Is the world heading for deflation or inflation? If you talk to serious investors and long-term followers of economic trends, this is the big question. As in the boom – when the major conundrum was whether we could continue borrowing and spending – the experts are divided again.
The mainstream view appears to be that the world will suffer from some – or a lot of – inflation in the coming years. This thinking stems from the fact that all the money printed by the world’s central banks in the past 12 months will find its way into the real economy, and be shunted on from stocks to property to general prices and, then, towages.
This is one of the reasons that the price of gold – a traditional hedge against inflation – is skyrocketing. Another compelling reason to fear inflation is that the world, or at least some of the world, wants it. Many suspect that inflation will rise in the years ahead because only via inflation will the US be able to inflate away its enormous debts. Consequently, investors believe that the dollar will continue to fall against most major currencies.
The general consensus is that, while prices won’t rise now or next year because economies are too weak, as economies recover afterwards inflation will return. But the general consensus has been wrong before. In fact, the consensus has been wide of the mark about practically everything in the past five years. So what if it is wrong again?
What if, rather than entering a world where prices rise all the time, we are about to enter a period where prices and wages fall for a long, long time?
The historical portents are disturbing. The world has experienced long bouts of deflation in the past. From 1876 to 1900 was one such period, and the resulting agricultural unemployment in Ireland led to a huge upswing in emigration to the US in the final three decades of the 19th century. We had another long period from 1929 to 1939,when deflation was again the norm. Japan had a dreadful experience with deflation in the 1990s.Could this happen again?
A crucial determining factor in whether we will get global deflation or inflation in the years ahead will be the banks. (In Ireland, deflation is highly likely, as is the nationalisation of the banks, but more on that later.) If banks lend out all the money they are getting from the central banks there will be inflation, if they don’t there will be deflation. It is really that simple.
In monetary economics, there is a thing called the ‘multiplier’. This measures how many times a single euro lent out by the banks is lent and lent again. Think about the boom. If house prices went up, your net worth also went up – and this made you feel wealthy.
Therefore, you felt comfortable borrowing against this new wealth, and the bank, because it had the security of your house, which were rising in value, felt comfortable lending against it.
As long as prices were rising, you didn’t care about savings, so you spent and borrowed more and the bank lent more.
This is the multiplier effect, where one upward movement in prices and borrowing reinforces the logic of the boom and begets more upward movements in prices and borrowings and so on.
This created the bubble which has now well and truly burst, leading to the total destruction of the banks’ balance sheets.
Then the state has a choice: either it can let the banks go and create new ones, or it can save the banks and inject enough new cash to allow the banks to lend again.
But what if the banks have a different objective to the government? Yes, the banks want the cash, but not necessarily to lend out to you and me (who might not want to borrow anyway). If the banks stopped lending out cash and used the cheap central bank money they were getting to invest somewhere else, then we would have a major problem.
Let’s say that the banks use the money they are getting at 1 per cent from the European Central Bank (ECB) to buy government bonds which are yielding 5.7 per cent in Ireland and 3 per cent elsewhere, in order to rebuild their balance sheets and give the money back to shareholders. Now all the new money is stuck and doesn’t leave the banks, there is no multiplier and, what’s worse, if the people see just how much debt is costing them, they will stop borrowing and start saving.
Already, we can see that people’s attitude to debt has changed. All around the world, debt and credit (which had been expanding progressively since the 1980s) has become, not only unfashionable, but reprehensible. People want to pay off debts when they can and save more.
This causes prices to fall. And people – seeing prices falling – then expect this to continue. If you think you are going to get a bargain by postponing spending today and waiting for prices to fall even more tomorrow, deflation takes hold. This trend will be reinforced if the banks use the cheap cash they have been given to buy risk-free, high-yielding government bonds, since they will not put money into the economy.
Therefore, the very act of saving the bad banks fuels deflation and leads to less, not more, credit in the system. We get zombie banks presiding over zombie economies.
This is a possibility around the world and, as such, suggests that the recent stock market rally – one of the most dramatic in history – as well as the surge in the price of gold, could well reverse themselves. Such a reversal would usher in stage two of the crisis.
