Why Worry About Low Inflation?

[scandal 951]

http://www.theatlantic.com/business/archive/2010/10/why-worry-about-low-inflation/64673/

Why Worry About Low Inflation?

Oct 16 2010, 10:00 AM ET 23

On Friday, Federal Reserve Chairman Ben Bernanke all but promised that another round of monetary expansion is imminent. He emphasized that to take such a drastic measure, both aspects of the Fed's mandate would have to be invoked. Obviously unemployment is too high, and lately inflation has also been lower than U.S. central bankers would prefer. It's easy to understand why high unemployment is awful, but what's so bad about low inflation?

In fact, a 1% inflation rate isn't necessarily worse than a 2% inflation rate -- it's more about expectations. Since the market understands that the Fed targets an inflation rate of around 2%, when it sinks well below that, as it has recently, then the market may begin to change its expectation of the Fed's ability and desire to hit that target. This risk becomes even greater when interest rates are already near zero, as the Fed would have to rely on alternative means to raise prices. So the market's expectation could potentially lead to deflation -- particularly in a time when the economy is very slow and firms might already be cutting prices to conjure up more consumer demand.

So the problem is more one of instability. The fear is that deflation could eventually result if inflation is allowed to decline below its target. Deflation is a particularly dangerous problem, because central banks don't have strong tools to fight a deflationary spiral.

But what's so bad about deflation? It can hurt an economy in several ways.

First, wages are sticky in general, but even stickier when needing to move downward. With inflation, it's pretty easy for employers to tell workers that their nominal wages are increasing. No arguments there. But it's much messier to force pay cuts. Employee morale suffers and unions often won't allow them. And Congress would probably never cut the minimum wage or Social Security benefits. So employers and lawmakers feel pressure to leave wages alone, as prices -- and consequently revenue -- decline. That leaves less money for expansion and additional hiring, which are both very desirable when unemployment is high and the economy is slow.

Next, deflation discourages spending. After all, if prices are declining, it's logical to wait a little while before making purchases you have planned. Until deflation ends, it's best to spend as little as possible, as the money you save will be worth more and more as deflation continues. Since spending is essential to economic recovery, this would also be a major problem right now.

Finally, this point extends to very large purchases like cars and homes that generally depend on loans. You don't want to be stuck with debt that will be harder to pay if your wages have to be cut due to deflation. Moreover, the value of those big purchases would decline with more deflation. The housing market is already miserable, and deflation would make it even worse.

If the Fed does fail to stabilize prices and prevent their further decline, then deflation could begin. That would make the recovery even slower, and possibly act as the catalyst to a double-dip. So even though it is not yet clear that the U.S. is on a path to deflation, you can begin to understand why the Fed might be concerned about even the vague possibility.

[Obama 2012 1,714]

deflation is a very good thing overall actually, except as mentioned for banks.

Part of the problem with deflation as the article mentions, is no one wants to move with it. If you want a vital and stable economy, wages & prices need to really follow each other all over the place. You can't have high wages when everything is dirt cheap and you can't have low wages when everything is priced high. You need to find a happy median, which is near impossible with all of the politics involved.

Not everyone looks at the 'big picture.' You have someone on these boards like BY who will argue that it's great that houses in Australia cost double or triple the price of homes here... that bread @ $5 a loaf in Aussie land is terrific. When you look at it though, pay attention to wages there. Sure minimum wage might be $13 an hour, but if you look at the fact that everything costs a helluva lot more, then that money is really the exact same value here as it is there.

An economy has to be balanced and your income to debt ration needs to be small as well. Of course we have ignored this on a Federal level as well as a personal level for a long time now and it's what has helped to put us into the bind we are now.

One of the best things that could happen to this economy right now is for it to actually bottom out and the Fed needs to stop just keeping it afloat. That or the next bubble that bursts will be much more severe than the current one and everyone will be running around like chickens with their heads cut off once again....

[Mr. Big Dog 10,747]

Bring healthy inflation. A lower value dollar will make US exports more attractive around the world and at the same time make imports less attractive to the US. More production here and less imports. That's good for jobs around here. Housing prices will appreciate once more and an ever larger part of under-water mortgages will be a thing of the past. A properly functioning housing sector will spur construction once more - more jobs there. Yes, trips overseas will become more expensive as the dollar buys less foreign currency. The flip side of that, though, is that tourism to the US will be quite attractive due to the increased purchase power that EUR, Yen and Pound Sterling earners will have around here. Bring them tourists and let's benefit from their visit - both on jobs and sales tax collections.

I can't see many downsides to ensuring that we maintain inflation rates at or slightly above target.

[scandal 951]

Bring healthy inflation. A lower value dollar

I can't see many downsides to ensuring that we maintain inflation rates at or slightly above target.

