Something economists thought was impossible is happening in Europe

[Crazy Eddie]

Yeah, but to be fair, I thought those $100k gold certificates were only traded between Federal Reserve banks?

Though one could use $10,000, $1,000, and $500 bills until Tricky Dick started taking them away in 1969... A money belt, or a small safe deposit box, sure could hold a lot stuffed full of $10k bills.

Yeah, the point was that the denominations were a lot bigger and the dollar was worth a lot more. But that was a controversial statement apparently.

Interesting, though. The point being that having money -- even large amounts of cash if you actually had it -- is worth less over time than a financial investment of identical size.

Your $100k bill remains a $100k bill pretty much forever, slowly loosing value due to constant inflation, while $100k long term investment can grow considerably over time, slowly gaining value due to interest rates (which, in turn, are due to inflation).

Does this mean I'm finally going to get a coherent explanation from somebody as to why inflation is good and deflation is bad? Because almost everything I understand about the market-driven economy tells me that the exact opposite should sometimes be true...

 

[laughing dog]

Yeah, the point was that the denominations were a lot bigger and the dollar was worth a lot more. But that was a controversial statement apparently.

Interesting, though. The point being that having money -- even large amounts of cash if you actually had it -- is worth less over time than a financial investment of identical size.

Your $100k bill remains a $100k bill pretty much forever, slowly loosing value due to constant inflation, while $100k long term investment can grow considerably over time, slowly gaining value due to interest rates (which, in turn, are due to inflation).

Does this mean I'm finally going to get a coherent explanation from somebody as to why inflation is good and deflation is bad? Because almost everything I understand about the market-driven economy tells me that the exact opposite should sometimes be true...

Whether inflation or deflation is good or bad depends on the situation. Take deflation first. If the cause of deflation is an economy that is increasing production faster than liquidity, then deflation is typically not viewed as bad for the economy as a whole even though it redistributes purchasing power to creditors from debtors. However, if deflation is the result of recession or depression, then deflation is typically viewed as bad.

In the case of inflation, if inflation is high, it is viewed as bad. If inflation is the low and accompanied by a growing economy, it is not typically viewed as bad for the economy for a number of reasons. First, while there is some debate over this, the consensus appears that the methods for measuring inflation overstate the effects of inflation, so that an inflation rate of 1% to 3% really represent no damaging effects from inflation due to this "overstatement". Which is why many central banks set a "target" rate of inflation around 2 to 3 percent. Anything higher is thought to be damaging and to be avoided.

That is the general overview. It gets a bit trickier, because inflation if anticipated correctly has no effect on lenders or borrowers because that anticipated inflation is thought to be incorporated into the interest rate. So, it really unanticipated inflation (or deflation) that causes any redistributing of purchasing power between lenders and borrowers.

 

[Loren Pechtel]

Yeah, the point was that the denominations were a lot bigger and the dollar was worth a lot more. But that was a controversial statement apparently.

Well, besides the quibbling.... Sure, my dad (if he had them) could have bought his house in 1962, with just 2 of those $10k bills, and would have gotten several $1,000 bills in change. Could have been fun.

I know of a guy, who in the early 1990's bought a Camry with cash (literally), but it took a good sized wad of green paper. Yeah, the dealership freaked out too....

I know someone who bought a condo this century with cash--each bill worth ~$12. It was a substantial bag of money. Nobody freaked out, though, that's what was expected.

 

[Togo]

Does this mean I'm finally going to get a coherent explanation from somebody as to why inflation is good and deflation is bad? Because almost everything I understand about the market-driven economy tells me that the exact opposite should sometimes be true...

The main issue with deflation, is that it makes investing or lending less attractive than simply sitting on an asset and waiting for it to increase in value.

 

[Axulus]

Interesting, though. The point being that having money -- even large amounts of cash if you actually had it -- is worth less over time than a financial investment of identical size.

Your $100k bill remains a $100k bill pretty much forever, slowly loosing value due to constant inflation, while $100k long term investment can grow considerably over time, slowly gaining value due to interest rates (which, in turn, are due to inflation).

Does this mean I'm finally going to get a coherent explanation from somebody as to why inflation is good and deflation is bad? Because almost everything I understand about the market-driven economy tells me that the exact opposite should sometimes be true...

