
The Rising Threat of Deflation - MaysonL
http://www.aei.org/outlook/100971
======
ruang
Neither deflation nor inflation are a problem. Instead it is the speed at
which they occur.

Having prices move to their natural supply/demand equilibrium is a good thing.

The problem is if they move too slowly.

For example, if I believe a house is worth $100,000 instead of $200,000, I
will wait until it reaches $100k before buying.

Now whether this happens in 1 day or in 1 decade is the problem.

If it happens in 1 day, everyone will start spending again in a matter of
months, if not days. If it happens in 1 decade (aka Japan), then people will
hold their money until price reaches the natural equilibrium.

Thus, the US should stop trying to artificially prop up housing prices. It
only delays the inevitable.

~~~
gte910h
The US should allow bankruptcy judges to partially invalidate mortgages,
gently reducing the value of homes.

As it is now, foreclosures vs overvalued real homes means we have a hideous
home buying landscape out there now.

~~~
grandalf
What will happen to mortgage interest rates if the contract can be easily
invalidated by a judge? That luxury (to the borrower) is not free, and will be
borne by all other borrowers.

Lenders resort to foreclosure b/c they realize that if they give an inch, they
will absorb all of the losses. If you invest in something, even if you borrow
money to do so, you typically agree to suffer the losses and to profit from
the gains.

~~~
gte910h
Mortgage interest rates are at historic lows....

Even that being the case, that means markets in which risk is low, will have
lower interest rates than in markets in which risk is high. So people buying
in overheated markets will have another dampening effect on them (ie, interest
rates go up when the market get's risky).

>If you invest in something, even if you borrow money to do so, you typically
agree to suffer the losses and to profit from the gains.

Yes, like the people investing in mortgages. Remember, the people lending the
money are making an investment.

The people buying a house may just be buying a place to live.

I actually see what will happen to interest rates with this change being a
nice dampening effect on house price speculation, flipping and overheated
property markets.

~~~
grandalf
What difference does it make if mortgage rates are at historic lows? Are you
claiming that the low rates are evidence of low risk?

Who buys a place to live? These days the main reason people buy houses is
naked, ugly greed. Renting is more financially prudent, preserves mobility (in
case one loses his/her job it's easy to move to a different city), and exposes
the renter to no investment risk.

Most people who buy do so b/c they deludedly think that prices always go up or
because some sort of government tax incentive or rebate makes buying look
cheaper than it is (and causes them to greedily ignore the risk they are
undertaking)

Since WW2 real estate prices 1% relative to inflation. Real estate is a
remarkably poor investment but is lauded b/c of the social engineering notions
of planners who think people will be more obedient and docile if they own
property.

Ask anyone buying today what he/she expect the real estate market to do...
i.e. how much he/she thinks his/her new place will appreciate each year over
the next 15 years. You'll find that they are greedily expecting 5-7% returns
annually.

~~~
gte910h
>What difference does it make if mortgage rates are at historic lows? Are you
claiming that the low rates are evidence of low risk?

No, but interest rates _would be tied to risk_ if principle adjustments were
on the table in court proceedings

That's why it's important they're currently at historic lows, as it would mean
rates in risky areas would go up.

As banks are better than random people at assessing risk, this would also push
people towards safer investment.

>Ask anyone buying today what he/she expect the real estate market to do...
i.e. how much he/she thinks his/her new place will appreciate each year over
the next 15 years. You'll find that they are greedily expecting 5-7% returns
annually.

As are the banks and those who buy mortgages. Everyone is taking risk, lenders
and buyers, just they're not doing it in the most sensical way. You can't
malign one party without hitting the other.

------
lowkey
It doesn't exactly take a Nobel Prize in Economics to figure out deflation is
in the forecast - only access to good data. Since the Federal Reserve stopped
reporting M3 Money Supply several years ago, it is a bit harder to come by
this data - but not impossible.

Take a look at this link and tell me if you can spot the deflation:
[http://www.shadowstats.com/alternate_data/money-supply-
chart...](http://www.shadowstats.com/alternate_data/money-supply-charts)

Banks got bailed out by taxpayers but they are not making loans - hence M3
velocity is collapsing. When the money supply contracts, deflation results.
See, economics is pretty simple when you strip out all the fancy words and
replace them with good data :)