Umm... inflation <> a devalued dollar. They're not unrelated concepts, obviously hyperinflation will adversely affect exchange rates. But they're not directly correlated either. Inflation is a measure of the purchasing power of the currency in the domestic economy: how much stuff consumers can buy with their money. The exchange rate is the value foreigners (and investors) put on a currency's purchasing power in some OTHER economy. A devalued currency is one which monetary authorities actively pressure that exchange rate to cheapen the currency abroad. Inflation is a function of the perceptions of consumers and businesses in the domestic economy, whereas exchange rates fluctuates with the supply and demand of the FX marketplace, with central banks being major participants in that market.

The Fed is shooting for inflation "at target". Not above, and not below. Inflation is a bad thing: it eats away at the savings of Americans, ruins long term planning for retirement and college savings. Deflation is bad too, as noted in the quoted article. A goldilocks scenario of very modest and controlled inflation, 2%, has been the Fed's target for years now.

[SuperDuper! 230]

'Scuse Scandal for asking a naive question. If you actually have ever OWNED a business and actually contributed to the productive economy instead of just taking from it, you KNOW that DEFLATION prevents you from RAISING prices and thus profits, and things just STAGNATE. Word.

[scandal 951]

'Scuse Scandal for asking a naive question. If you actually have ever OWNED a business and actually contributed to the productive economy instead of just taking from it, you KNOW that DEFLATION prevents you from RAISING prices and thus profits, and things just STAGNATE. Word.

How do you know what I have or have not ever done in the productive economy? You don't know thing 1 about me. I sleep well with my contributions, but thanks for taking an interest.

Oh, and what pray tell is your "naive question". I don't see one of these '?' anywhere in the above. Just a soapbox and a rant.

[lostinblue 1,989]

http://my.opera.com/weirdling/blog/show.dml/32853

Inflation (monetary) Is Not Inflation (price)

Wednesday, 28. September 2005, 18:44:31

Most people aren't aware that there are two common types of inflation. One, the classic definition of inflation, is monetary inflation. This simply means that the money supply is growing. The money supply encompasses anything that might be convertible to cash at some point. So, a new fractional loan, where the amount of real money backing the loan is less than the amount of the loan, is an increase in the money supply so inherently inflational.

The other type of inflation is price inflation, which is commonly used as a proxy for money supply inflation because, due to the price curve, they obviously go hand in hand at most times. But not always. Let me explain.

First off, fractional banking. Our banking system hasn't been on a real gold standard for a very long time. We issue money when the treasury says so. We issue debt through the Federal Reserve Bank, which is a 'lender of last resort', meaning that the fed lends money when money isn't available elsewhere. The idea is that when business runs out of money to do a given thing, they can get it from the fed and thus avoid having to simply forego that thing for lack of capital. Theoretically, this should lead to a more stable economy and more jobs for everyone. What it actually does is cause inefficiency and a bubble economy.

See, that money the fed loans out like a firehose goes into banks. These banks are allowed to loan, right now, over 100 times as much assets as they have. This means that every dollar they borrow from the fed they can loan at least $100. In case you were wondering where easy credit came from, there it is. This is called 'fractional banking' and is generally considered to be a good idea if kept low enough to not endanger the financial health of the bank. In the case of the current system, the banks do not have to worry because they can always borrow to cover bad loans.

Now, it is argued that this is not inherently inflationary because the loans go to buy goods and services that have value so the value of the goods and services offset the value of the money created out of thin air. This is true, to a point, of price inflation, so long as the scheme does not get out of hand. If the money is actually going to necessary things and if the rate of monetary expansion does not exceed the rate of production expansion, you're ok. In other words, as long as the total number of dollars does not grow faster than the total number of things you can buy with dollars, we are ok.

It has also been argued, by me, even, when younger and dumber, that a little inflation is good because it drives investment by reducing the value of liquid assets and thus driving capital investment. I, of course, no longer hold this view.

Both of those arguments confuse price inflation with money inflation. It is easily possible for the money supply to inflate at a faster rate in real terms than the production of the economy and still not see serious price inflation. This is happening now to some extent.

Here is how it happened. The fed lowered rates during the run up to the dot-com explosion. People took loans out on their houses at the low rates and bought stuff, stuff they would have done without or bought out of income. They took their income and played the stock market. This is part of why the market went on such a tear.

This is, basically, the stock market sopping up the excess credit. Now, due to wage increases and improvements in efficiency, prices actually went down during this time. So, we had monetary inflation and price deflation for some periods of time.

Then the bears set in and the market crashed. If you were wondering where all the money came from that was lost, it came out of income displaced by debt. This means that people now have greater debt without the compensating assets. This is value destruction. With money quite scarce, prices fell. So, we had price deflation again. But, unlike a true recovery, in which money would flow out of the stock market into a revitalized bond market based on higher interest rates, the fed lowered rates, so, once again, money flowed out of equity in houses into another bubble.

