I have a problem with this debt creation means deflation meme.
In a restricted economic model, where we have some actors and some money, the value of each unit of money depends only on the actors willingness to hold. The demand and supply sides consists of the same people, where demand is the wish to hold more, and supply is the less willingness to hold.
Extending this with debt, a debt which is safe and of static volume, extends the money supply. The debt is more like money if it is transferable. If a debt is completely safe, have very low interest and is due very long time in the future, and is transferable, it is in practise equivalent to money.
In all cases up till now in the model, the money supply is static and we should have stable price level on goods in the market.
Extending the model again, now with an expanding money supply in the form of base money and debt, which is the current situation in the world, value of the money unit should fall, as the supply is now the willingness to hold less plus the new money, demand being the willingness to hold is the same.
Now the big unknown, hitherto considered static, is the willingness to hold. This is of course not static in the real world, as it depends on the actors life situation and the world situation, including the important prospect of the future value of the money. Basically, if there is an expectation that the money will fall in value, people will hold less money and hold long lasting, transferable goods instead. But this will only accelerate the fall of the value of the money, it will not be an upward pressure of the value of the money unit (otherwise called deflation).
I do not disagree that deflation is a real risk (or that it is happening now), i disagree only that it is the expanding money supply in the form of debt that is the reason for it.
In my view, it is a collapse of debt that is the reason for a possible deflation. A collapse of debt will happen when the market actors consider the risk of lending too high, or when other risks make people hoard wealth in the form of long lasting consumer goods like houses and cars, paid not with loans but paid for by less consumption of other goods.
In a restricted economic model, where we have some actors and some money, the value of each unit of money depends only on the actors willingness to hold. The demand and supply sides consists of the same people, where demand is the wish to hold more, and supply is the less willingness to hold.
Extending this with debt, a debt which is safe and of static volume, extends the money supply. The debt is more like money if it is transferable. If a debt is completely safe, have very low interest and is due very long time in the future, and is transferable, it is in practise equivalent to money.
In all cases up till now in the model, the money supply is static and we should have stable price level on goods in the market.
Extending the model again, now with an expanding money supply in the form of base money and debt, which is the current situation in the world, value of the money unit should fall, as the supply is now the willingness to hold less plus the new money, demand being the willingness to hold is the same.
Now the big unknown, hitherto considered static, is the willingness to hold. This is of course not static in the real world, as it depends on the actors life situation and the world situation, including the important prospect of the future value of the money. Basically, if there is an expectation that the money will fall in value, people will hold less money and hold long lasting, transferable goods instead. But this will only accelerate the fall of the value of the money, it will not be an upward pressure of the value of the money unit (otherwise called deflation).
I do not disagree that deflation is a real risk (or that it is happening now), i disagree only that it is the expanding money supply in the form of debt that is the reason for it.
In my view, it is a collapse of debt that is the reason for a possible deflation. A collapse of debt will happen when the market actors consider the risk of lending too high, or when other risks make people hoard wealth in the form of long lasting consumer goods like houses and cars, paid not with loans but paid for by less consumption of other goods.
The 'money supply' is only a fraction of total debt (USA 60 trillion). As long as debt creation in an economy is faster than productivity, you'll have inflation. As soon as the total debt sum doesn't increase as fast as productivity, you'll have deflation (Japan first and now the rest of the western world following).
Good point. Increasing productivity has been known to cause deflation since at least Adam Smith (1776). I still don't see how collapse of debt (which reduces the demand for money because now that debt isn't going to be repaid) causes deflation. If you have to make debt payments, you will try make sure you have enough dollars to pay them. This is why debt increases demand for dollars. Again, yes initial issuance is short term inflationary, but I don't see how you can claim it is inflationary overall.
Imagine that 99 pct of the 60 trillions of debt would be wiped out. That means that the other side of the balance sheet would be wiped out as well. The price level in the economy would return to that level on which it had been as the total debt sum was at 0.6 trillions.
Sure the banks would lose a lot of "assets" but all the entities who owed that money previously would find themselves keeping more of their income. We know the banks aren't spending, but can we count on the general population and the government to sit on a surplus?