In Ireland, things are unfortunately more clear-cut. Such an outcome is almost guaranteed. The National Asset management Agency (Nama) will not lead to any resumption of credit because the banks are traumatised and have better things to be doing with the ECB’s largesse than lending it out to a country where prices fell 6 per cent year-on-year in October; and the market expects Nama Mark Two.
Remember Nama covers â‚¬77 billion of a total Irish bank lending book of â‚¬400 billion. Already the valuations for Nama are coming in much lower than the government’s estimates (surprise, surprise).When bad debts and defaults spread to the rest of the crocked â‚¬400 billion loan book, the banks will be submerged – and will have to be taken into public ownership because no private investor will give them a cent. They will become zombie banks owned by a zombie government.
The only way we can get credit flowing again is through a new bank or a system of new banks in Ireland. With this now ruled out, because our government refuses to admit what a Leaving Cert economics student can see, the spectre of deflation stalks the land.
What about these bonds then. at 5+% at what point to they become unsaleable? Irish bonds by now surely are the international equivalent of a sub-prime mortgage. It would be helpful and pragmatic to understand the risk of an Irish Government default, whether real or a de-facto default covered up by some financial fudge with the major bondholders, who could be the Irish banks. Speaking of fudges, its been bugging me for a couple of weeks now. SPV: I now remember where I heard this before. Well, actually, “Special Purpose Entities” was the accounting description of where Enron used to… Read more »
David I think that’s how the “grey eminences” in the DOF are seeing their only salvation. They are gambling that deflation with its inherent price falls will result in wage’s falling which they hope will improve competitiveness and balance the fall of Sterling/Dollar which has affected the exports of the non-American multinationals, which tend to trade in Dollars anyway. They also reckon that deflation will justify cuts in Social Welfare etc.etc. as prices tumble. They also factor in a lower GNP going forward as the Economy re-adjusts to the absence of any meaningful turnover in the now ailing property sector,… Read more »
Folks, giving more money to the banks is just crazy – especially when the 1% Nama bond given is only at 1% for the first six months; then, the gloves may come off; and when the banks can gain a net of 4.7% on the deal. Why? Because we know how these people operate: they gamble. They may even “short” the government that is raising the Nama bonds for them and short eachother, as well. More “smash-n-grab” stuff! The economy runs when money is running through it and changing hands – as many hands as possible. NAMA bonds, like the… Read more »
David, Ireland’s problems all stem from the mishandling of the guarantee. The guarantee in itself was not wrong if the actions taken after it made sense. The problem is they didn’t. There is/was a simple solution. One word – Incentive. Capitalist banks would lend if they were ‘encouraged’. The carrot and the stick. The carrot is the guarantee. The stick is bankruptcy . Even accepting this these banks needed some good ole fashioned competition. The old adage – If you want something done its best to do it yourself. So we create a new state bank. Put the money where… Read more »
This is an excellent and easily understood article. We might however address the reality and not paint over the cracks. As John Perkins points in G’s comment to this site last week – Capitalism is not at fault. The problem is the new “with-the-gloves-off-capitalism .” I worked 30 years ago in bringing industry to Ireland. We did as we were told – get the unemployed off the streets! If we had also been mandated to insist on corporate governance we would have done so. Under present jurisdiction banks will invest in where they can maximize profit if they can get… Read more »
This article reminds me of Rugby in Ireland . When does Red turn to Blue as in when does Leinster win over Munster as in when do your red cells turn to blue as in when do you lose oxygen as in when does cash disapear as in when does bankruptcy arrive as in when does the country default in payments .Until the end of the year welcome to BLUE MOON season.
