Wednesday, May 26, 2010

Did you say DEflation?

Read it and weep, folks: The U.S. money supply fell by $300 Billion in the first quarter of 2010. This happened despite the trillions of dollars borrowed and printed over the past couple of years which were supposed to turn the economy around and prevent a depression.

When the money supply goes down, it tends to accompany deflation, or a general drop in prices. It was a strange blogger named Alstry who first made me aware of the concept of a deflationary spiral as the ultimate outcome of our mounting debts, and today's news may be the first bit of evidence that his verbose rants have been right all along.

My limited understanding tells me that cash is a good thing to have during a deflationary spiral, because as money becomes more scarce, its value actually increases relative to everything else. That's why I've been hoarding cash for nearly a year now. Of course, if the Federal Reserve Bank turns around and prints $10 trillion dollars this year, then deflation will be fended off for a little longer. Government policymakers can be fickle, so it's impossible for a private citizen to know for sure how to weather the storm.

May 29 Postscript:
Remember that high inflation helps a debtor, whether we're talking about a homeowner or a nation, because the fixed amount of money owed becomes a smaller fraction of the total money available. Conversely, deflation is a disaster for the debtor for the opposite reason. A little bit of deflation will make our debt larger in proportion to the economy, thus drawing away a larger fraction of the money to make next month's payments, which leads to more deflation, etc.


John said...

I've really enjoyed your posting over the past few weeks. I have been preaching "deflation" to friends for some time. Deflation appears to be a matter of when not if. Monetizing the debt may delay deflation but deflation appears inevitable (reference Japen over the past two decades). There has been significant wage deflation that has not shown up on the official government data sources that will continue to dampen demand. The US consumer is on life-support. Comments were made during the Greek crisis that the PIGS private sector savings rate was 8%, significantly below where it needs to be. The US savings rate is close to 3% and was negative a few years ago. That is unsustainable.
The irony of all this is that I got back into oil (DBO)yesterday despite my firm belief that the long term outlook for the market is dismal. It is a traders market not an investors market. Cash is still king!
John from CO

The Western Chauvinist said...

I've been reading Amity Shlaes' Forgotten Man lately and I'm wondering what you think of the possibility of there being both deflation and a subsequent loss of confidence in the currency all together? Cash was so scarce in the Depression that localities started issuing their own currencies and the barter system was "king." But our sovereign debt was nothing compared to today and our economy wasn't so dependent on foreigners buying our debt. Have you thought about what to do if the currency collapses?

Jody Wilson said...


Thank you, and well said. I agree that it's just a big trading game right now.


Given what little I know, I don't see scarce dollars during the depression as being equivalent to the collapse of the dollar. Sure, if nobody had any dollars in a particular town then they were forced to find alternatives for trading, but I'll wager that the few people who had actual dollars were indeed able to buy things.

On the other hand, if the Fed starting creating hundreds of trillions of dollars so that everyone became a millionaire, then prices would skyrocket and the dollar would indeed lose most of its value - i.e., collapse. My only plan in that case would be to buy something that preserves its real value, like metal or property.