This time, it was the houses themselves. People are bidding houses to silly prices using loans written on fed credit. Once again, except for housing, energy, food and insurance, inflation isn't really all that bad, but monetary inflation is off the charts. All that money is now finding its way into seriously overpriced real-estate. We're seeing double-digit price inflation in real-estate with no double digit increase in income. We're seeing housing stocks trade ridiculously high.

And, then, two hurricanes hit, raising the spectre of direct aid to this market segment. This means more money into an already tight real-estate market. Now, conventional wisdom says that what goes up must come down, or, to use an economist's catch phrase, everything regresses to the mean. Those house prices have to come down at some point because even the most creative loan can't have a payment larger than the income of the borrower.

In some areas, the lender is counting on the increase in value as part of the payment on the loan, thus creating partial-payment mortgages that will become serious problems if the market even stops going up.

What kind of serious problems? Well, when a market crashes, it takes with it price inflation, meaning you can often buy stuff for pennies on the dollar, but it does not necessarily remove monetary inflation, meaning that all those outstanding loans are still due. Well, only an idiot would still stay in a home with a million dollar mortgage that is now worth $200,000, particularly if he just got laid off because his company is feeling the crunch of nobody having any money.

What he will do is walk away from the house. Now, the bank has to sell that house in order to recoup cash so that it does not become insolvent. It ends up unloading it at 30% below its market value, or about $160,000. It must now raise rates to cover its losses. This will raise the price of capital, meaning bonds will go up, meaning that companies will have to charge more to cover the increased price of their carrying balances. In the short term, the market would be badly mauled. In the long term, we'd all be better off.

Is this going to happen? No. The fed WILL step in and loan more money to keep bonds low. It will bail out banks that have written bad debt. It will prop up the housing market and the stock market with all its might. Foreign investors will continue to pull out of the US. Asian markets will continue to sop up dollars until their own currency begins debasement or must be allowed to float free of the dollar. The dollar will continue to decrease on the international market, causing prices to creep up in the US. Inefficient corporations will still have access to bridge loans to keep up their barely legal activities. Oversight boards in the SEC will still act as if they reduce fraud when fraud is the only way to make a buck.

How long can this go on? As long as the Asian countries let it. When they stop accepting dollars but start demanding some other currency or gold, we're screwed. That's when the real inflation sets in. Even worse would be for those foreign exchange banks to start selling off all the dollars they have. They'd turn the US into an essential island overnight and drive massive price inflation as so much of our economy is based on imports.

They have good reasons to not do this, being as how it would ruin their economies as badly, if not worse, than it ruins ours. In a word, there is no way out of this.

[Mr. Big Dog 10,747]

Inflation is a bad thing: it eats away at the savings of Americans.

That would be true if Americans had savings. The sad truth is that scores of Americans are in net debt. They'd actually benefit from inflation - their debt will effectively decrease. And while it is true that inflation does not necessarily mean a devalued dollar, the inflation that the Fed is spurring does exactly that. They print more dollars. Hence, the dollar is being diluted. It's like a stock split - suddenly there are more shares but the larger count of shares still represent the same overall value of the company that issued them - i.e. each share is less worth than it was prior to the split. That's what's going on - a deliberate devaluation of the dollar.

[Obama 2012 1,714]

That would be true if Americans had savings. The sad truth is that scores of Americans are in net debt. They'd actually benefit from inflation - their debt will effectively decrease. And while it is true that inflation does not necessarily mean a devalued dollar, the inflation that the Fed is spurring does exactly that. They print more dollars. Hence, the dollar is being diluted. It's like a stock split - suddenly there are more shares but the larger count of shares still represent the same overall value of the company that issued them - i.e. each share is less worth than it was prior to the split. That's what's going on - a deliberate devaluation of the dollar.

a deliberate way to turn the US into a 2nd-world nation as well.

[Mr. Big Dog 10,747]

a deliberate way to turn the US into a 2nd-world nation as well.

Or a deliberate way to stave off a massive US default on it's debt - both public and private.

[Obama 2012 1,714]

Or a deliberate way to stave off a massive US default on it's debt - both public and private.

The question is who really benefits though.

The people will suffer a lot more under mass inflation and the banks like the FED and its investors will continue to get wealthier. Nothing is ever about what's "good" for the American people and it hasn't been for the past 70+ years. It's always been about the FED making money and having huge payouts to those invested in it (a very large amount of foreign investors in it as well).

Our system has been scientifically played with for awhile now. Every incident that has happened has been by design and those at the top knew exactly what would happen in the past decade. One truth never changes and that's those invested keep making money while others suffer.

You ever dare to question anything, compare the past 3 administrations and pay attention to who the top advisors are who are the same, or who have had important rolls that are tied to the FED... It's all truly interesting.

People spend so much time blaming Wal-Mart for everything wrong with this country, when it's been staring at them on the street corners of every major city in this country for a long time now.