Hi Believable.
I'm going to take a stab at exploring your previous posts re: inflation/deflation. I'm just going to explore the meaning of such terms as Inflation, Deflation, Credit, and Debt, to see if I can come to some sort of understanding of how the various terms "fit" with each other. I don't know how useful this exercise will be, but I'm going to give it a whirl just the same.
I am going to work with the following definitions:
Inflation = an increase in money in circulation compared to the supply of goods and services in an economy.
Deflation = a decrease in money in circulation compared to the supply of goods and services in an economy.
Would these be appropriate definitions or not?
Working with the hypothesis that we are in a powerful deflationary environment, what does this mean? It would have to mean that there is a powerful force reducing the money in circulation when compared to the supply of goods and services in an economy.
So I'm then led to ask, well what exactly is money? Can we say that money is properly reflected in the standard monetary aggregates M1, M2, and M3? If so, what economic force would powerfully reduce the amount of this money in circulation?
Well, speaking from my own example, a little over two years ago I had perhaps $80,000 in cash in a variety of cash or chequing accounts. This money came from liquidating capital gains made in the stock market during the course of 1999 and 2000. I presently have a negligible amount in liquid cash parked in cash and chequing accounts (or money market instruments). The reason being largely is that I took this cash and reinvested it in the equities, which have subsequently declined in value so that my total wealth as measured by the value of non-liquid assets has also been reduced, but my liquid assets are very close to zero (for arguments sake).
So even though the Fed may have increased the "money supply" at a rapid rate over the past year or two, I have seen a drastic reduction in liquid cash at my disposal. It would not surprise me if many investors have shared this experience of reduced liquidity. And not just investors, but businesses also - some having so severely experienced a "liquidity crunch" that they have been forced into bankruptcy, and thus a complete liquidation of their assets.
Leaving aside Inflation and Deflation for a moment, what about the role of Credit? It seems how we got into this mess in the first place is that the Banking System provided a whole swack of Credit that people and corporations liberally accessed to consume goods and services. This Credit was borrowed, then spent, and when the money disappeared, there was little liquidity left but a whole lot of Debt.
This then is the real powerful Deflationary force - Debt, debt that was accumulated through a massive Credit expansion that was liberally accessed and spent.
So the powerful Deflationary force of which I speak must come from two primary factors: (i) the collapse of Asset values which sustained an illusion of wealth and Credit extension, and (ii) the necessity for Debt liquidation.
Against this powerful deflationary force, the Fed is trying to expand the availability of Credit (again) so as to achieve a corresponding increase in Money in circulation in the economy, but this time with a collapsing Asset bubble and massive Debt liquidation.
... and what will happen then, is that the Fed will try to expand the Money Supply, but will be unable to. Because no one can afford to borrow money, even when the cost of capital is essentially free. And once deflation kicks in, and prices start to fall as an oversupply of goods and services meets with diminishing money in the financial system, the Demand for Money will nearly evaporate. And you have a very big problem.
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So UnBelievable, you stated:
"If the Fed is increasing the Money Supply by 15-18% per year, but the economy (real goods and services) is only growing at 2% a year, wouldn't that necessarily create an inflationary environment?"
... I'm not sure I yet know what the answer to this question is. But what I do figure is that in Debt Deflation, the Fed cannot through monetary mechanisms create "demand for Money". It can go as far as basically making money available for free, but it cannot compel citizens to "borrow" this money if they do not feel they can profitably reinvest it or repay it.
I don't know if I've helped clarify any issues, or rather merely exposed for all the muddledness of my thoughts on the matter.
But I think I'll leave it at that for now to see if anyone else can shed some clarity on the issue.
Oh, one more thing, re: the fundamental role of a central bank, I think that "stablity of exchange" or "currency stability" would definately be their main priority. However, in extreme cases, could their not be a case where a society would want to shift an extreme burden on Debtors to Creditors, or an extreme burden on Creditors to Debtors. In other words, are there not situation where a society may wish to allow for gradual inflation or disinflation/deflation?
Dunno really, it just seems to me that there may be economic scenarios where the above might be a valid socioeconomic goal.
Regards,
Glenn |