‘Grey Eminence’ – this is the limestone rock found mainly in the burren and Dun Aengus that once was a powerful source of energy ( dee noblesse) and now is a dark grey dull cold rock devoid of life it once had in another life many thousand years ago.When you look back it empowers you to the future The once wheel ( circle) of Dun Aengus went round now comes round only this time the ‘grey eminence in Merrion Street ( DOF)’ will crack and it’s wheel ( circle) will divide in two leaving a feeling of an ‘after time’… Read more »
Hi again David, Yes, the topic of inflation or deflation is an interesting one. However, to consider price changes one has to examine not the direction of change but the change of the values in scalar terms, ie: there is a big difference between +0.2% inflation and +10% inflation. You remember vectors in mathematics and scalars? Indeed, I would profer the theory (and who knows, there may be others on the planet that think likewise) that deflation and inflation rates anywhere between -2% and +2% are benign, or between the range of -2% to +5%. Humans, in our limited ability,… Read more »
I think Dr Ed Walsh has got it right, http://www.thepost.ie/commentandanalysis/its-time-to-change-the-way-this-country-is-run-45632.html Fundamentally we got a serious talent problem. We need something similar to the Scandinavian List system urgently if we are seriously going to be able to get the right calibre of people into politics to reform and modernise Ireland Inc. This alone can bring the reforms required to bring the DoF and dormant civil service to heel. NAMA pot of gold crazies, decentralisation , property bubble support, the list of failed moves over the past number of years, need to be consigned to the tiphead and our country brought alive… Read more »
“Already, we can see that people’s attitude to debt has changed. All around the world, debt and credit (which had been expanding progressively since the 1980s) has become, not only unfashionable, but reprehensible. ” Interesting point, fascinating to see how tastes change, today’s fad, must do, get on the ladder is tomorrow’s lunacy – one must be careful in this world of financial illusions! Just how bad can this all get? 1920s/1930s Germany come to mind when inflation/deflation is mentioned! 400 billion (?) on the books (somewhere) 54 billion offered for 77 billion in bad loans, hard to know when… Read more »
David said: “The mainstream view appears to be that the world will suffer from some — or a lot of — inflation in the coming years.” Most readers won’t remember the inflation that accompanied the first oil crisis in the 1970s when interest rates on mortgages rose to over 15%. The real value of housing in UK is tabulated at: http://www.mortgageguideuk.co.uk/housing/uk-house-price-index.html This shows the effect of earlier inflation as well as the recent housing bubble that began in about 2000. From 1975 to 1999 the average REAL (current) value of houses in UK was Â£79,655. From 2000 till 2nd Q… Read more »
David, I believe that most economists are mixing up cause and effect when they paint a negative picture of deflation. Deflation is just an inevitable correction to the many years of unsustainable inflation that precede it and is a reversal of the profiteering of the boom years. It coincides with recession but does not cause it. Both are just part of the process that follows the bursting of the bubble. The deflation in the US in the 1930s and in Japan in the 1990s, which you mention, were preceded by huge economic bubbles. The same thing is happening in Ireland… Read more »
Worth quoting this article in full from today’s Irish Times Poor pay for reckless spending, says priest A JESUIT priest has challenged possible reductions in social welfare, stating that the poorest were being forced to pay for reckless spending. Why, given the behaviour of our banks, given Nama (National Asset Management Agency), are we talking about reducing social welfare rates, asked Fr Gerry O’Hanlon. It suggested “that Ireland’s poorest people are being forced to pay for the recklessness and corrupt activity of a number of extremely wealthy people and institutions”, he said. Fr O’Hanlon was speaking at the annual citizenship… Read more »
Inflation is but a side effect of too much money/ expectations/ psychology and loads of other stuff which really does not get to the nub of the matter in Ireland. If I want a job, I have to drop my prices and have sufficient skillset/ product which people are willing to buy. Competitiveness is the primary issue we face. NAMA is merely putting off the day when we have to grasp the competitiveness nettle. Keeping the banks afloat with funny money so there might lend (if they like you) is as meaningful as keeping the brain dead alive on an… Read more »
David. Dense article. I’m going to comment first ‘ on the ‘multiplier effect’ ‘s upward movement in prices and borrowing reinforces the logic of the boom and begets more upward movements in prices and borrowings and so on, this created the bubble’. I dunno about that one, what created the bubble was predatory lending by the banksters in conjunction with regulators in pockets in conjunction with turning blind eyes on application forms in conjunction with low i rates in conjunction with access to easy monies on the wholesale markets and most sickeningly of all all deliberately perpetrated on kamikazee greed… Read more »
If the banks purchase Gov bonds with the money provided by the EU central bank, does the Gov not then get this money, which will then find its way into economy due to Gov spending ?
