Obtaining credit doesn't mean that you need a huge financial sector.  After all, obtaining credit is a market, between those wanting to offer credit, and those wanting to obtain it.  In principle, it is sufficient to bring together both parties.  It is a bit like e-bay.  There is a business opportunity to bring together creditors and debtors, but it doesn't have to be as big as the banking sector.


I don't know where you get that.  In a mildly deflationary environment, nominal interests on loans are much lower than in a mildly inflationary environment.  That was my whole point.

What do you prefer ?
A $200 000 loan in a 2% inflationary environment at 5% interest, or a $200 000 loan in a 2% deflationary environment at 1% interest ?

There is no contradiction.  The financial sector is not just "speculation".  In fact, speculation is indeed useful. By financial sector, I mean, essentially the banking world that has access to freshly printed fiat money.  Speculation can be done by any person, and has a priori nothing to do with the financial sector.  Loaning money can also be done between private persons. 
Of course, there are justified financial services.  But most of the banking activity consists in obtaining fresh fiat money to speculate or to lend.  There's not much, or even no, added value in taking fresh money from the central bank at 0.1%, and lending it out for 2% to people wanting a mortgage.   

I have to say that I exaggerated: there is a very small fraction of the financial sector that does have value.  Professional speculation with customers' money is such an activity, for those customers having a lot of money, but who want to outsource their speculative decisions.

It is.  You have the situation where you have an object A that you can acquire for X NOW or for X - Y LATER.  The anti-deflation proponent's claim is that if such a situation presents itself, people will postpone their acquisition.  You would be crazy to buy A now for X, if you can buy it next year for X - Y, no ?  That's the argument, isn't it ?

Well, empirical evidence shows that that is not true.  People queue to buy A at price X NOW, and they don't buy it a lot one year later at price X - Y.  Some people do, but most don't.


That is not the point.  And even that is not true.  For the i-phone, it may be the case.  But for personal computers, the "state of the art" latest machine has been dropping in price for decades.  My very first personal computer, I bought it beginning of the eighties for the (non-inflation corrected !) sum of about 6000 Euro (it weren't Euros back then).  My second personal computer was a Mac-plus, which I bought for 3000 Euro.
In 2000 I bought a PC for 1200 Euro.  I recently bought a good laptop for 800 Euro.

It is a huge parasite on the economy, yes.  Their true added value is essentially zilch, and they can appropriate them a lot of production, through seigniorage that goes with monetary inflation.

There is absolutely no indication that Apple could not do so in a deflationary environment.  Because exactly things like i-phones indicate that people do not postpone their acquisition, even if the same item gets much cheaper one year later.  The i-phone 4S got much cheaper one year after it got released, but people were standing in a queue to be able to buy it, the first day, at full price.  When the i-phone 5 got out, the same happened.  And the same happened when the i-phone 6 came out.

If people were going to postpone their demand because items become cheaper, then nobody would ever stand in a queue before an Apple shop the day when a new version of an i-phone comes out, wouldn't they ?

So, no, people do not postpone their demand because of mild deflation.  As such, in mild deflation, companies can still have ideas, bring out new products, generate (or not) demand for it, in exactly the same way as under mild inflation.

Under mild inflation, business have to pay higher interest on their loans than under mild deflation.  But "money doesn't get cheaper".  The price of money (the real interest rate) is determined by offer and demand.

For businesses, there is no real difference between an environment that is mildly inflationary or mildly deflationary.

Yes, apple postponed the production of his first i-phone until there was demand for it.  Then they piled up a million of i-phone 2 in their warehouse.

There is a cost to storing value in stocks, whether there is inflation or not.  There is a cost to buying stuff now, that you will only use in your production 2 years from now.  That cost is financial (I had a long discussion about this in the previous posts), and that cost is also one of storage, and risk of it getting stolen or degraded.  Nobody buys expensive electronic components now to be soldered on a board 2 years from now.  

So in ANY CASE it is best to limit the amount of stock of goods you have, and to obtain them as late as possible, ideally just in time for production.

You don't postpone production of course, because production is your source of income.  You don't want your income to be delayed further in the future.  

Whether there is inflation or deflation, you want:
1) to get your production time to be as short as possible (the time between having to spend money to start your production, and to sell your product)

2) get your product out as soon as you can (to be the first one on the market, to beat the competition).

