A Visual Guide to Deflation

wow! A great piece of didactics, well done – thanx a lot. Peter

What nonsense. People hoard money, while things get cheaper…to what end? The vast majority of people see that they have money and spend it when things get cheaper, relative to as little as 2 days ago (random number, but it’s a very short period since most humans have an increasingly short memory). The idea that the economy is composed of a vast number of people who save aggressively and even understand the concept of purchasing power, is a myth.

Great way to help people understand this stuff in an easy way.

Wait… What about the ability for the federal government to cut taxes. This also causes more money to be put into the economy. With the amount of money that the government wants to spend we can eliminate all income tax for more than a year. This allows money in the economy and doesn’t create inflated state budgets.

There is no promise that the federal government will continue to fund these over inflated budgets. People become dependent on these new budgets.. Schools, Police, Firefighters, Services all will be left in the lurch. If you cut the programs you incite protest. This causes the state governments to raise taxes. This hurts twice. Double dip.

You can kill a growing economy by taxing it’s people and businesses. Don’t forget even states need to be competitive. Help grow the economy buy doing more with less. Cut taxes, don’t increase spending. The effect is still a deficit, but the results are different.

Very informative. Really put it into perspective for me.

“The vast majority of people see that they have money and spend it when things get cheaper, relative to as little as 2 days ago … The idea that the economy is composed of a vast number of people who save aggressively and even understand the concept of purchasing power, is a myth.”

Brilliant. So all those people I know who waited several months for HDTV prices to decline must have been mythical, like unicorns.

Complete and utter horseshit. Nothing but propaganda. Realize this, lambs: Guv’ment generates the money necessary for this “massive spending” through one of three ways -
1) taxes
2) foreign investment (through US Bonds)
3) the printing presses

And if you think it’s morally and ethically correct for the Fed to magically generate a few trillion dollars at the flip of a switch, consider, for a moment, how this very same government would respond to your circulating counterfeit personally-generated $100 bills as part of your own efforts to “stimulate” the ailing economy.

You are presenting the Keynesian view as if it were the only view, yet hundreds of economists disagree with Keynes’ analysis. Your guide would be more valuable if it were less one-sided.

mint.com believes the very same foolish economists who got us into the problems we are having now and are doing the exact worse thing to prolong and deepen the pain. mises.org for education

Holy Propaganda batman! What kind of nonsense is this?

One question…if you have thousands of dollars in credit card debt, do you go out and max another card to pay off the first?

Very good comic interpretation of deflation. Unfortunately, deflation will never be the counterpart to inflation, since it’s effects are minor compare to inflation’s effects.

Actually, there is a lot of evidence that Keynesian policies (which dominate the economics in both U.S. political parties) did not “work” during the great depression, and are unlikely to work now–major flaw being the perspective on savings–and that inflation is on the way regardless since money supply is bound to WAY outpace GDP.

The answer is to stop injecting manipulations/regulations (I know this is unpopular to say) into the market willy nilly. Both dot com and housing bubbles were caused by deceptive overvaluation. The real answer is that stability only occurs when the market is close to “fair value” and neither over- nor under-valued.

I admire the creativity, but the conclusions are fundamentally flawed based on the information as presented.

First, the never-ending spiral does eventually decelerate and stop when an economic equilibrium is reached. That equilibrium is when prices have reached natural minimums that people are willing to spend incremental amounts of their income of goods of equivalent incremental value. That’s a basic microeconomic principle driven by basic needs of food, clothing and shelter. It bears mentioning specifically towards this point that the historical averages for home prices are 3x annual income or 30% of gross monthly income over the long term. The total prices increased on most places to at least double that and in some places more.

This leads me to my second point, which is that the actual rate of inflation has been understated for years. Since the Consumer Price Index only looks at a basket of goods, the underlying primary (material inputs to manufacturing)and ancillary costs (housing costs that need to be supported by wages). Those ancillary costs which should’ve been included in CPI as a function of the total cost of a home were instead masked as the *MONTHLY* expense of such housing. This mask was, of course, loans with ridiculous terms and/or allowed proportions of income which in some cases rose above 80% and with no down payment as a bank risk hedge. Add to that all of the side bets in the form of CDOs which many pension and investment funds blindly poured their money into, and it was a disaster. In any case, central banks should’ve taken action by greatly increasing interest rates to quell the demand for housing that drove up prices. They didn’t because they were attached to a deceptive CPI number instead.