Surely this money is then not “stuck ” as David suggests ?
Folks, “Half-joking, full in earnest”:
David. ‘But if what if the banks have a different objective to the government? Yes the banks want the cash, but not necessarily to lend out to you and me’. This raises the question as to who controls the banks then, right or, moreso, how the banks are controlled. Now as it is, banks are set up and supported by gov for the benefit of the macro economy via providing a payments system and lending in a way that is specifically defined by regulators???!!! If the bank does not fall in line with regulatory requirements (which is proven now to… Read more »
David. “NAMA will not lead to any resumption of credit ‘cos the banks are traumatised and have better things to be doing with the ECBs largesse than lending it out” Is it possible to traumatize oneself. I don’t think so. The banks are laughing their @rses off at how easy it was too make so much easy money and then when the scam hit the bricks how easy it was too escape the arm of the law and then how it easy it was to reset the pieces on the board and restart the money making scams again. The banks… Read more »
David. ‘When the bad debts and defaults spread.’… banks are done for.. ‘ and will have to be taken into public ownership…… becoming zombie banks owned by a zombie gov’ Well directed truth serum there and it means us irish will just have zombie banks @rses sitting on our faces. What the fu&k is going here with this. I for one do not want a zombie bank and zombie gov sitting on my face telling me ah sure what can you do, were going to have to tax you more and cut your allowances and sure what can we do… Read more »
Are we faced with the fact that the bankers and the politicians here in Ireland simply do not know what they are doing.
Is it they have inherited a system that they do not understand technically.
Maybe they just blindly believe there is no alternative and merely continue with the status ante and leave it at that due too convience and comfort and boat rocking and if so i implore them and anyone else to investigate alternatives and here is one.
Lets Get Real – if we are serious to want a new banking system our new central bank should be called ‘ The Bank of Ireland’.
We can then start to believe in our new monetary pride.
P.S. If anyone on this forum tries to say these people fell asleep at the wheel, I will bang my head on the desk for 10 bloody minutes.Its not a question of “we are where we are” but its “ we are where we were bloody led”. Count to 10 Tull remember your blood pressure….1.2.3……
A good analysis of “Where we were bloody led” :wink:
@G 12above The church will adapt to our new banana republic, it does well in similar plutocracies in Latin America and elsewhere. The more extreme will probably resist any efforts towards advanced democracy along the Scandinavian List model – preferring a return to 1930’s. Plus they need to get their own house in order from what we read in the papers. I’m thinking a benign dictatorship with puppet Brian at the helm and a parish pump church controlled junta might do the trick:) Come to think of it, seems we may get to that if there’s a lot of civil… Read more »
@colm brazel Interesting you say the above, especially your reference to Latin America. One of the reasons why I posted the full article is because the Jesuit priest quite cleverly dropped in subtle hints to liberation theology and the concept of ‘social disgrace’. In Latin America as you may know, liberation theology took hold through the Jesuits and for the first time in about 500 years (with notable exceptions such as the Dominican BartolomÃ© de las Casas), took the side of the poor. The consequences were self-evident, a number of Jesuit priests were killed in Central America along with nuns… Read more »
@MALCOLM, I’m starting to scratch my head at all these going on’s. Cliff Taylor carried a piece on yesterday’s SBP on the NTMA, in which he outlines some facts that I’m sure most people will find strange. Michael Somers appeared before the Public Accounts Committee last May and pretty much said that he knew bugger all about NAMA, lack of information and all that old evasive stuff, yet it seems it was he who commissioned Peter Bacon to draft the report which was to form the basis for NAMA. It also transpires that Corrigan, the guy who takes over the… Read more »
