Is deflation truly that bad for an economy?

[ffe]

Which is a HUGE part of the economy!!!

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.

Umm,  production requires credit if you are big business.  Without finance production would massively slow down.

In a mildly deflationary enviroment cost of borrowing is too expensive. People wont afford to buy big ticket things like houses or cars if they had to pay cash.

Yes. You need loans to move the money to the people with the opportunities, the ideas, the drive, the vision. Only in very rare cases do these people have money of their own.

Now with loans the important factor is the stability of the trend. Inflation or deflation that is constant for many years can be accounted for in loan agreements. However, shocks causing inflation or deflation to change can be disruptive, even ruining these people.

 

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[ffe]

The argument for deflation has always been that the holders of cash should be able to claim a fixed fraction of economic output even if that output grows.

With a fixed number of Bitcoins each coin represents 1/21millionths of the whole economy and as the economy grows the holder of 1 Bitcoin still has claim to 1/21millionths of the larger economy. If a home is dropping in value (priced in bitcoin) then this just means it represents a smaller and smaller fraction of the total economy. So maybe it should fall in price in terms of Bitcoin. Same Bitcoin balance buys more.

Some think that's wrong.

This other side of the argument is that a holder of 1 Bitcoin should be able to buy a fixed amount of goods. A crate of apples for example. If the economy grows by 10% and the fraction of value of the total economy that the crate of apples represents falls 10% then so be it. He is still able to buy the crate with his Bitcoin. The economy as a whole requires more Bitcoin over time to account for the extra 10% for this stability in purchasing power to happen.

If one wants his own purchasing power to rise with the economy he should loan his money (and take risk) under an agreement that accounts for inflation, positive or negative. He should not expect to hoard his cash under a mattress and get more goods for them in the future.

In the end we can all agree that instability in Inflation/Deflation is bad. However, absolute inflation vs. zero inflation or deflation, even if stable, is really a choice between a fixed value for your unit of money in the future vs. a fixed fraction of economic output for your money as the economy grows.

[twiifm]

The argument for deflation has always been that the holders of cash should be able to claim a fixed fraction of economic output even if that output grows.

With a fixed number of Bitcoins each coin represents 1/21millionths of the whole economy and as the economy grows the holder of 1 Bitcoin still has claim to 1/21millionths of the larger economy. If a home is dropping in value (priced in bitcoin) then this just means it represents a smaller and smaller fraction of the total economy. So maybe it should fall in price in terms of Bitcoin. Same Bitcoin balance buys more.

Some think that's wrong.

This other side of the argument is that a holder of 1 Bitcoin should be able to buy a fixed amount of goods. A crate of apples for example. If the economy grows by 10% and the fraction of value of the total economy that the crate of apples represents falls 10% then so be it. He is still able to buy the crate with his Bitcoin. The economy as a whole requires more Bitcoin over time to account for the extra 10% for this stability in purchasing power to happen.

If one wants his own purchasing power to rise with the economy he should loan his money (and take risk) under an agreement that accounts for inflation, positive or negative. He should not expect to hoard his cash under a mattress and get more goods for them in the future.

In the end we can all agree that instability in Inflation/Deflation is bad. However, absolute inflation vs. zero inflation or deflation, even if stable, is really a choice between a fixed value for your unit of money in the future vs. a fixed fraction of economic output for your money as the economy grows.

You can observe Japan from 1990's to see the effect of a constant deflation.  Not terrible but not desirable either.  Constant inflation is preferable

[thaaanos]

Depreciation from obsolescence is not the same as monetary appreciation.

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.

Iphone 4 depreciates against iphone 5 etc, latest iphone doesnot depreciate against the dollar, and similar other fast iterating products

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.

buying a product 1year later has lower utility for the consumer that is reflected on the price no deflation play here

It is the point, the whole point!
State of the art Pc can exceed 10k euros, and it is going up up up through the decades, your needs follow a milder trend that in a price tag goes down. You no longer need state of the art.

[thaaanos]

In the end we can all agree that instability in Inflation/Deflation is bad. However, absolute inflation vs. zero inflation or deflation, even if stable, is really a choice between a fixed value for your unit of money in the future vs. a fixed fraction of economic output for your money as the economy grows.

Stability is not always expressed by a single point, it may well be a periodic set, or if you like a wave.

Would you prefer a measure that changes every time the extend it measures changes?
People are comfortable when the locality doesnot relay on global information.

[johnyj]

Just because oil dropped by half, Russia fall into inflation, is that good for Russian economy? For Russia, the export of oil brings less income, the Ruble has become weaker, the import price rose, that's bad for economy

However, for a country that export daily consumption goods, a weak currency will stimulate the export thus make the economy stronger

So, from practical point of view, inflation and deflation can have totally different affect for two countries with different export/import profile. There are many factors more important than these small parameters, it is just an political claim for banks to print themselves some money

[tee-rex]

Which is a HUGE part of the economy!!!