~~~
stretchwithme
one interesting aspect of inflation/deflation is that neither moves through
the economy uniformly. one market can be inflating even while another is
deflating

Right now, things are definitely deflating if looking at the whole. The loss
of hundreds of billions in perceived value definitely removed some of the
"currency" people thought was part of total buying power. The currency left
over is naturally more valuable and price declines are the result.

------
narrator
One important thing to realize is that in a credit bubble the price of things
like houses, college education, etc increase even as the supply rapidly
increases. This is because there is more and more credit available to pay for
them from the same constant income stream of the consumer. This increase in
credit is caused by the lowering of lending standards and interest rates.

This credit is payed for by a continuous stream of income. Once the stream of
income is fully tapped and debt service becomes around 30% of income, credit
can no longer grow and a deflationary cycle gets going where the prices of
those goods that were inflated by credit revert to the prices that they would
have commanded had the supply of those goods (housing,education,etc) just been
increasing and not the money supply.

The "deflation" is the business infrastructure built around constant expansion
of debt collapsing. In the end it is healthy as the economy was unreasonably
warped towards over-production of credit secured assets. This warping is what
has led to the current underconsumption of house-poor and student-loan poor
individuals who are unable to spend because they sold their productive years,
in the form of debt payments, to the dream of making it rich by overpaying for
credit inflated goods.

WHEN DOES THIS END? This ends when we reach the end of the K-Wave and prices
come back down to levels where the cap rate on renting a house competes well
with risky bonds. Even then, you've got the whole multitude of debt laden
consumers who need to default on everything so they can have some spending
money again. Unfortunately they are not yet out of the woods as higher
taxation by our government, in order to pay its debts, is still an on-going
problem that will overhang the economy until the massive bulge of government
pensioners of the baby boomer era start to die-off and we end the
Iraq/Afghanistan wars.

~~~
grandalf
Exactly. Prices are value neutral. When the government decides that housing
prices should be higher (applies its own value judgments to prices) it creates
a bubble which may then burst, leading to deflation, which of course would be
viewed through the lens of this value judgment as "bad".

A price is just the nexus of supply and demand and cannot be good or bad.

------
RyanMcGreal
You know it's serious when the American Enterprise Institute and Paul Krugman
are saying the same thing.

~~~
MaysonL
Strangely enough, Krugman linked to this AEI piece in his blog.

------
stretchwithme
Deflation is not a threat. Its just prices returning to normal after the
collapse of largest bubble in human history.

And its not over. Housing prices will be dropping some more now that some of
the artificial support has been removed.

~~~
btilly
If deflation was just happening in housing, I might agree. But it is not.

The problem is that deflation is happening across the board. The price of
food. The price of clothing. The price of furniture. All are affected. Most of
those products were not part of the bubble, but all are impacted by changes in
the money supply.

The _real_ problem comes when people get used to deflation and start counting
on it. In that environment people don't think, "I have 10,000 dollars, what
can I invest it in?" Instead they think, "I have 10,000 dollars, imagine how
much more I can buy with that next year!" And when you kill investment, all
sorts of bad things happen. For instance in the short term companies stop
growing, stop hiring, and you are likely to get prolonged periods of high
unemployment. And in the long term you have reduced productivity.

~~~
SHOwnsYou
A lot of the decline in prices in food and furniture and other items that have
to be transported is due to the oil bubble in 2008.

An easy example is milk. It now costs less than in did in 2008 because gas is
so much cheaper.

------
MartinCron
What helped me understand deflation was, as with so many things, the Planet
Money team from NPR.

<http://www.npr.org/tablet/#story/?storyId=96993728>

------
grandalf
Deflation just means prices are going down. This is a good thing for people
who want to buy those things.

Of course, after a bubble bursts prices will be lower.