You are simply indoctrinated with an idea that has no ground, and that idea is that "a little inflation is good".  If you analyse EVERY aspect, EVERY argument that would be in favor of "a little inflation", you see that it contains a major economic misunderstanding, and that it has a mirror argument with "a little deflation".  But "a little inflation is good" is an unfounded dogma that is repeated so often, for which so many bogus after-the-fact arguments are given, that it is hard to see the evident falsehood of that claim.

"a little inflation is good" for the financial sector.  That's all.

There is also a lot of empirical evidence that people DO NOT POSTPONE buying articles because their price depreciates over time.

In fact it is both, of course.   Debt has nothing to do with morality.  Debt is worth what the creditor can enforce to obtain.  As such, as a creditor you take a certain risk by writing out a loan.  If you do not know how to enforce paying back, then the risk is all yours.  There are two parts to "enforcing to pay back":
1) there must be something that can be paid back.  If the other one is broke, there's nothing to be taken
2) there must be enough force to convince the other to pay it back (or you have to go and take it with force).

If those two conditions are not satisfied, as a creditor, you're a dumb ass, and your losses are your "rightly risk".

As a debtor, you should pay back your debt, if it is advantageous to you.  Otherwise, you don't.  This means that the creditor has means to make life actually worse when you don't pay back your debt, rather than when you do. If your creditor doesn't have those means of pressure, you better don't pay back your debt.
Of course, another part of "life is worse when you do not pay back" is your credit worthiness. If you don't pay back your debts, you will have more and more difficulties making new creditors believe you will.  So not paying back also costs you some reputation as a debtor.

As a debtor, you should make the balance between all that before deciding to pay back or not (at least, if you can).

A loan is a gamble: the gamble by the creditor that the debtor will pay back.

No, what I'm saying, what I'm repeating, and what you don't seem to understand, although this is very elementary in every form of business, is that money that is used on time A, and made only available again on time B, has a cost, equal to the interest rate times the amount of money, times (B - A).

That has nothing to do with inflation or deflation.  It is the fact that that value is blocked during that time in whatever you spent it on.  

Now, what interest rate to pick exactly is a point of discussion: is it the savings account rate, the "risk free interest rate", or is it the best possible loan rate you could get, that can be discussed, but doesn't alter the principle.

If you spend an amount of money X at time A in order to produce, to only get it back at time B when you sell your stuff, then the COST of that "frozen" amount of money equals s * (B - A) * X, and it is a cost, just like the cost of using electricity or the rent or whatever.

Look up http://en.wikipedia.org/wiki/Discounted_cash_flow and http://en.wikipedia.org/wiki/Time_value_of_money

These are very elementary concepts, you know.

Consider no inflation/deflation, and an interest rate of 5% (whether this is on a savings account, the best loan you can get, or the "risk free interest rate").

Suppose, case A, that you spend today $1000,- and that you will sell your product for $1200 in a year from now.
Using the method of discounted cash flow, that $1200 a year from now has to be reduced by the interest:
$1200/(1.05) = $1143.-
The value of selling something for 1200 in a year is worth 1143 today.
And you are spending 1000 today.  So the value of your undertaking is $143,-

Suppose now, case B, that you spend $10 000 000 today, and that you will sell your product for $10 000 200 in a year from now.
Using that method again, 10 000 200 a year from now is worth (10 000 200 / 1.05) = 9523809 today.
But you are spending 10 000 000 today.  So the value of your undertaking is - $476 190.-
You're making a loss of half a million almost !

Now go and study "discounted cash flow" and "time value of money".  I'm not going to explain this basic concept again, 10 times in a row.

I'll just copy part of the Wiki example, that is almost exactly the same as the examples I'm using here:

The long term deflation is normally equal to the economic growth, assuming average constant velocity in the long run.

As such, if activity would diminish, deflation would also diminish.  In periods of economic recession, a fixed money supply would give rise to inflation.

The only ESSENTIAL difference between inflation and deflation, is that in inflation, you need a financial sector to help protect your savings from value decrease, a financial sector which takes a margin between borrowing and saving ; while in the case of deflation, you don't need that financial intermediate, as a pile of money "brings his own interest".  You can still use financial intermediates, to get MORE than the deflation rate, and they can still lend out at a positive nominal interest, but they cannot take too large margins because otherwise the interest they would give you on your savings would become negative.

The only thing for which deflation is bad, is financial institutions.  They live essentially on inflation.

