I've recently heard speculation on Lew Rockwell's podcast with Ron Paul and Jeffrey Tucker (I think) that the federal reserves responses to the current situation is more of the same and could potentially lead to high inflation. I understand that even if this is what happens it isn't instantaneous. However can someone explain to me the causes of the current deflation that we are seeing? Does this mean the base money supply is contracting or the value of the dollar is rising?
The price "deflation" is due to a bubble being burst, i.e. the realization that various investments were in fact malinvestments due to a lack of real credit to finance them. Banks are now unwilling to extend credit, even with adequate reserves, which in effect is, as far as my understanding goes, a cessation of further expansion of the money supply (and perhaps even a contraction.)
Freedom of markets is positively correlated with the degree of evolution in any society...
My view is that it means that people are not spending or taking loans as aggressively as they have been while the central bank is busy creating lost of currency thus making the non-spenders poorer. People are not spending because they are worried about the future where money is increasingly worth less and their business situation is increasingly unstable. And why would they not worry about the future when they are increasingly poorer?????
The solution is simple. The central bank should stop operations completely and stop creating money. The people will be able to at least have a stable value of their current money. Then they can make better predictions of the future.
What the economy should not do is what causes depressions and rapidly rising prices which is exactly what the central bank and government are trying to do. That is create tons of money and have consumers go nuts taking loans. Of course this competition to use increasingly valueless money will cause prices to rise rapidly.
Maybe I'm wrong but my understanding is that the overall price level is determined by the quantity of good and services in the market place vs the quantity of money in circulation. If that is true does it not follow that for the price level to drop either the quantity of goods and services have to increase relative to the quantity of money in circulation (doesn't appear to be the case right now) or the quantity of money in circulation has to decrease relative to the quantity of goods and services (also doesn't appear to be the case)?
But isn't the problem with FRB as well? Banks give out multiplied ammount of credit based on deposits, so when a crisis hits and people start to default, the money supply contracts. Do I have anything wrong with seeing it like that? Admittedly I still don't quite understand how central banks work.
Yeah, I think you're right. My knowledge on how central banks work is admittedly limited, but that seems correct to me.
I think it's largely the result of numerous businesses and individuals selling their assets to pay their debts after losing easy access to credit, plus a significant decrease in consumption to respond to the prospects of a nasty recession. The bursting of the housing and credit bubbles also play a major role, but don't expect the deflation to last too long.
When you print $8,000,000,000,000 (TRILLION) in new money, you can't expect the dollar to retain its value. That's 50% of last year's GDP, and keep in mind that the economy was much healthier and GDP is based on consumption. Given that we have a negative savings ratio, massive foreign and domestic obligations, and a huge increase in the money supply, hyperinflation is a very real possibility within the next several years.
So no, the money supply isn't contracting, and a rising dollar is nothing but a figment of the imagination. It can only rise in relation to other falling fiat currencies. There are some hopes for the dollar, though. If the credit markets are pryed open, people would be apt to invest rather than consume or save in this environment. Offering easy credit, over-rewarding investment, and punishing savings is the perfect recipe for a bubble. Perhaps that's just the bubble big enough to keep this phony economy up and running, where consumption is #1 and savings and innovations are completely meaningless. Or, the central banks could always take that 15% of the world's gold they happen to keep and, I don't know...back it with gold.
I posted something relevant here: http://mises.org/Community/forums/p/5052/67582.aspx#67582
Okooka:But isn't the problem with FRB as well? Banks give out multiplied ammount of credit based on deposits, so when a crisis hits and people start to default, the money supply contracts. Do I have anything wrong with seeing it like that? Admittedly I still don't quite understand how central banks work.
However, you should take things a step further by asking What permits the banks to use fractional reserve banking?
I believe the answer is the government by virtue of its insurances, bailouts and guarantees against failure.
Granted, fractional reserve banking would probably still exist to a degree without government guarantees. However, it is highly unlikely that the banks would be as cavalier as they are now. Furthermore, any losses suffered by customers of cavalier banks would be their own.
Not really. It existed way before insurance, bailouts and guarantees.
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
Charles Anthony: You are right and there is nothing wrong with seeing things that way. However, you should take things a step further by asking What permits the banks to use fractional reserve banking? I believe the answer is the government by virtue of its insurances, bailouts and guarantees against failure. Granted, fractional reserve banking would probably still exist to a degree without government guarantees. However, it is highly unlikely that the banks would be as cavalier as they are now. Furthermore, any losses suffered by customers of cavalier banks would be their own.
You are right and there is nothing wrong with seeing things that way.
I know all about governments being bad, I just don't know much about the financial system, so I wasn't sure if I had gotten it right, or left out something.
I should read more and lurk less :/