The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy by David Wiedemer, Robert A. Wiedemer, Cindy S. Spitzer Page A
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matters more confusing, there is a difference between a change in the “nominal” price, which is the price paid, and a change in the “real” price, which is the price adjusted for inflation. The nominal price can rise due to inflation, while the real price can fall due to falling demand or rising supply. The fact that some asset values (in real dollars, adjusted for inflation) will fall due to popping bubbles does not mean we have deflation. What we have is falling bubbles.
Wrong Deflation Argument #2: Demographics Are Changing
Another argument we’ve heard for deflation is based on demographics. Some have said that as the Baby Boom generation reaches retirement, more people will be saving what money they have, which will make dollars scarcer and therefore more valuable. The problem with this is that, in the twenty-first century, when people save their money, they don’t put it under their mattresses. They invest it. It circulates in the economy just like it always has. Even if there were some truth to this idea, there’s no way that a little extra penny pinching by the Baby Boomers could offset the massive money printing by the Fed that we’ve seen so far and will continue to see. Also, remember that we have had no periods of deflation in the United States since the end of the Great Depression when the government began to print more money. Inflation helped pull us out of the Depression. We simply cannot have significant deflation now or in the future when we are massively printing money.
Wrong Deflation Argument #3: Debt Write-Offs and Bankruptcies Reduce the Money Supply
Another common argument for deflation is that when debts cannot be repaid, the resulting write-offs and bankruptcies will effectively decrease the money supply. This argument seems to come from the fact that money is created as debt. But the argument goes one step too far in assuming that when debt is destroyed, that reduces the money supply. A simple thought experiment will show why this is untrue: If you lend me money and I can’t repay you, the debt may be wiped out, but the money went wherever I spent it. It’s still in circulation. Destroying the debt does not destroy the money.
Wrong Deflation Argument #4: Available Credit Is Declining
A similar argument is that, when we talk about the increase in the money supply, we’re not considering that credit effectively functions as money. So if the amount of credit goes down in a struggling economy, the money supply is effectively decreased, too. But decreasing credit doesn’t cancel out any money already in the system—it just slows the rate of new money being introduced in the economy, which doesn’t matter much if the economy has already been flooded with money. Whenever a purchase is made using credit (say, when you buy a TV with your credit card), sooner or later it ends up in a bank account somewhere. Once it’s in a deposit account, it makes no difference where it came from. It’s in the economy for good.
Wrong Deflation Argument #5: The Fed Can Get Rid of the Extra Printed Money before Serious Inflation Kicks In
There are two reasons why this will not happen. The first problem with this solution is that the economy is showing no signs of growing under its own steam. (Remember, there is no “natural” growth rate; the bubbles have been the growth engine, and without the bubbles, not much growth happens). Pulling money out of a no-growth economy would just make the recession far worse not better, so that won’t work. The second problem is that even if the economy did recover somehow, not only would a contraction of the money supply jeopardize those gains, but the only way the Fed can pull that money out of the economy is by selling $1 to $2 trillion worth of government bonds. Not exactly a winning scenario in an already precarious public debt situation. If they tried to do this by selling the bonds, interest rates would rise. Higher interest rates would have a negative impact on
Wrong Deflation Argument #2: Demographics Are Changing
Another argument we’ve heard for deflation is based on demographics. Some have said that as the Baby Boom generation reaches retirement, more people will be saving what money they have, which will make dollars scarcer and therefore more valuable. The problem with this is that, in the twenty-first century, when people save their money, they don’t put it under their mattresses. They invest it. It circulates in the economy just like it always has. Even if there were some truth to this idea, there’s no way that a little extra penny pinching by the Baby Boomers could offset the massive money printing by the Fed that we’ve seen so far and will continue to see. Also, remember that we have had no periods of deflation in the United States since the end of the Great Depression when the government began to print more money. Inflation helped pull us out of the Depression. We simply cannot have significant deflation now or in the future when we are massively printing money.
Wrong Deflation Argument #3: Debt Write-Offs and Bankruptcies Reduce the Money Supply
Another common argument for deflation is that when debts cannot be repaid, the resulting write-offs and bankruptcies will effectively decrease the money supply. This argument seems to come from the fact that money is created as debt. But the argument goes one step too far in assuming that when debt is destroyed, that reduces the money supply. A simple thought experiment will show why this is untrue: If you lend me money and I can’t repay you, the debt may be wiped out, but the money went wherever I spent it. It’s still in circulation. Destroying the debt does not destroy the money.
Wrong Deflation Argument #4: Available Credit Is Declining
A similar argument is that, when we talk about the increase in the money supply, we’re not considering that credit effectively functions as money. So if the amount of credit goes down in a struggling economy, the money supply is effectively decreased, too. But decreasing credit doesn’t cancel out any money already in the system—it just slows the rate of new money being introduced in the economy, which doesn’t matter much if the economy has already been flooded with money. Whenever a purchase is made using credit (say, when you buy a TV with your credit card), sooner or later it ends up in a bank account somewhere. Once it’s in a deposit account, it makes no difference where it came from. It’s in the economy for good.
Wrong Deflation Argument #5: The Fed Can Get Rid of the Extra Printed Money before Serious Inflation Kicks In
There are two reasons why this will not happen. The first problem with this solution is that the economy is showing no signs of growing under its own steam. (Remember, there is no “natural” growth rate; the bubbles have been the growth engine, and without the bubbles, not much growth happens). Pulling money out of a no-growth economy would just make the recession far worse not better, so that won’t work. The second problem is that even if the economy did recover somehow, not only would a contraction of the money supply jeopardize those gains, but the only way the Fed can pull that money out of the economy is by selling $1 to $2 trillion worth of government bonds. Not exactly a winning scenario in an already precarious public debt situation. If they tried to do this by selling the bonds, interest rates would rise. Higher interest rates would have a negative impact on
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