The real interest on a loan, in a deflationary scheme, has a lower bound equal to the deflation rate.  That is, if the deflation rate is 2%, any loan will cost AT LEAST 2% in real terms, and probably somewhat more.  This lower bound on loans avoids people to invest in low-rentability projects.  There wouldn't be any "cheap money" with which bubbles can be blown, and which can be misallocated in huge amounts.  So the correction for mis investment would come much earlier and wouldn't be able to be pushed back and back with more and more cheap money until there is a major crisis.

But there's a feedback.  If that interest rate would be too high, and would cripple businesses, then growth would diminish, and so would deflation rate.  So there is no danger for "permanent depression due to deflation".  After all, at zero growth, there wouldn't be any deflation either !  And if there would be a depression, you'd get inflation.

Assume no deflation or inflation, right.

WHY would one business be less profitable than the other then according to you ??  After all, they both made $200 of profit according to you.  The first one uses $1000,- in January, and sells for $1200,- in December ; the second one uses $10 000 000 in January, and sells for $10 000 200, - in December.

From what amount onward wouldn't they become profitable ?
When they need to block 1 billion ?  20 billion ?  500 billion ?
Because even a company that needs to use 500 billion in January, if it can, according to you, sell his production and everything else for $500 billion + $200,-, is profitable according to you, right ?

And of course they get that money for free and don't pay any interest on it, right ?

So whether they have to borrow $10 000 000, or $1000 during a year, for a certain production on which they will make a "profit" of $200 in both cases, is entirely equivalent to you

Could you please explain that to tee-rex who thinks that the amount of money blocked in the production process (that is, between the moment you need to spend it, and the moment you get to sell your production) has no cost.

So, for you, if you need for $ 10 000 000 of material during a year, or you only need $1000 of material during a year, if in the end you sell for $200 more than the expenses you did a year before, you made a benefice of $200 ?

As I told you, good luck with your business


This simply means that the real risk-less interest rate was negative.  There is so much demand to place money, and there is so little demand to borrow money, that people even want to pay for others to keep their money.  This is a real possibility when there is inflation: that you are willing to PAY for people to borrow your money, because you can attenuate somewhat the loss of value due to inflation.

Yes, it is cashflow.  Now tell me, is cash flow free ?
If you immobilise (I called it "freeze") money in raw materials, machines and other things for a year, do you think that that is for free ?  

Consider these two different business plans:

A) Joe needs to buy a computer worth $10 000 000 on January, and will design, using that computer, a new spoon.  In June he will buy $1000 of metal and make spoons out of it, which he will sell in December for $1200,-.  At that point he will sell his computer for $10 000 000.

B) Jack needs to buy a PC worth $1000 on January, and will design, using his PC, a new spoon.  In June he will buy $1000 of metal, make spoons out of it, and he will sell them in December for $1200,-.  At that point he will sell also his PC for $1000,-.

Are you SERIOUSLY saying that both Joe and Jack are going to make the same profit, namely $200,-

My point is that if the interest rate is, say, 2%, then Jack is making a profit of $200 - $10 - $20 = $170
(the $10 is the $1000 of metal that he immobilised for 6 months, and the $20 is the $1000 of his PC that he immobilised 1 year)

Joe, on the other hand, is making a monumental loss of about $200 000.  In fact, his loss is exactly:
200 000 + 10 - 200 = $199 810,-

If you monopolise capital (here, $10 000 000) during a certain time (if you "freeze" it), then that costs money.  The cost is called the interest.

If you are buying goods on Monday for $1000 000.- and you can only sell your products on Friday, then you have frozen one million dollars during a week.  The cost of that freezing of money in your raw materials is the interest on it.
That's very elementary business accountancy, you know.


You do freeze the money.  That's why you pay interest on it !

The interest rate that is used is normally the "risk free interest rate", usually determined by state bonds.  Savings accounts are usually slightly lower.  So, no, you do not compare to the return on investment of drugs dealers. 

Ask any business if money, locked up in a warehouse, buildings, machines, etc... is not a cost factor.
If you calculate, for any business, the discounted cash flow, then any "frozen" money during a time is discounted as a cost equal to the interest you pay on that amount of money during that time.

If you are going to claim that you make a profit, because you've locked up 10 million dollars during a year in material, and you got a return of 200 dollars over what you spent, I wonder how many people are going to consider that *you* are still in touch with reality

And if you think that a savings account has zero real interest, you should change bank.  Because a bank uses your money you put on a savings account to lend it to people wanting to get a loan.
It is true, however, that these days, real interest rates are so terribly low (because low demand, and high offer) that you hardly distinguish nominal rate and inflation.  But on a savings account, you're supposed to get more than just the inflation.

