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User Info	Why we will experience deflation; entered at 2007-12-02 01:00:59
Shrpblnd Posts: 1202 Registered: 2007-08-06 Los Angeles, CA	In evaluating whether the economy moves into a hyper-inflation or a deflation condition, the key is determining whether the unsustainable debt load is private debt or public debt. In Germany public debt became was no longer serviceable, because the state was forced to pay enormous war reparations. African countries with hyperinflation also suffer from overwhelming government debt. In Japan massive private debt, fueled by a real estate bubble bursting, led to deflation. In the US during the Great Depression, private debt, fueled by a stock market collapse, led to deflation. While the US government does have a large national debt, it is still manageable, at least over the next decade or so. As a percentage of GDP, our national debt is not at record levels. However, private debt, largely fueled by the housing bubble, is at astronomical levels that are no longer manageable. When the credit market collapses, we will indeed experience deflation, just like Japan. Consider the reasons cited for deflation in Japan and notice how they all currently apply to the US: • Fallen asset prices: There was a rather large price bubble in both equities and real estate in Japan in the 1980s (peaking in late 1989). When assets decrease in value, the money supply shrinks, which is deflationary. • Insolvent banks: Banks with a larger percentage of their loans which are "non-performing", that is to say, they are not receiving payments on them, but have not yet written them off, cannot lend more money; they must increase their cash reserves to cover the bad loans. • Insolvent companies: Banks lent to companies and individuals that invested in real estate. When real estate values dropped, these loans could not be paid. The banks could try to reposses, but this wouldn't pay off the loan. Banks have delayed that decision, hoping asset prices would improve. These delays were allowed by national banking regulators. Some banks make even more loans to these companies that are used to service the debt they already have. This continuing process is known as maintaining an "unrealized loss", and until the assets are completely revalued and/or sold off (and the loss realized). • Imported deflation: Japan imports Chinese and other countries' inexpensive consumable goods, due to lower wages and fast growth in those countries. Thus, prices of imported products are decreasing. Domestic producers must match these prices in order to remain competitive. True there are some key differences between the Japanese economy and US. Japan was a nation of savers, and we are a nation of consumers. That will likely cause the deflation to be felt even more sharply here. The US population is younger, which should help us recover from a deflation faster. The US economy is more diversified, which may also prove helpful. Public money creation (by the Fed and the Treasury) is very small relative to private banks and market money creation. Right now less than 5% of money supply is made out of central bank money. Credit has become a substitute for money. The actual creation of credit isn’t limited to the commercial banks, but includes all sorts of institutions that are not even affiliated with the Fed. Investment banks, such as Goldman Sacks, Morgan Stanley, and Merrill Lynch are not members of the Fed, and have created massive amounts of credit through their exotic derivatives. It is impossible to replace private money by public money overnight, and generally private agents resent this as spoilation. The problem we face currently is that the ratio of public/private money has never been so small. Once a credit collapse in the trillions of dollars begins, the Treasury and the Fed will be powerless to stop it. Last modified: 2007-12-02 01:14:37 by shrpblnd