of money being put into circulation by the fed the effects of deflation are negating the runaway inflation we should be seeing. In essence the markets are maintaining current price levels despite the dollar devaluation which would normally cause a sharp rise in the cost of living.

prairie2 said...

Inflation/deflation are the extremes of supply and demand.

deflation reduces the amount of money in circulation until it becomes impossible to sell enough goods and services at the current price to conduct business and prices begin to fall as business is desperate to raise money. Wages are driven down by soaring unemployment as business tries to cut costs. However all things are not equal and monopolies don't always behave by text book rules. We have been in a deflationary period due to all the debt defaults and the Fed's efforts to counteract this have fallen short because the fat cats have taken 3 trillion of the free Fed money and are sitting on it (it doesn't cost them anything)they are waiting for deflation so they can buy up assets for pennies on the dollar. This is a stupid way to run an economy unless you are an aspiring feudal lord.

Anonymous said...

Hello Prairie2:

It seems you may have a number of us nonplussed with your comments on deflation. You alluded to items that might have seemed natural conclusions, but were less than obvious to those less keyed into economics (even though I take an interest in the subject).

Could you please describe in one of your excellent articles what the effects are to the common person of deflation, and how we might best guard against it, what the impact will be on someone with debt/ with no dept and those with/without a mortgage, and if someone has just a few $K what they should do with it, particularly if they don't think their job is going to last much longer?

*

Always interested - very - in your reports on the Mike Malloy show, thank you for providing such well informed, if often a bit cryptic, insights into what the heck is going on financially.

-Glenn (UK)

prairie2 said...

I'll see what I can do...

Anonymous said...

I'd like to second the request for a more detailed explanation of inflation and deflation and the impact positive or negative on the average person. The popular meme in the media is that deflation is the boogeyman and inflation is what will keep our economy going. But common sense is pointing me in the other direction so I think it would be helpful to a lot of us armchair economists trying to grasp the financial world around us.

prairie2 said...

Inflation eases the burden on long term debt as new cash comes in larger amounts so in effect your debt is discounted, not that it really is a good thing. Deflation makes your old cash (money in the bank) go further but quickly translates into lower income so acquiring new cash is harder. Then the debt becomes more difficult to pay. Even if you are well prepared (lots of cash) the risk is high. Gold won't protect you from deflation.

Anonymous said...

I guess what I don't agree with is that the trillions that the fed prints out and loans to the banks and financial institutions at zero percent interest trickles back down to those of us who work for our wages and results in us having more money. The financial system has more money but doesn't mean the average people get it and the more money that gets printed out of thin air just devalues all of the existing currency...hence causing inflation. I don't consider a boost in the ability to take out business or personal loans (as if that was even happening) as more money for me...just more debt. And I don't see businesses that borrow large amounts of money as using that to then pay workers more than they did previously. If anything over the last decades we have seen take backs and pay cuts and many new jobs paying less than the old ones. That is assuming they were not outsourced all together.

In short I am not convinced inflation via the practice of printing fictitious money coupled with the practice of fractional reserve lending (when up to 10 times the amounts deposited in a bank can be loaned out/invested by them and perhaps even more these days) increases working peoples wealth.

When the Fed introduces a trillion into the economy it really is 10 trillion or more. So its easy to see how the banks with a 100 dollar deposit can then make 50 dollars (or 5% of 1000 dollars) of profit on it and hand you 1 dollar back as interest. But in a very real way that 100 dollars you have lent a bank via your savings has devalued your money further than the 1 dollar you receive back as *payment* a year later.

I think the disconnect occurs for me from where the money goes after the fed prints it. When you think about it the banks had to work really hard to end up losing their shirts when they play with house rules on their side. Creating a moratorium on the printing of imaginary money would mean what exactly? That banks would have less zero percent interest money to hoard? And frankly even if they were passing it out like candy on Halloween all it would mean is that a lot more people would be taking on a lot more debt and we would likely have a lot more defaulting on the loans in the near future. None of this represents income for anyone other than the banks and financial institutions. I would argue that the reason we have seen so many too big to fails in the financial industry is because we have essentially given them an unlimited supply of low/no interest money fueling inflation and risky speculation/investing. And when we top that off with a bailout they even win when they lose. And everyday our own dollars become worth less. Its a system that is bound to crash because there is no balance. Just a continuation of ever increasing pressure on the common people to do more with less while the rich do less with more.

Anonymous said...

I think the disconnect occurs for me from where the money goes after the fed prints it. When you think about it the banks had to work really hard to end up losing their shirts when they play with house rules on their side. Creating a moratorium on the printing of imaginary money would mean what exactly? That banks would have less zero percent interest money to hoard? And frankly even if they were passing it out like candy on Halloween all it would mean is that a lot more people would be taking on a lot more debt and we would likely have a lot more defaulting on the loans in the near future. None of this represents income for anyone other than the banks and financial institutions. I would argue that the reason we have seen so many too big to fails in the financial industry is because we have essentially given them an unlimited supply of low/no interest money fueling inflation and risky speculation/investing. And when we top that off with a bailout they even win when they lose. And everyday our own dollars become worth less. Its a system that is bound to crash because there is no balance. Just a continuation of ever increasing pressure on the common people to do more with less while the rich do less with more.

prairie2 said...

QE is different than lending in that they are buying bonds from anybody who wants to sell and not just giving the money to banks. The idea being that if they can convince bond holders that there will be inflation from QE that they have incentive to invest in something that makes more money than low interest bonds. This can work but it's dangerous. Real reform would be better than tinkering with monetary policy.