And finally, I already explained that caveat.

Yes, that's the idea.  Because if there is no inflation or deflation, the monetary gain is the gain in value.  The "real interest rate" is the actual gain in value.  The nominal rate is the rate you have to pay, and which compensates for the inflation or deflation, if you borrow a monetary asset.  If there's no inflation or deflation, both are the same.


Yes, because you should consider that he's borrowing.  The point is that you have two investment options:
1) doing your thing USING the money
2) lending out the money (which comes down to putting it on a savings account, say).

If you get more by putting the money on a savings account rather than doing your thing with it, doing your thing is a losing affair.

Let us assume no inflation or deflation for the moment, just to illustrate the point.

Say that you have $1000.- lying around.

You have 2 options:

1) putting that $1000.- in a savings account with an interest rate of 5%

2) doing something with it with a return on investment of 2%

Obviously, if you go for 2), you make 3% loss as compared to what you would obtain if you didn't actually do something with the money but put your money in a savings account, right ?

If you do an investment, and you get less from it than you'd get from a savings account, you're actually making losses.  That can seem strange, but it becomes more obvious if you consider that you have to borrow the money to do your thing.

Now of course I'm neglecting something here, and that is the margin taken by the bank, who gives a lower return on savings accounts than it takes on loans.  True.  I'm taking out the bank as an intermediate, and consider that a savings account is directly a loan to someone.  So it is true that you get cheaper off using your own money than having to borrow (because of the margin taken by the bank).  The "real interest rate" for savings accounts is smaller than the real interest rate for loans.  The difference goes in the bank's pockets.  But of course the reasoning here is somewhat simplified, to get down to the essentials of the effects of inflation and deflation, without working out an entire business plan

The cost of borrowing money in NOMINAL terms you mean (the actual rate you have to pay) includes, as you say, inflation and indeed, the expected profit margin for the lenders, which is exactly the real interest rate.

The profit margin of the lenders is indeed what is market-determined, between demand for borrowing value, and offer for borrowing value.  It is "the price for putting value at disposal during a year".  If we want to compare things, we have to keep this condition constant.

The REAL margin for creditors (the real price for debtors) is the real interest.  It is, as I said, determined by the offer by creditors and the demand by debtors.

If a potential creditor wants to put a certain value on the market, which is worth $1000 right now, and there is 10% inflation, he will only consider that he makes a benefit for everything ABOVE 10%.  Indeed, if he lends his $1000 right now, and he gets back $1100 a year from now, he cannot buy anything more with it than right now.  So there's no incentive for him to not buy the stuff right away and lend his money.  If the nominal interest he asks is 15%, he will consider that he got 5% VALUE back.  The real interest rate.  The nominal rate on the market will then be 15%, and the real interest rate 5%.

If the inflation is only 2%, he will be satisfied, in the same circumstances, with a nominal rate of 7%.  In the same market conditions, then, the nominal rate will be 7%, and the real interest rate still 5%.

Because the lender looks at his real rate to offer or not to offer.  So the offer on the money market will be determined by the REAL interest rate.  It is the same, for a lender, to get 15% if inflation is 10%, or to get 7% if inflation is 2%.  Offer will be the same in both conditions.

On the side of the borrower, you get a similar reasoning.  His demand will also depend on the real rate, not on the nominal rate.

This is why the market conditions actually determine the real rate.  

I put up a few links earlier.

Real interest rate has nothing to do with inflation and deflation.

Real interest rate has to do with the price of borrowing value (no matter in what currency).
Inflation and deflation have to do with a specific currency: it is the price change of a currency.

Real interest rate is independent of a currency.  If the real interest rate is 5%, and I borrow you 20 houses during a year, it means I want an extra house back.  It is the market-determined cost of putting value at disposal during a year.

It has nothing to do with inflation or deflation of a specific currency.

The nominal interest rate is the real interest rate, corrected for the expected change of price of the currency at hand.  It is what you have to pay.

If the real interest rate is 5%, and I borrow you 100 eggs during a year, I expect 105 eggs back.

If the real interest rate is 5%, and I would lend $1000, and inflation is 2%, I know that next year, this $1000 is worth less, so in order to obtain really my 5% value, I have to ask you a nominal interest rate of 7%.

If there is deflation, and I know that $1000 will be worth 2% more next year, I'm happy with a nominal interest rate of 3% (because I will have my real value increase of 5%).