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.

I was not going to reply to your posts any longer, but this made my cup of patience to overflow finally. Your turn out to be a hypocrite of even deeper dye than I previously thought.  You've been recently laying yourself out to prove that sheer speculation (in a narrow sense of buy-and-sell) does really create economic value to consumers, and now you dare say that the financial sector is a huge parasite on the economy and their true added value is essentially zilch?

It is by re-arranging the possession of assets through exchange such that they are in the hands of those people appreciating them most, that value is created.

[dinofelis]

[

I was not going to reply to your posts any longer, but this made my cup of patience to overflow finally. Your turn out to be a hypocrite of even deeper dye than I previously thought.  You've been recently laying yourself out to prove that sheer speculation (in a narrow sense of buy-and-sell) does really create economic value to consumers, and now you dare say that the financial sector is a huge parasite on the economy and their true added value is essentially zilch?

It is by re-arranging the possession of assets through exchange such that they are in the hands of those people appreciating them most, that value is created.

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.

[dinofelis]

Umm,  production requires credit if you are big business.  Without finance production would massively slow down.

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.

In a mildly deflationary enviroment cost of borrowing is too expensive. People wont afford to buy big ticket things like houses or cars if they had to pay cash.

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 ?

[dinofelis]

Now with loans the important factor is the stability of the trend. Inflation or deflation that is constant for many years can be accounted for in loan agreements. However, shocks causing inflation or deflation to change can be disruptive, even ruining these people.

THIS !!

[dinofelis]

If one wants his own purchasing power to rise with the economy he should loan his money (and take risk) under an agreement that accounts for inflation, positive or negative. He should not expect to hoard his cash under a mattress and get more goods for them in the future.

In fact, this can be debated.  After all, if you would invest in a "total economy basket" (that is, a basket of shares that is an image of the actual economy), then your basket's value will grow with the economic growth.  You could think of such a basket as the most possibly hedged fund.  There is no lower risk.  Even a state bond has a higher risk, and it is considered in the financial world as the risk-less investment reference.

So whether you buy into that "total economy fund" or whether you simply have fixed supply, shouldn't alter anything.  At fixed supply, the deflation is (in the long run) equal to the economic growth.  If the economy grows with 2% a year, under fixed supply, you can expect a 2% rate deflation.  If the economy shrinks with 5%, you can expect, under fixed supply, an inflation of 5%.  This is assuming long term stability of the velocity of money.

Now, I don't see the economic utility of investing in a "total economy basket" because it expresses NO PREFERENCE.  Now, the value of speculation and investment resides exactly in the CHOICES you make: to support THIS business OVER that business, and hence send a signal to the market.  But to send a signal to "the whole of the economy" is equivalent to not sending a signal.

So what can you do ?  You can invest specifically.  Then you "add value" if you do so in a faster-growing sector, with higher return than the average growth.  But you can still do that in a deflationary environment, because investing in a faster-growing sector than the average economy will bring you MORE than the gain by deflation.

If average economic growth is 2% (and hence deflation is 2%) but a certain sector grows at 5% (has a return on investment of 5%), then it would still be beneficial to invest in that sector: you would win 3% in nominal terms (and hence 5% including inflation).  You would win over just hoarding.

The only thing is that deflation would evidently make you loose if you invested in sub-optimal sectors, which is less evident to see in an inflationary environment. 

So, in the end: in a deflationary environment, hoarding money gives you the average return on your value, in the same way as a useless "full basket" investment would do in a non-deflationary environment.  You can still win by investing in a faster-growing sector.  However, nobody can win in (over) investing in a lower-return sector, which is possible by a financial sector in an inflationary environment.  It is about the sole difference.

[twiifm]

Umm,  production requires credit if you are big business.  Without finance production would massively slow down.

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.

In a mildly deflationary enviroment cost of borrowing is too expensive. People wont afford to buy big ticket things like houses or cars if they had to pay cash.

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 ?

If we dont need a huge financial sector then why does it exist?  Obviously it came i to existence because demand is there.  Free market after all

Sorry what I meant is that.  If you borrow mortgage and your house falls in value.  When all payments made you lose money.

Also interest rates doesnt matter if you have no money anyways.  In defation you have high unemployment

[dinofelis]

If we dont need a huge financial sector then why does it exist?  Obviously it came i to existence because demand is there.  Free market after all

Because of fiat inflation.  I'm convinced that 80% of the "useless" and very lucrative part of the financial sector resides in the inflation driven fiat currency.  The financial sector has the MONOPOLY in obtaining fresh fiat money from the CB, and hence obtains its seigniorage (indirectly).

