Who Suffers from Deflation?

It often seems that the financial media treats deflation as if it were some sort of financial plague.

It's somewhat obvious that everyone is hurt by inflation, right? Oh yeah, I almost forgot. People who owe money to banks or other lenders like inflation because they get to pay off their debts with cheaper money. That must mean that the lenders don't like inflation and logically should like deflation. And debtors should be the ones who get hurt financially during periods of deflation.

But it seems that it's the bankers who scream the loudest about the evils of deflation. Why is that?

Put simply, it's because they have less money to loan at interest rates above what they have to pay for the money.

The banks get money to lend from three main sources. One is from the money that is deposited with them. They can loan up to about 90% of those deposits to borrowers at interest rates above what they have to pay the depositors. The second source of money is from the deposits by the borrowers or from people who have borrowed funds from other banks. But that is probably their most expensive source of funds.

The third source of funds is from the Federal Reserve and it is often the cheapest source of funds. Right now, the Fed is keeping the interest rates they charge member banks as low as possible. In fact, the rate is so cheap that the banks are finding it safer and more profitable to just park that borrowed money in U.S. treasury bonds.

With deflation, it works pretty much in the opposite way.

Fewer people are borrowing money so the banks have less money to lend. The Fed is likely to try to push money into the market with lower interest rates but if people aren't borrowing, it's like pushing on a string.

With deflation, prices are generally declining. Each dollar in circulation has more purchasing power. Although borrowers pay off their debts with more valuable dollars, that's not a profitable thing for them to do. So they try to pay off debts as soon as possible instead of delaying the payments as long as possible. And there is then less money in circulation which reduces the profits for the banks.

The bottom line is that it is the bankers who are hurt the most because of deflation. And the Fed is owned by the bankers. So if I have to place a bet on whether we are more likely to have inflation or deflation, I'll bet on inflation.

But there are some times (like now) when some deflation or at least a lack of inflation is unavoidable. That's because bankruptcies and loan defaults are inherently deflationary. They offset the money that was created when the loans were made and reduce the money in circulation.

But in the long run, those who avoid debt would be better off with deflation.

At least that's the way it seems to me.

Vern