Just Add Another Zero: Part II
In Part 1, we saw how deflation occurs naturally through the means of supply and demand.
- Over-production lead to a fall in prices (deflation in supply).
- Lack of consumers also lead to a fall in prices(deflation in demand).
For those unfamiliar with matter, deflation by “definition” is a decrease in the general price level of goods and services within the economy.
When deflation occurs, the dollar in your pocket can actually purchase goods in the market for cheap, but unfortunately that’s only half of it. When consumer good prices start to fall, that leads to profits dwindling as well as wages. This in turn, has a negative effect on your purchasing power.
There is something else that happens to your purchasing power during deflation.
If you took out a loan for $100,000 you would still be obligated to pay back that $100,000 (plus interest). Now that your purchasing power has gone down from deflation, it now takes a longer time to pay back any outstanding debt.
Same amount of debt, longer time to pay back? This is the result of a leaky-dollar.
That’s why it is advantageous to hold debt during inflation(when purchasing power rises) than deflation.
We all know that debt is the ability to borrow from your future self… Plus interest.
With the level of complexity debt adds to our society, it is often misconstrued by everyone. Debt is a multidimensional force that has cycles just like everything else in our world. Century-over-century, Empire-over-empire, All have faced the negative consequences of debt.
Debt is similar to waves of the ocean. A metaphor made famous by Irving Fisher’s work on deflation. When a boat is stuck in a storm, it tends to take on a little water, but every ounce of water added to the boat- increases the leverage of the existing water on the boat. If the boat can’t regulate the amount of water it is taking on, the boat forces will now work against you in the opposite direction, leading to a capsize (equilibrium). Debt operates in the same way especially during deflation.
“When Debt is not controlled threats rise quickly And we all know that a minor disease may lead to a major one. Just as a bad cold leads to pneumonia, so over-indebtedness leads to deflation.” — Irving Fisher
“Someone’s Poisoned The Waterhole!”
The reason why we are so concerned about debt when talking about deflation is because debt is often used to fund our assets. Assets are the fountain that springs the waters of prosperity amongst the people. The buildings, the land, machinery, labor(wages), all make up a crucial part of the economy that results in productivty and an overall increase of a nation’s wealth.
Without debt, there wouldn't be the expansion we have today, but over-funding the great feats of the 21st century is coming at a grave price. The over-debtness of nations around the world is leaving a bitter taste to it’s waters, and if not careful I reckon the whole fountain may be doomed for contamination.
Deflation Spiral Engaged?
Coronavirus dealt a serious blow as it left governments scrambling for ways to repair the damage done from this pandemic. It is reported that right now The US government debt makes up 50% of our GDP, and to repay this debt this is nearly impossible. So the next best thing is credit/debt management.
It’s the credit worthiness of a nation that should be the main concern. The inability to hold creditworthiness is what triggers a spiral-esque episode. Deflationist believe these spirals act like a poison pill that inevitably cripples a nation for an extend period of time.
Based on his catastrophic experience with the 1929 Crash, Irving Fisher’s work ‘The Debt Deflation theory of Great Depressions’ unravels what he believes occurs during these deflationary spiral.
Debt Levels become unsafe= Distress Selling= Reduction in Money Velocity= More Distress Selling.
The example we mentioned above with the boat caught a storm is exactly how this debt cycle or negative feedback loop feeds on itself.
When a country is unable to bring in revenue from… let’s say taxes, It faces tremendous scrutiny from bond holders holding their debt. When these bond holders no longer deem the countries balance sheet safe… it either forces them to:
- Defer buying the government debt until a later time, or
2. Selling the government debt completely.
Either scenario above leads the reduction of additional income to the government, A reduction of the REAL money leaves little room to repay outstanding debt obligations and expenses.
From this we can see that the means to obtain money to produce and income becomes scarce. As these big corporations aren’t receiving the revenue stream from consumers, they too run agrounds to pay whatever debt and expenses (wages). And just like that bob’s your uncle; the debt spiral begins to unravel.
Central Banks to the Rescue
Not all is lost when is comes to debt and deflation. As a matter of fact, this is why we created central banks in the first place.
To be able to come to the rescue, deploy monetary policy, and protect citizens from such financial crises.
In part III, we will discuss how the ideology of an independent organization controlling the money supply sounds perfect in principle. However the practicality of a monetary policy is proving to be the task of the century.