In an inflationary situation, hoarding money is losing value.  So you are FORCED to put your money on a savings account, even to try to keep its value.  This forces you to give your money to a bank, not even to gain in value, but just trying to KEEP the value.  Now, that bank then gets A LOT OF MONEY at its disposition to do a lot of stuff with, like gambling, investing in doubtful things, and hence blowing bubbles.  Moreover those banks also get the fresh money from the central bank at lower rates than it writes out loans take a lot of value for nothing, but you are obliged to pass through them.  You can't borrow directly from the central bank as they can.  They have a privilege. 

THAT's why they exist. 

As I said, not entirely, because there ARE useful financial services, but not at the scale of the financial sector.  MOST of the financial sector exists because of fiat inflation --- which is why they are scared to death of deflation.

[Wekkel]

If we dont need a huge financial sector then why does it exist?  Obviously it came i to existence because demand is there.  Free market after all

As I said, not entirely, because there ARE useful financial services, but not at the scale of the financial sector.  MOST of the financial sector exists because of fiat inflation --- which is why they are scared to death of deflation.

Makes you wonder... 

[twiifm]

If we dont need a huge financial sector then why does it exist?  Obviously it came i to existence because demand is there.  Free market after all

Because of fiat inflation.  I'm convinced that 80% of the "useless" and very lucrative part of the financial sector resides in the inflation driven fiat currency.  The financial sector has the MONOPOLY in obtaining fresh fiat money from the CB, and hence obtains its seigniorage (indirectly).

In an inflationary situation, hoarding money is losing value.  So you are FORCED to put your money on a savings account, even to try to keep its value.  This forces you to give your money to a bank, not even to gain in value, but just trying to KEEP the value.  Now, that bank then gets A LOT OF MONEY at its disposition to do a lot of stuff with, like gambling, investing in doubtful things, and hence blowing bubbles.  Moreover those banks also get the fresh money from the central bank at lower rates than it writes out loans take a lot of value for nothing, but you are obliged to pass through them.  You can't borrow directly from the central bank as they can.  They have a privilege.  

THAT's why they exist.  

As I said, not entirely, because there ARE useful financial services, but not at the scale of the financial sector.  MOST of the financial sector exists because of fiat inflation --- which is why they are scared to death of deflation.

They get reserves from Central Bank not money.  Your view of finance is incredibly simplistic.  I dont think you know how that industry functions

[anonyymi]

inflation is important for economy to grow.

[twiifm]

It's logical to assume that when you create more of something, you dilute the value of what's already in existence. That's exactly what has happened to the US dollar since the 2008 financial crisis hit.

Not if it doesnt enter into the economy.  Dollar actually became stronger against most major currencies in case you didnt notice

[thaaanos]

If one wants his own purchasing power to rise with the economy he should loan his money (and take risk) under an agreement that accounts for inflation, positive or negative. He should not expect to hoard his cash under a mattress and get more goods for them in the future.

In fact, this can be debated.  After all, if you would invest in a "total economy basket" (that is, a basket of shares that is an image of the actual economy), then your basket's value will grow with the economic growth.  You could think of such a basket as the most possibly hedged fund.  There is no lower risk.  Even a state bond has a higher risk, and it is considered in the financial world as the risk-less investment reference.

So whether you buy into that "total economy fund" or whether you simply have fixed supply, shouldn't alter anything.  At fixed supply, the deflation is (in the long run) equal to the economic growth.  If the economy grows with 2% a year, under fixed supply, you can expect a 2% rate deflation.  If the economy shrinks with 5%, you can expect, under fixed supply, an inflation of 5%.  This is assuming long term stability of the velocity of money.

Now, I don't see the economic utility of investing in a "total economy basket" because it expresses NO PREFERENCE.  Now, the value of speculation and investment resides exactly in the CHOICES you make: to support THIS business OVER that business, and hence send a signal to the market.  But to send a signal to "the whole of the economy" is equivalent to not sending a signal.

So what can you do ?  You can invest specifically.  Then you "add value" if you do so in a faster-growing sector, with higher return than the average growth.  But you can still do that in a deflationary environment, because investing in a faster-growing sector than the average economy will bring you MORE than the gain by deflation.

If average economic growth is 2% (and hence deflation is 2%) but a certain sector grows at 5% (has a return on investment of 5%), then it would still be beneficial to invest in that sector: you would win 3% in nominal terms (and hence 5% including inflation).  You would win over just hoarding.

The only thing is that deflation would evidently make you loose if you invested in sub-optimal sectors, which is less evident to see in an inflationary environment. 

