Maurice -
...Re those comments you made, wouldn't the Fed cut money supply if demand was dropping, causing inflation, by not lending US$? That would reduce the number of dollars circulating, [or, as you say, in cash balances], which would mean each dollar would be worth more, which would maintain the currency's value. ...
If there is going to be deflation, I think it may come about from something like the following --
At some point the FED will decide that it simply cannot continue to inflate the money supply. At this point, the companies that are struggling to handle heavy debt loads will no longer reap the benefits of a continuing slide in the purchasing power of the repayments that they are obligated to make. As these companies go into default, and possibly into bankruptcy, the debts that they owe to the banks become worthless and can no longer be claimed as bank assets. The banks must immediately retrench, reducing their excessive leverage by increasing the level of their fractional reserves. Now the next level of marginal companies have both lost customers to bankruptcy and are unable to get the banks to roll over their loans, and may fail themselves. How far this goes, and the degree of bank failures, is unpredictable. However, the large reduction of outstanding credit undoes the original expansion and is equivalent to a large reduction in the money supply, reducing the money prices of goods (and company revenues and profits) across the board, and increasing the purchasing power of the continuing repayment obligations associated with the remaining outstanding debt, making them increasingly difficult to meet. Under this scenario, it is the banks that are causing deflation as they de-leverage, and there is little that the FED can (or should) do about it. Once the banks initially expanded credit with the encouragement of the FED, the die was cast.
Regards, Don |
