I've been trying to wrap my brain around the concept that we are in the middle of deflation while the government is printing money like crazy. I think I finally figured it out this morning.
Deflation and inflation are not about the overall amount of money in the economy, they are about the amount of money circulating in the economy. That is, what is the ratio of goods being sold to dollars being spent?
Say you've got $1000 of cash laying around you could spend on Christmas gifts and that you had the same amount last year. Last year you spent all of it. This year, concerned about the future, you hold back $200 of it and only spend $800 of it. That's deflationary. The stores still have the same number of gifts for sale, but now there are only $800 being spent on them. In order to get you to buy their products, they have to lower prices. The amount of money in the system hasn't changed, but the amount of money circulating has. Because of that, prices have fallen. Deflation.
In a recent post, Mish explained this in technical terms, showing this chart.
Deflation is a bad thing for people with debts. Their debts become larger as dollars become worth more. People like, oh, I don't know, the ones with $10,600,000,000,000 in debt. The same ones who tell us that the deficit can be ignored in the short run and are planning on borrowing another $1,000,000,000,000 and throwing it into a wood chipper. They don't like deflation at all. That's why they're screaming at the banks to lend money and consumers to spend it.
Deflation is a good thing for people with cash. All you have to do is sit on it and it becomes worth more. The more people decide that they can make money by not spending it, the less they will spend. The less they spend, the more prices fall. This also explains why businesses are laying people off. Why pay employees to make things that no one will buy when instead they can just sit on their cash and watch it grow?
When enough people are making the buy vs. hoard decision in favor of hoarding, you get deflation.
Did that help?
2 comments:
Right, that's called the velocity of money, but typically what happens even if you save the money is that the bank will lend it out to somebody to buy a car; or to a new business for inventory, plant equipment, etc. They can't quite lend the full dollar; they have to keep a certain portion for reserves. One thing the government can do to increase the velocity of money is reduce the reserve requirement.
The problem now is that banks have to make up reserves now that they got hammered with huge losses on sub-prime mortgages, companies going bankrupt and the like. So instead of lending the dollars out they are sitting on them. The real deflation is due to the countless billions of dollars that just evaporated when the stock market went down and property values went down.
Brian
Good point about the annihilation of all that wealth. Thanks!
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