Topic: Help me understand deflation scenario (of fiat) - page 2. (Read 2852 times)

Actually, automation increases average productivity which increases average wage.

It used to take an army of people to farm a field; now it takes one guy and a tractor.  Those excess people are (over time) free to be productive elsewhere in the economy.

More production over the same number of people is higher GDP per capita, which is higher wages.

(I know, I know, I don't understand just how advanced these robots are going to be...)

+1

Sadly given how little humans have evolved I think automation will lead to massive poverty rather than a post-scarcity utopia that it possible.

An interesting piece of fiction:
http://marshallbrain.com/manna1.htm

Another significant reason of deflation is the technology advance. It's not hard to imagine, at an extremely high tech level, robot will replace most of the human work, and that will dramatically reduce most of the people's income if today's "income based on work" model still used. Reduced income will surely cause deflation

You make a very good point!

This is precisely why an aggregated view of the economy (like looking at GDP) says nothing (or at least not much) about the health of that economy. The GDP might grow, but what's growing might be all the wrong stuff (crassest example: the GDP growth coming from running a war, which is not producing wealth, but destroying it).

I think this is a huge chunk of what's wrong with current monetary policies around the world. The policy-makers are actually blind as to the state of the economy they are trying to regulate. They're blindly pumping money into the economy (trusting some greed-driven criminal private investment bankers to decide where to put it) and then pointing to a 1% increase in GDP, saying: "everything on track, no need to worry, choose our party again next election".
The economy itself sees its price-finding mechanisms totally distorted by the cheap money injections all over the place and doesn't function properly and as a result misallocates resources.

The humongeous capital misallocations this produces will have to be cleaned out at some point. The longer it takes, the more hurtful this will be. A deflation will probably do the job just fine. After that it's probably hyperinflation, then new sound money (currency competition, bitcoin ftw!). Ergo my investment advice: during the possibly coming deflation, when you need cash, don't sell all your bitcoins.

Good point!

And , the deflation/inflation is not happening everywhere at the same time to everybody,  especially with today's production model, some of enterprises can sit on tons of cash while others might be suffering long unemployment, commodities can have fast price rise while IT products keeps drop in price

So the current "one size fit all" monetary policy (e.g. either easing or tightening from top to bottom), when it solve problem in one part of the system, it will create problem in another part of the system. If the new money flow can directly injected into certain area which needed money most, then the whole situation can be controlled with much more flexibility and efficiency, and the regain of confidence is much quicker

For example, instead of inject money to buying underwater mortgage assets and save banks, put the money to jobless insurance program and ensure all the jobless people will have at least 10 years of jobless insurance, then the total consumption power of the nation will not change by too much, thus the economy will be easier to back on track

Someone might argue that these money will just be consumed and not generate any profit but that is a misconception, these money will surely generate profit for many enterprises which sold their products to those jobless people. It does not matter HOW money enter the system, but it does matter WHERE it enter the system

In theory the perfect monetary policy (if you think you are god and can control an economy) would be 0% price inflation/deflaiton.  The money supply grows at same rate as the underlying economy and in aggregate prices remain the same.  $20 today would buy one ounce of gold just as it did 100 years ago.

Central banks tend to be wary of deflation because it is a far more difficult cycle to break.    Inflation can be easily controlled via interest rates.  Deflation not so much.  Due to that risk Central banks tend to hedge their bets (in theory) on a target of consistent modest price inflation to give them a buffer against a deflationary cycle.

Personally I think modern economies are far to complex for Central Banks to control via monetary policy and it is just a fools errand but they keep trying.

money velocity
sounds very reasonable, thanx,

I could not articulate that by myself, but i understand the concept

it was a pleasure reading above posts

Prices actually going down all across the economy is an extremely rare phenomenon. It might had happen 100 years ago, in the age of precious metals, but people nowadays don't realistically expect prices to go down, and they don't "hoard" money in order to buy more stuff later. You might see it in some asset classes, say real estate, but not enough to cause a generalized and significant price drop in the whole economy.

What actually happens when deflationary expectations set in is not really a drop in prices, but a sharp drop in the velocity of money. It's intuitive: if the total monetary mass changes hands half often than it used to, the total economic output of the economy halves, even if prices stay the same. Because of the lower aggregate consumption, businesses start failing and credit becomes scarce. Mass unemployment and underemployment ensues. People start to consider themselves "lucky" to have a job at all, setting in motion the recessionary feedback loop: households and business defer consumption and investment because they anticipate "hard times" ahead, and holding onto their savings, preferably in the most liquid form possible, becomes an issue of survival. This reduces velocity further, in a self-fulfilling prophecy.

It important to underline that people don't deffer consumption for the sake of speculation, i.e "money will be worth more in the future". Most economic agents are risk averse and they hoard money to ensure continuity and survival, not to seek future profit. That's why simply injecting liquidity (preventing price deflation thus denying the future profit) does not solve the economic crisis. As governments around the world grudgingly start to realize, economic recovery is an issue of confidence, pure and simple. Unlike inflation, you can't manufacture confidence in the printing press - you need good policies and credible leaders.

Oh, I forgot to mention fractional reserve banking.  This is where actual deflation (instead of just increasing value) happens.

In most countries the majority of fiat is not issued directly.  Instead it is created through debt - as debt grows, the money supply grows, and the inverse.

During inflation (value loss) it is advantageous to borrow money (worth a lot now) and pay it back later (when it is worth less).  Generally interest rates are higher than the inflation rate, so it's not a free ride, but inflation partially subsidizes your loan.

During deflation your money is worth comparatively little now but it will be worth more in the future - so if you can you pay down your loans now (when money is easy to get), and have less debt load when money is more valuable (requires more work to get) in the future.

Since debt is money, everyone paying down their debt decreases the money supply - and thus causes self-reinforcing deflation.

If people perceive that the currency will be more valuable in the future they will tend to hoard it.  That reduces the amount in active circulation, thus increasing purchasing power and decreasing prices - IE, the currency's value goes up.  People see that and perceive that it will continue in the future, creating a feedback loop.  This cycle can be broken by carefully increasing the money supply but overdoing it can cause a crash, especially if it has been deflating for some time.

This is currently happening in cycles with Bitcoins (issuance cannot be increased), it was happening until recently with gold (issuance is limited by miners' ability to ramp up; I'm not in metals so I won't say if it's done or not), and it can easily happen to any fiat currency.

I'll leave the rest of your questions to the metals guys.

I like to think that I understand the (hyper)inflationary scenario that
could happen because of money printing, and how that would be "prefered" because it
is better environment for tax collection.
But that is exactly my problem,
I can't see how or why there is deflation scenario possible
if nothing else, because of ever increasing volumes of currencies.
Is deflation possible at this point in time and with todays circumtances ?
Who and how can withdraw that kind of volume from circulation ?

I found very little information on these questions :
How precious metals perform in deflation ?
Do they preserve purchasing power ?

If PM-s double price this year - sell half or hold ?
If PM-s double purchasing power this year - sell or hold ?

what to use next for wealth preservation, after PM-s bubble burst ?

What must happen for FED to increase interest rates ?
Would it be just a political decision or they "must" wait for something in economy ?