Whether inflation or deflation is good or bad depends on the situation. Take deflation first. If the cause of deflation is an economy that is increasing production faster than liquidity, then deflation is typically not viewed as bad for the economy as a whole even though it redistributes purchasing power to creditors from debtors. However, if deflation is the result of recession or depression, then deflation is typically viewed as bad.

In the case of inflation, if inflation is high, it is viewed as bad. If inflation is the low and accompanied by a growing economy, it is not typically viewed as bad for the economy for a number of reasons. First, while there is some debate over this, the consensus appears that the methods for measuring inflation overstate the effects of inflation, so that an inflation rate of 1% to 3% really represent no damaging effects from inflation due to this "overstatement". Which is why many central banks set a "target" rate of inflation around 2 to 3 percent. Anything higher is thought to be damaging and to be avoided.

That is the general overview. It gets a bit trickier, because inflation if anticipated correctly has no effect on lenders or borrowers because that anticipated inflation is thought to be incorporated into the interest rate. So, it really unanticipated inflation (or deflation) that causes any redistributing of purchasing power between lenders and borrowers.

Is there a reason why contracts aren't written with inflation/deflation adjustments built in as standard practice, to protect both sides from unexpected inflation/deflation?

 

[dismal]

Is there a reason why contracts aren't written with inflation/deflation adjustments built in as standard practice, to protect both sides from unexpected inflation/deflation?

In my business it is very common for longer term contracts to have some sort of inflation adjustor. It's hard to get it exactly right because not all things track CPI or PPI or whatever, so there is some benefit to relatively low and predictable inflation or deflation in long term contracting.

 

[laughing dog]

Whether inflation or deflation is good or bad depends on the situation. Take deflation first. If the cause of deflation is an economy that is increasing production faster than liquidity, then deflation is typically not viewed as bad for the economy as a whole even though it redistributes purchasing power to creditors from debtors. However, if deflation is the result of recession or depression, then deflation is typically viewed as bad.

In the case of inflation, if inflation is high, it is viewed as bad. If inflation is the low and accompanied by a growing economy, it is not typically viewed as bad for the economy for a number of reasons. First, while there is some debate over this, the consensus appears that the methods for measuring inflation overstate the effects of inflation, so that an inflation rate of 1% to 3% really represent no damaging effects from inflation due to this "overstatement". Which is why many central banks set a "target" rate of inflation around 2 to 3 percent. Anything higher is thought to be damaging and to be avoided.

That is the general overview. It gets a bit trickier, because inflation if anticipated correctly has no effect on lenders or borrowers because that anticipated inflation is thought to be incorporated into the interest rate. So, it really unanticipated inflation (or deflation) that causes any redistributing of purchasing power between lenders and borrowers.

Is there a reason why contracts aren't written with inflation/deflation adjustments built in as standard practice, to protect both sides from unexpected inflation/deflation?

Some "contracts" are "written" that way. For example, SS benefits are automatically adjusted for inflation. As to why all contracts aren't, I could only guess that in eras for low inflation, it simply is not worth the bother to have an explicit adjustment.

 

[Nice Squirrel]

Some "contracts" are "written" that way. For example, SS benefits are automatically adjusted for inflation. As to why all contracts aren't, I could only guess that in eras for low inflation, it simply is not worth the bother to have an explicit adjustment.

In most instances it is not worth the bother and can lead to unnecessary legal wrangling.

 

[fromderinside]

That is the general overview. It gets a bit trickier, because inflation if anticipated correctly has no effect on lenders or borrowers because that anticipated inflation is thought to be incorporated into the interest rate. So, it really unanticipated inflation (or deflation) that causes any redistributing of purchasing power between lenders and borrowers.

Actually these items are nonstarters if the rates are very low +/-. Such would be factored in to the overall arrangement between parties so that both wouild be compensated adjusting for these low percent changes over the term of the transaction with little or no effect on demand or supply. If rates are high relative to the term of transaction or contract then such adjusters would become onerous for one party or the other. The real effect is on psychology. High inflation increases demand and production to unsustainable levels whole high deflation reduces demand and production to unsupportable levels.

 

[Jason Harvestdancer]

Does this mean I'm finally going to get a coherent explanation from somebody as to why inflation is good and deflation is bad? Because almost everything I understand about the market-driven economy tells me that the exact opposite should sometimes be true...

