07 September 2009

Debt + Deflation --> Default

If you find yourself deeply in debt, and wish to avoid default, you should hope for an inflationary environment. Debtors in an inflation can pay off debts with ever more plentiful money of reduced value. But if you owe a lot of money -- like the US government owes -- and find yourself in a deflationary environment, you are up a dirty creek without an implement of propulsion.

By all accounts, the US government and the Federal Reserve, have been anticipating the creation of a "somewhat inflationary" economy following the fiscal stimulus and loose monetary policy. Sooner or later, you almost have to have inflation with US budget deficits in the multiple trillions of dollars per year. But something odd -- and ominous -- happened on the way to the planned inflation.
Irving Fisher explained why the self-correcting mechanism of economies breaks down in his Debt Deflation Theory of Great Depressions in 1933: “Over indebtedness to start with, and deflation following soon after”. Most of the West has exactly that, but worse – debt is much higher. _Telegraph_via_NakedCapitalism
Many people are predicting huge new blows to the US economy from commercial real estate foreclosures, and from another round of residential mortgage foreclosures driven by growing unemployment. Hundreds of additional US banks are in danger of folding, and the FDIC can't take much more. The US government is hiring, but few other employers are doing so. The private sector is in danger of shriveling before our eyes.

If economic activity continues to shut down from the grass roots upward -- despite the exploding indebtedness of government at every level within the US -- the prospects point toward a cascading avalanche of government default.

No one really wants to look at what happens should the US government default on its debts.

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Blogger Hell_Is_Like_Newark said...

I accept that we are in deflation for the time being, but I haven't accepted the govt. can't make things worse by inflating the dollar in the future.

Given the destruction of the private sector equity markets, manufacturing, service, etc. causing the highest unemployment rates since my youth, I envision a way to Obama and Co. to inflate the dollar:

Obama will need to keep the legions of unemployed happy (keep paying those mortgages). Him and his cohorts in Congress can keep extending unemployment benefits (72 weeks, 90 weeks....). Those benefits will be paid with printed dollars (Treasury issues bonds, the Fed buys them with printed money). Then add on more benefits paid out as food stamps, WIC, etc.

In the future, you will have possibly 20%+ of the now non-working work-force with newly printed dollars in hand, needing to consume goods and services (while producing none of their own). Those goods and services will be restricted by a domestic private sector that is non-functioning.
Import goods? What if the foreign nations no longer take the dollars but demand another nation's currency (or gold)?

This is how I see us swinging from deflation to really awful period of inflation.

Tuesday, 08 September, 2009  
Blogger al fin said...

Yes. With unemployment continuing to worsen, and millions of new foreclosures in commercial and residential real estate on the horizon, there are few good choices left.

Certainly the Zimbabwe situation is a warning for Obama not to emulate Mugabe too closely.

Thursday, 10 September, 2009  

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