Leading back to your conclusion that we need to reinflate, I assert that WE SHOULD NOT ENCOURAGE INFLATION given that your argument above glosses over hidden inflation. In fact, it could very well lead to something you left off your diagram, and that’s stagflation. When prices are reinflating during an economic downturn, companies freeze salaries and/or cut jobs to cut costs, putting further pressure while prices are still inflating and creating a psychology of spending avoidance in the average consumer. Japan for the last 15 years and the US in the 1970s recession have proven this. Your diagram accounts for none of this phenomenon. Spending government money that doesn’t exist as a valuation of a good or service produced means that money has to be printed, and this increased money supply in the free market can only lead to inflation at a time when many jobs were ill-suited (i.e. 20% of jobs in US as finance) to anything but a bubble economy. Only deflation can save us from this phenomenon, and it needs to run its course.

If you’re trying to justify this stimulus or spending government money to get us out of that mess, remember that the money either gets created to represent something of value. If the only thing of value is the paper it’s printed on, then that’s exactly why inflation will happen. Just don’t confuse dollar amounts with dollar value, because that will be the final trap – reduce interest rates which results in inflation of imported goods, or increase interest rates which results in increased taxes to service national debt costs.

Prices have to be real. Housing prices got so high that people were astonished at how expensive they were. When housing prices drop enough where the price is considered realistic, then people will buy. What is “real” mean? What the majority of people consider to be not too expensive.

As far as businesses suffering because of inflation, one thing they could do is stop paying their CEO’s millions of dollars a year.

This website seems to be a supporter of Keynesian Economics. (I wish they would espouse Milton Friedman instead). The idea is that a little inflation is a good thing because it stimulates people to spend now rather than be frugal and save. Guess what, we don’t want to be manipulated by the government. We want the freedom to work hard and spend or save our money as we see fit. That takes a stable currency.

I don’t know much about economy, but I wonder how deflation can pose a major problem.
The obvious remedy seems to be for the government to print more dollars, then use these to buy gold from other countries.
The treasury grows, the dollar is worth less, other countries have more incentive to import your goods – and you don’t need to meddle with your internal free market or make investments of doubtful value.
(There’s probably some reason why this won’t work. I wonder what it is…)

The reason the government is terrified of deflation is that it will make the middle class more irrational than they already are. Economics is based on assuming people will act rationally. It is impossible to predict and influence the actions of an irrational society. I think our government is worried about causing the evaparoation of an entire class of people- the middle class that elected them.

I enjoyed this depiction of deflation as a learning tool not as a concrete expample of what is going on today (though we may be close). Defining the implication of Deflation needs to be simplified in order to help readers grasp the consequences of such a problem. Unfortunately, the entire population of America may not be able to understand as quickly. A deflationary spiral is bad because the American people could not change their beliefs fast enough to cope with it rationally. If people get paycuts they will not be savvy enough to ask “have prices gone down further?” Will managers and CEO’s understand lower prices and sale revenues? or will they think the solution is layoff’s before reducing pay across the board?

I like that discussion that formed over the 70K house because that is relevant today. I too am too timid to find out how low prices would go in an actual deflationary spiral since I can’t predict when we would reach an equilibrium. When the mortgage backed securities deregulation house of cards crumbled in 2008, prices reset dramatically and dropped over 8 months evaporating over 6 trillion dollars of real estate wealth people “thought they had”. How much wealth do we “think we have” tied up in our salary number, price of gasoline, and how 3 bags of groceries cost? Do you remember when a cart full of groceries cost less than $100? I don’t. Now if you shop a co-op two bags of graceries can be over $100. This mint article does a great job of adding images to our perspective. Writing about prices of groceries doesn’t have the impact that the cash register and the cashier does when they look at you like “pay up. you picked out the food now pay for it before you take it out of the store” People feel different when the economy hits them in their wallet. People hate to have to put groceries back that they can’t afford. If consumer prices and incomes don’t fall with the exact same timing pressure and embarrasment could erupt into something more irrational.

Which leads me back to my growing concern over the middle class. I thought I grew up middle class. I think I’m going to be middle class. But this recession and conversations about deflation make me wonder if there will be a middle class left when I graduate school and begin working full time (again). The buying power of $50,000 today is different the the buying power of $50,000 in 1980. The government puts an identity on lower income and middle class income with brackets. This article on deflation made me question why we did that. We should have been looking at our buying power. They tried to do that with the CPI. but that is a crock if you look what products are still on there from 30 years ago. I gaurentee the middle class family of four feels differently about the CPI since there is not 4 cell phones and three computers and internet service is not on the CPI.

