Have you noticed that the Fed Chairman seems to be far more concerned about deflation than inflation? It's reflected in his public comments and in the policies being pursued by the Fed.
In a nutshell, when deflation is caused by corrections of bad investments made during a bubble (like the sub-prime mortgage loans and their related derivatives) it is manifested by bad loans that don't get repaid. Individuals and businesses take bankruptcy or they negotiate more favorable terms. Most of the lenders are banks and they don't get repaid. Never mind that the banks made a lot of those loans with artificial money created by the Fed or the fractional reserve banking system. The banks don't like to write off their loans.
In addition, deflation has the opposite effect of inflation. Whereas inflation is caused by an increase in the money supply, deflation reduces the money supply. The effect is to make it more expensive for banks to secure money with which to make loans.
in case you may have missed it, the Fed is owned by the banks. It's completely separate from the Federal government, despite the implication caused by the name "Federal Reserve Bank".
So it makes sense that the Fed is far more concerned about preventing deflation than about preventing the kind of inflation that is caused by an increase in the money supply and by the fractional reserve banking system.
Just my two cents.
Vern
Showing posts with label Fed. Show all posts
Showing posts with label Fed. Show all posts
Wednesday, January 19, 2011
Friday, July 23, 2010
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
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
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