Japan had a dreadful experience with deflation in the 1990s.Could this happen again? Good question. Japan in 1990 was the most technologically developed economy on the planet. In many ways Japan still is. This leads us toe the question – does reaching technoligical efficiency make deflation inevitable. If this is true, then maybe the entire inflationary economics of Greenspan, Gordon Brown, etc.. lead the road to technological and societal decline. Maybe we should have an economic policy that assumes deflation. I am saying that with an infrastructure base that is technologically based, the life cycle shortens with the result that… Read more »
Maybe this is how it works up there in Leeson St? This is the scene between Pooh-Bah, ‘Lord High-Everything-Else’ and Ko-Ko, the Lord High Executioner, from The Mikado. Ko-Ko. Pooh-Bah, it seems that the festivities in connection with my approaching marriage must last a week. I should like to do it handsomely, and I want to consult you as to the amount I ought to spend upon them. Pooh-Bah. Certainly. In which of my capacities? As First Lord of the Treasury, Lord Chamberlain, Attorney-General, Chancellor of the Exchequer, Privy Purse, or Private Secretary? Ko-Ko. Suppose we say as Private Secretary.… Read more »
Moon Warning – On the 24th Nov ’09 , the date of senior civil servants strike , is the 1st day of ‘The PULL ‘ – this is serious because what leads afterwards becomes very vociferous and emotional and maybe lots more – it definately will be the most dangerous Blue Xmas Season in our lives .
Buy Hot Water Bottles , Gas Cylinders , Lots of Candles . Lamp Oil, Heating Oil, Batteries etc
I was watching the news here in Oz tonight . There was a piece on our property bubble . This bank economist came on to give his two bobs worth and when asked what people should do who cannot afford a house and fear missing out said ” I would not worry to much , sit tight don’t buy now and just save . Property bubbles come and go but property always comes back to affordability at some stage “
Irish Times: “Mr Doherty’s annual salary is expected to remain at about â‚¬633,000, the amount he was paid in 2008, after his imminent promotion to the new role of managing director at AIB, according to sources with knowledge of the bank’s plans.” Extraordinary! A slap in the face for an t-Aire Airgeadais, Brian Lean-a’- ChÃ¡in!! At the peak of the property boom Mr Doherty would have been able to pay CASH for a luxury Dublin city-centre apartment with his DISCRETIONARY income. Today he could buy 2 such apartments thanks to property-price deflation. His discretionary income has increased by 50% and… Read more »
Irish property finally showing some realism. The property bubble deflation is coming near to where prices should be.
I still say emigrate – FF has bet the future with borrowed funds on a long shot (NAMA). The result won’t be like Bertie’s wins on the horses. Ireland will lose, and the recovery will take most of the rest of your working life if you’re more than 30 years old.
Ever get the feeling that there is a human capital deficit in the banks that is as bad as the financial deficit. The people who caused bad banking in the boom are still causing banking to be bad in the bust. This is a case of ‘institutionally derived failure”. Therefore we should let failed banks fail. Compensate the depositors. The deposits will flow to the post office system or the healthier banks. And the system will rebuild itself. Key driving engines behind deflation. i) The financial imbalances in the private sector. ii) the cost of imported goods coming down from… Read more »
Actually the only element that is causing inflation at the moment is government policy – injecting 20 Billion Euro of borrowed money into the economy, as a means of fighting price decreases. And this money is concentrated on 40% of the population exclusively. And in in fighting deflation, government policy is in effect trying to prop up the property market. But the fundamentals are driving the property market further downwards. Before anyone says that this is all FF’s fault, check out what the ILP have to say -they seem to think that even more should be borrowed. We need a… Read more »
“Already the valuations for Nama are coming in much lower than the government’s estimates (surprise, surprise).”
Does anyone have any figures for this? I’d really love to see the differences between the different valuations and government estimates? Will this revelation of Lenny nonsense get people marching on the street?
“All of our efforts, in Government, are aimed at getting people back to work”, said BL in the Dail, today.
That sound correct to “anybody”???
To me, that sounds like something BC “stuck-into” his speech, not something that BL would come up with by himself.