The main issue with deflation, is that it makes investing or lending less attractive than simply sitting on an asset and waiting for it to increase in value.

That's the theory, but there's little evidence that that's the practice.

 

[ksen]

You'd think deflation would make lending more attractive since you're going to be paid back in dollars that are worth more.

 

[dismal]

You'd think deflation would make lending more attractive since you're going to be paid back in dollars that are worth more.

If you tell me what inflation/deflation it is going to be up front I am indifferent. If I need a 3% real return and inflation is expected to be 2% I will charge a 5% interest rate. If inflation is going to be -2% I will charge a 1% interest rate.

Where inflation causes winner and losers is when there is a change in the rate after the bond has been issued.

For example, if I need a real 3% return and except inflation to be 2% and I lend you money at a fixed 5% coupon then inflation surges to 10% I will end up with a negative real return. Unexpected inflation hurts fixed rate lenders. Unexpected deflation would help.

 

[Loren Pechtel]

Is there a reason why contracts aren't written with inflation/deflation adjustments built in as standard practice, to protect both sides from unexpected inflation/deflation?

Long term contracts sometimes are.

 

[tupac chopra]

Does this mean I'm finally going to get a coherent explanation from somebody as to why inflation is good and deflation is bad? Because almost everything I understand about the market-driven economy tells me that the exact opposite should sometimes be true...

The main issue with deflation, is that it makes investing or lending less attractive than simply sitting on an asset and waiting for it to increase in value.

I'd say the main issue with deflation is that the debts wont be able to be serviced.
The enormous sovereign debts that have accumulated need inflation. They require things to be growing.

It is possible for you to go into so much debt that you need your income to be growing to avoid bankruptcy, and that is a far far greater problem , and the one facing Europe and America.

Deflation is dangerous today because of the enormous debts that rely on "inflation"

 

[tupac chopra]

The main issue with deflation, is that it makes investing or lending less attractive than simply sitting on an asset and waiting for it to increase in value.

That's the theory, but there's little evidence that that's the practice.

Exactly. If no one buys the asset the price comes down. Eventually it is attractive

 

[Togo]

Is there a reason why contracts aren't written with inflation/deflation adjustments built in as standard practice, to protect both sides from unexpected inflation/deflation?

Long term contracts sometimes are.

You can also buy inflation swaps.

 

[SimpleDon]

http://www.vox.com/2015/2/5/7981461/negative-interest-rates-europe

Something really weird is happening in Europe. Interest rates on a range of debt — mostly government bonds from countries like Denmark, Switzerland, and Germany but also corporate bonds from Nestlé and, briefly, Shell — have gone negative. And not just negative in fancy inflation-adjusted terms like US government debt. It's just negative. As in you give the owner of a Nestlé bond 100 euros, and four years later Nestlé gives you back less than that.

Negative interest bonds don't sound like a good thing to be happening.

If demand is that high for certain bonds then shouldn't more of them get offered to meet the demand and bring interest rates back up? But then you have most developed nations in the grip of austerity fever and so are reluctant to offer more bonds because somehow the mantra "debt is bad" became a thing very serious people have taken, well, seriously.

It seems to me that this is the ideal time for government to increase spending by issuing bonds. But of course, they'll wait until interest rates start going up and borrowing becomes more expensive because as a group they're idiots.

It is deflation. And deflation is very bad in a capitalistic system. You can simply ask the question is it desirable to reduce prices, profits and wages in an economy that has high levels of personal debt, when the level of deflation is effectively added to to the interest rates of the existing debt?

(Since there no such a thing as a rhetorical question here in Political Discussions I am forced to answer.)

No, it is not.

 

[Crazy Eddie]

http://www.vox.com/2015/2/5/7981461/negative-interest-rates-europe



Negative interest bonds don't sound like a good thing to be happening.

If demand is that high for certain bonds then shouldn't more of them get offered to meet the demand and bring interest rates back up? But then you have most developed nations in the grip of austerity fever and so are reluctant to offer more bonds because somehow the mantra "debt is bad" became a thing very serious people have taken, well, seriously.

It seems to me that this is the ideal time for government to increase spending by issuing bonds. But of course, they'll wait until interest rates start going up and borrowing becomes more expensive because as a group they're idiots.