So, in the end: in a deflationary environment, hoarding money gives you the average return on your value, in the same way as a useless "full basket" investment would do in a non-deflationary environment.  You can still win by investing in a faster-growing sector.  However, nobody can win in (over) investing in a lower-return sector, which is possible by a financial sector in an inflationary environment.  It is about the sole difference.

But isn't hoarding investing in oneself directly opposite to a total basket? Do both create the same economic environment regardless of inflation/deflation? or is your logic simply based on two negatives ?
Anyway the problem is not *your* wealth, but the economy as a whole. Not the ratios but the absolutes
As a final thought on deflation, Things tend to decay why not money?

[picolo]

It's logical to assume that when you create more of something, you dilute the value of what's already in existence. That's exactly what has happened to the US dollar since the 2008 financial crisis hit.

Not if it doesnt enter into the economy.  Dollar actually became stronger against most major currencies in case you didnt notice

It did but I would be surprised if the Dollar didn't go down against most real assets by the end of 2017.

[dinofelis]

They get reserves from Central Bank not money.  Your view of finance is incredibly simplistic.  I dont think you know how that industry functions

Of course, but that is sufficient.  The reserves and the imposed fractional ratio determine how much money a bank can create.  You should maybe read the first chapters of the Treatise on Money by Keynes again ?

Simply said, if I'm bank A, and you're bank B, we can write loans to each other as much as we like, and those loans become created money.  If there's no legal limit, two banks can create an infinite amount of money, by lending to each other.  The reason being that the "debt certificate" that bank A holds of bank B, is considered an asset of bank A, and the "debt certificate" that bank B holds of bank A, is considered an asset of bank B.  As such, by lending themselves, say, each, $ 100 000.- they have created two times $100 000.- of assets one another.  Their balances are in check: they have each an "asset" (the other bank's debt) of $ 100 000.-, and they have each a debt of $ 100 000.- (as a bank account they opened for the other bank with $100 000.- on it).  They can even ask interest.  There's a cash flow due, and there's a cash flow coming in.

Now that they have their balances in check, and they have money (that is, the bank account in the other bank with $100 000 on it), they can lend it out to, say, someone needing a mortgage.  They then ask that person 3% interest on it.  If bank A lends out its freshly created $100 000,- to Joe, who wants to buy a house, by writing him a cheque on the other banks' account and then Joe has to give them $ 3000.- a year.

So on Monday, Bank A didn't have a dime.  On Tuesday, Banks A and B do their money-creating swap.  On Wednesday, bank A loans its money to Joe.  Now, bank A has an income of $3000.- a year.  Its balance is still in check.  It has no dime, but it has a debt to bank B of $ 100 000.- and it has a mortgage contract worth $100 000.- with Joe.  Its balance is in check.
Bank B will do the same.

On Thursday, the directors of bank A and B meet in a bar, and decide to start over next Monday....
As such, they generate each an income of about $ 3000.,- a week, as long as they find mortgage customers...

They can do the same with a mutual loan of $ 1000 000.- or even $ 1000 000 000.- or ....
But in reality, they can't because there's a legal limit: their reserves.  It was Keynes' (correct) argument to require a reserve and a reserve ratio by law, to avoid the "runaway" of banks creating money.

Suppose that the reserve ratio is 5%, and bank A and bank B manage to have $ 1000 000.- each as a reserve deposit.  That means that they can now play that game until they have about $ 20 000 000.- of customer bank accounts (of the other bank, say ;-) ) and lending out $ 20 000 000.-

They cannot "go party" with $ 20 000 000.- because they have to have their balances in check.  It is not that they can SPEND that money. But they can LOAN that money, and invest it and they don't need a high return on it.  If their reserve COSTS them, say, 1%, and they can obtain even 0.5% on the $ 20 000 000.- they work with, then they make sheer benefit even though they invest badly.

Indeed, the 1% on their reserve costs them only $ 10 000, and the 0.5% on the $ 20 000 000 brings them $100 0000 !

So IF you can obtain reserves, you can create money.  And if you can create money, you obtain the interest on it "for free".  You cannot spend the money itself, but you can spend the interest, which you do get for free.

When banks get into problems is when they screw up so badly that they LOSE money, and that they loose their $ 20 000 000.-

The trick of "pumping money" with banks is to use the reserve fraction ratio as a leverage on the interest: if you get $ 1000.- more reserves, you can play with 20 000 or so.  So you only need to generate a return on those 20 000 that is 20 times smaller than the cost of your 1000 in order to break even.  If you become greedy, and you start doing risky things with those 20 000, then you might be very rich, or you might be in deep shit if it goes wrong.