Friday, 1 August 2008

Fisher's Debt-Deflation Theory of Great Depressions and a possible revision

“Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.”

- Mr John Mills, Article read before the Manchester Statistical Society, December 11, 1867, on Credit Cycles and the Origin of Commercial Panics as quoted in Financial crises and periods of industrial and commercial depression, Burton, T. E. (1931, first published 1902). New York and London: D. Appleton & Co

I have been both a central banker and a market regulator. I now find myself questioning whether my early career, largely devoted to liberalising and deregulating banking and financial markets, was misguided. In short, I wonder whether I contributed - along with a countless others in regulation, banking, academia and politics - to a great misallocation of capital, distortion of markets and the impairment of the real economy. We permitted the banks to betray capital into “hopelessly unproductive works”, promoting their efforts with monetary laxity, regulatory forbearance and government tax incentives that marginalised investment in “productive works”. We permitted markets to become so fragmented by off-exchange trading and derivatives that they no longer perform the economically critical functions of capital/resource allocation and price discovery efficiently or transparently. The results have been serial bubbles - debt-financed speculative frenzy in real estate, investments and commodities.

Since August of 2007 we have been seeing a steady constriction of credit markets, starting with subprime mortgage back securities, spreading to commercial paper and then to interbank credit and then to bond markets and then to securities generally. While the problem is usually expressed as one of confidence, a more honest conclusion is that credit extended in the past has been employed unproductively and so will not be repaid according to the original terms. In other words, capital has been betrayed into unproductive works.

The credit crunch today is not destroying capital but recognising that capital was destroyed by misallocation in the years of irrational exuberance. If that is so, then we are entering a spiral of debt deflation that will play out slowly for years to come. To understand how that works, we turn to Professor Irving Fisher of Yale.

Like me, Professor Fisher lived to question his earlier convictions and pursuits, learning by dear experience the lessons of financial instability.

Professor Fisher was an early mathematical economist, specialising in monetary and financial economics. Fisher’s contributions to the field of economics included the equation of exchange, the distinction between real and nominal interest rates, and an early analysis of intertemporal allocation. As his status grew, he became an icon for popularising 1920s fads for investment, healthy living and social engineering, including Prohibition and eugenics.

He is less famous for all of this today than for his one statement in September 1929 that “stock prices had reached a permanently high plateau”. He subsequently lost a personal fortune of between $6 and $10 million in the crash. As J.K. Galbraith remarked, “This was a sizable sum, even for an economics professor.” Fisher’s investment bank failed in the bear market, losing the fortunes of investors and his public reputation.

Professor Fisher made his “permanently high plateau” remark in an environment very similar to that prevailing in the summer of 2007. Currencies had been competitively devalued in all the major nations as each sought to gain or defend export market share. The devaluation stoked asset bubbles as easy credit led to more and more speculative investments, including a boom in globalisation as investors bought bonds from abroad to gain higher yields. Then, as now, many speculators on Wall Street had unshakeable faith in the Federal Reserve’s ability to keep the party going.

After the crash and financial ruin, Professor Fisher turned his considerable talents to determining the underlying mechanisms of the crash. His Debt-Deflation Theory of Great Depressions (1933) was powerful and resonant, although largely neglected by officialdom, Wall Street and academia alike. Fisher’s theory raised too many uncomfortable questions about the roles played by the Federal Reserve, Wall Street and Washington in propagating the conditions for credit excess and the debt deflation that followed.

The whole paper is worth reading carefully, but I’ll extract here some choice quotes which give a flavour of the whole. Prefacing his theory, Fisher first discusses instability around equilibrium and the influence of ‘forced’ cycles (like seasons) and ‘free’ cycles (self-generating like waves). Unlike the Chicago School, Fisher says bluntly that “exact equilibrium thus sought is seldom reached and never long maintained. New disturbances are, humanly speaking, sure to occur, so that, in actual fact, any variable is almost always above or below ideal equilibrium.” He bluntly asserts:

“Theoretically there may be — in fact, at most times there must be — over- or under-production, over- or under-consumption, over- or under-spending, over- or under-saving, over- or under-investment, and over or under everything else. It is as absurd to assume that, for any long period of time, the variables in the economic organization, or any part of them, will “stay put,” in perfect equilibrium, as to assume that the Atlantic Ocean can ever be without a wave.”