It is deflation. And deflation is very bad in a capitalistic system. You can simply ask the question is it desirable to reduce prices, profits and wages in an economy that has high levels of personal debt, when the level of deflation is effectively added to to the interest rates of the existing debt?

(Since there no such a thing as a rhetorical question here in Political Discussions I am forced to answer.)

No, it is not.

You're kind of begging the question there.

Prices profits AND wages? If you decrease all three, then it's a wash; the only issue is that it takes longer to pay off a debt, which sucks for creditors and kind of sucks for consumers. If you INCREASE all three at the same rate, debts get paid off faster, which is good for creditors and is kinda good for consumers.

In practice, however, it's usually very difficult to DECREASE the wages of existing employees. Especially in the United States, where wages almost NEVER follow the pattern of inflation or do so only sluggishly; even then, employers are reluctant to reduce the pay of their workers for fear of generating ill will among them.

Given that wages remain stagnant in both inflationary and deflationary periods, falling prices means increased consumption and/or faster paying off of debts, which is good for creditors AND for consumers. Furthermore, the stagnant wages and increased consumption, coupled with the falling value of long-term investments, means a gradual distribution of wealth away from investors and towards consumers and producers. Corresponding increases in tax revenue would also have a positive effect on NATIONAL income, as well as national debt.

IOW, deflation can actually be very good for the economy as long as wages (or profits) don't fall at the same rate.

 

[SimpleDon]

No, you haven't.

$100 in cash after a year: $100
$100 with negative 2% interest after a year: $98

This is the case no matter what happens to prices in the meantime. $100 buys more goods than $98.

That makes sense.

But you have to remember that under deflation money becomes more valuable. The money after a year can buy more goods than it could the year before. This is the problem with deflation in a capitalistic system, you can get ahead by putting your money in a mattress. You don't have to invest it.

If you do invest it you have to get a higher return to compensate for the deflation. If you have a 5% rate of deflation and you need a 10% rate of return to justify the risk you need a total of a 15% rate of return now, 10% to justify the risk plus an added 5% to compensate for the value that your money would have gained in value had you not invested and kept the cash. Another way of thinking about it that maybe more intuitive is that under the condition of deflation the value of all assets are going to drop in monetary terms every year by the rate of deflation. If your property was bought for $100,000 last year and the economy is under 5% a year deflation you will only get $95,000 dollars for it now.

 

[Crazy Eddie]

But you have to remember that under deflation money becomes more valuable. The money after a year can buy more goods than it could the year before. This is the problem with deflation in a capitalistic system, you can get ahead by putting your money in a mattress. You don't have to invest it.

You're sort of ignoring the middle option there, which is to deposit that money in a savings account. A steady deflation rate means that that money is actually worth more the longer you keep it in the bank, and this encourages workers to save since the cost of products is going down and they are able to save more of their income for the future. This reflects the old model of savings accounts where you could actually put money in the account and collect some interest on it over a reasonable amount of time; presently, savings accounts offer interest rates at a tiny fraction of a percent, where it makes no sense to open an account at all.

Another way of thinking about it that maybe more intuitive is that under the condition of deflation the value of all assets are going to drop in monetary terms every year by the rate of deflation.

Which, IF your income is purely dependent on the exchange of assets, is something to be concerned about; you have to add ALOT of value to the same asset to get a return that exceeds its deflated value.

But considering that most of the economic activity of a given country doesn't actually revolve around investments or the liquidation of assets, I'm still not seeing how this could be bad FOR THE ECONOMY. It's already clear that sudden/unexpected deflation can cause problems, but a steady/predictable/constant deflation would almost certainly have a stabilizing effect on the nation's cash flow, especially it would drive an increase in banking activity among consumers.

To use your own example:

If your property was bought for $100,000 last year and the economy is under 5% a year deflation you will only get $95,000 dollars for it now.

Which isn't actually a problem for the majority of people in an economy who either have no property to sell or aren't looking to participate in the property market. On the contrary, it's an economy that strongly rewards saving and strongly discourages credit, since the relative value of a debt also increases in a deflationary period (by ALOT, in fact, since interest rates would almost certainly remain positive). In short, consumers stop borrowing money and start saving it.