This is completely retarded. The author (yet another idiot Keynesian) told you that the government should pump money into the economy to stimulate it, increasing the debt, yet before that he said “For better or worse, the US has a credit based economy…”. He should have said “.. the US has a DEBT based economy, because every dollar printed means a dollar+interest in debt to the Federal Reserve. Put those two together, and the author implies that we need to COMBAT THE DEBT WITH MORE DEBT.

Deflation – or a contracting economy/money supply – is a natural consequence to the inflation – or expanding economy/money supply – caused by fractional reserve banking. You cannot expand an economy forever. Eventually the dollar will be worthless, logically, if you kept printing more and more of them.

These would be problems of spiraling deflation, but considering its so easy to stop with fiscal and monetary policy, deflation isn’t really a problem on its own; the federal reserve would just increase the money supply by buying securities.

Nevertheless, deflation is extremely rare and only becomes a problem if you’re already in a deep recession. And in that situation, it’s the recession that’s the root problem, not the deflation.

What is this article about ? US government has injected so much money, and it’s debt is so big that you can forget about deflation forever.

Fundamentally flawed in the conclusion that massive government spending is the answer.

A Government cannot create wealth. It can only spend what it takes from its people. That creates an entirely different–yet equally dangerous vicious cycle. People stop spending money because they don’t have any–because the Government took it all to spend itself.

Across the board tax cuts are the only answer. Tax cuts on the rich, tax cuts on the poor, tax cuts on corporations, tax cuts on small businesses. Tax cuts for ALL is the only way to truly keep the wealth in the hands of the people and encourage spending.

When will people learn: Republicans want to spend your money one way; Democrats want to spend your money another way. Better idea: You spend your money YOUR way!

This just reminds me of how pitiful the human race is. Without our greed and politics, none of this would even be necessary.

2 things to add. The first is on the front page of http://www.zmag.org

a VERY ambitious overhaul of what we can call “really existing capitalism”.

the second point is that giving private banks more incentives to lend will not necessarily solve the problem in the U.S. This has been the strategy thus far, and I think it is deeply flawed on moral grounds, (i.e. continuing to extend social power to a few on the top, who then bless the rest of us with their magic money power trickling down) but it is also flawed on practical grounds.

If there were a place to invest that was employing lots of people at high wages, and also producing growth and profits, the banks wouldn’t have had the subprime problem to begin with. They simply could have written it all down, and it would have been partly offset in the short term by the new investment sectors, and the ANTICIPATION of future growth of the new investment sectors.

The fact of the matter is the economy is a big social bond between human beings. And the second fact of the matter is that for the vast majority of working people in the U.S., we make less, have fewer benefits, etc.. this meant higher profit margins for a very long time as more could be drained out of a cheapening labor force. But at the same time, the american consumer’s role was his or her consumption of products and services. This stand off, with the many having too little power, is the root of what makes a country a 3rd world country, and it is going to be the reason equity markets go up in the short term–but won’t stand the test of the next year.

Pau Garcia: Right on. We should not accept so called “trade” when it boils down to leveraging one group of people against each other…so that they are forced to give up more in order to survive. That is a thug economy, and is should be done away with.

All jobs, even the so called “good jobs” of manufacturing sector in the U.S. from the 1930s until the 1980s, were not good out of task or leverage by individual workers. After all, they are relatively low skilled jobs. They were POLITICALLY made to be wealth producing jobs, where workers took home fatter checks, and spent more money on each other.

And likewise, when the politics shifted towards the right over culture, militarism, and other psychological branding/marketing type issues that the Reagan right brought into play, those jobs could then be broken, unions could be broken, more jobs could were allowed to be sent overseas, new non union service sector jobs could be created, etc..

But don’t kid yourselves, this is PURELY a political decision, not an economic law of nature. We can just as easily tax investors, and force spending on projects that pay higher wages, and give more arbitrary power to work–rather than ownership.

Are you saying debt against future production is money? You sir are a great slave!!!

Nature has provided the proper materials for money, gold and silver,
and any attempt of ours to rival her is ridiculous. The evils of paper
money have no end. Its uncertain and fluctuating value is continually
awakening or creating new schemes of deceit.