No price is intrinsically "good" or "bad". Price is a measure of supply and
demand. The idea behind the typical Fed policy of slow inflation is that by
constantly adding a bit of inflation, the Fed has something to take away when
the economy needs to be slowed.

Keep in mind that it is US policy to inflate housing prices, so it's no wonder
that after a while it just wasn't sustainable. As a renter I find this
practice abhorrent and wish that somehow the brunt of the economic crisis
could be foisted upon all the mortgage debtors who thought they were Warren
Buffet just before the crash. After the crash billions more were poured into
housing in the hope that nobody would realize it was way, way overvalued.

I think that most of this is built upon the desire not to have more people
walk away so that there is still a remote numerical chance of deeming a the
typical mortgage debtor aka "homeowner" credit worthy.

~~~
gte910h
>Deflation just means prices are going down. This is a good thing for people
who want to buy those things.

You have no clue what deflation is like if you think it "just means prices are
going down".

Deflation means people have _great_ incentive to just hold on to money and not
spend it. A vacation that costs $1000 today will only cost $950 next year.

Deflation also means you have no need to invest your money to get a return.
This makes people pull money out of circulation as they can just hold it and
get richer. This causes even more value accretion per day, which causes even
more people pull their money out.

With all this money going out of circulation, and everyone putting off
purchases, people are fired, laid off and downsized. Which causes people to
have even less money, and the cycle spirals onward (This is what happened
during the Great Depression btw).

~~~
barmstrong
I've never bought this explanation of why deflation is bad for a few reasons:

1\. as someone else pointed out, computers gets cheaper per unit each year but
if you want a computer now you still buy one (as many people do). In fact, you
may just end up buying one now AND in a year as they keep getting cheaper.

2\. In the same way, taking a vacation _right now_ might be worth an extra $50
bucks. Delaying a vacation for a year might not sound fun.

3\. If people stop investing their money they might save it instead. Why
assume that saving money is bad? Americans have record levels of credit card
debt, mortgage debt, car debt, etc. Why is saving more money such a bad thing?

I've never seen any convincing proof that this is a positive feedback loop
where people saving money causes more people to save money, in some sort of
run away saving binge.

It looks a lot more like a natural ebb and flow of saving vs. spending,
returning to a market equilibrium.

What am I missing?

~~~
billswift
The only _real_ problem is that wages are sticky, there is significant
resistance to reducing wages, which means the cost of labor is going _up_
relative to everything else - which in turn means lay-offs; which will be a
major problem now, since unemployment is already high from the recession.

~~~
gte910h
You don't think _everyone_ spending less money on everything is a real
problem? You don't think people buying fewer cars, computers, software, video
games, ipods, houses and groceries is a bad thing for the economy?

When just holding your money makes it more valuable, people do that like
crazy.

~~~
grandalf
Do you believe the converse, that inflation is good for the economy (people
buying things now bc the price will double in a year)?

Unless you're willing to prescribe a specific policy remedy, I suggest you
clarify your thoughts before making the argument you're making.

~~~
gte910h
Large amounts of inflation is bad as well. Small-moderate tends to be good, as
it causes investment, and stops us from accidental deflation.

I'm arguing to keep the current "small amounts of intentional inflation"
doctrine that's currently the goal.

~~~
grandalf
The Fed shows no signs of stopping its approach. With quantitative easing,
etc., the Fed has actually created negative real interest rates.

If anything I'd be worried that there are powerful interests lobbying for
targeted booms. The housing/building sector has been a huge beneficiary of
transfers of wealth from taxpayers and users of currency as a store of value,
and probably has its sights on another Fed-fueled building/housing boom.

Right now lots of Americans make payments on credit cards which are useless bc
the limit has been reduced, etc. There is also pressure on the Fed from banks
who know that there could be waves of new defaults in consumer credit cards.

So on balance I think the fear is an over-reaction by the Fed rather than an
under-reaction. There is also an interesting meme coming into focus in which
credit is viewed as a right just like healthcare.