While disturbances will cause oscillations which lead to recessions, he suggests:

"[I]n the great booms and depressions, each of the above-named factors has played a subordinate role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after; also that where any of the other factors do become conspicuous, they are often merely effects or symptions of these two.”

This is the critical argument of the paper. Viewed from this perspective we may see USA and UK decades of under-production, over-consumption, over-spending and under-investment as all tending to a greater imbalance in debt which may, if combined with oscillations induced by disturbances, take the US and UK economies beyond the point where they could right themselves into a deflationary spiral.

Fisher outlines how just 9 factors interacting with one another under conditions of debt and deflation create the mechanics of boom to bust for a Great Depression:

Assuming, accordingly, that, at some point of time, a state of over-indebtedness exists, this will tend to lead to liquidation, through the alarm either of debtors or creditors or both. Then we may deduce the following chain of consequences in nine links: (1) Debt liquidation leads to distress selling and to (2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes (3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be (4) A still greater fall in the net worths of business, precipitating bankruptcies and (5) A like fall in profits, which in a “capitalistic,” that is, a private-profit society, leads the concerns which are running at a loss to make (6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies and unemployment, lead to (7) Hoarding and slowing down still more the velocity of circulation.

The above eight changes cause (9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.

Evidently debt and deflation go far toward explaining a great mass of phenomena in a very simple logical way.

Hyman Minsky and James Tobin credited Fisher’s Debt-Deflation Theory as a crucial precursor of their theories of macroeconomic financial instability.

Fisher explicitly ties loose money to over-indebtedness, fuelling speculation and asset bubbles:

Easy money is the great cause of over-borrowing. When an investor thinks he can make over 100 per cent per annum by borrowing at 6 per cent, he will be tempted to borrow, and to invest or speculate with the borrowed money. This was a prime cause leading to the over-indebtedness of 1929. Inventions and technological improvements created wonderful investment opportunities, and so caused big debts.

* * *

The public psychology of going into debt for gain passes through several more or less distinct phases: (a) the lure of big prospective dividends or gains in income in the remote future; (b) the hope of selling at a profit, and realising a capital gain in the immediate future; (c) the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; (d) the development of downright fraud, imposing on a public which had grown credulous and gullible.

Fisher then sums up his theory of debt, deflation and instability in one paragraph:

In summary, we find that: (1) economic changes include steady trends and unsteady occasional disturbances which act as starters for cyclical oscillations of innumerable kinds; (2) among the many occasional disturbances, are new opportunities to invest, especially because of new inventions; (3) these, with other causes, sometimes conspire to lead to a great volume of over-indebtedness; (4) this in turn, leads to attempts to liquidate; (5) these, in turn, lead (unless counteracted by reflation) to falling prices or a swelling dollar; (6) the dollar may swell faster than the number of dollars owed shrinks; (7) in that case, liquidation does not really liquidate but actually aggravates the debts, and the depression grows worse instead of better, as indicated by all nine factors; (8) the ways out are either laissez faire (bankruptcy) or scientific medication (reflation), and reflation might just as well have been applied in the first place.

The lender of last resort function of central banks and government support of the financial system through GSEs and fiscal measures are the modern mechanisms of reflation. Like Keynes, I suspect that Fisher saw reflation as a limited and temporary intervention rather than a long term sustained policy of credit expansion a la Greenspan/Bernanke.

I’m seriously worried that reflationary practice by Washington and the Fed in response to every market hiccup in recent decades was storing up a bigger debt deflation problem for the future. This very scary chart (click through to view) gives a measure of the threat in comparing Depression era total debt to GDP to today’s much higher debt to GDP.

Certainly Washington and the Fed have been very enthusiastic and innovative in “reflating” the debt-sensitive financial, real estate, automotive and consumer sectors for the past many years. I’m tempted to coin a new noun for reflation enthusiasm: refllatio?

Had Fisher observed the Greenspan/Bernanke Fed in action, he might have updated his theory with a revision. At some point, capital betrayed into unproductive works has to either be repaid or written off. If either is inhibited by reflation or regulatory forbearance, then a cost is imposed on productive works, whether through inflation, higher interest, diversion of consumption, or taxation to socialise losses. Over time that cost ultimately hollows out the real productive economy leaving only bubble assets standing. Without a productive foundation, as reflation and forbearance reach their limits, those bubble assets must deflate.

Fisher’s debt deflation theory was little recognised in his lifetime, probably because he was right in drawing attention to the systemic failures that precipitated the crash. Speaking truth to power isn’t a ticket to popularity today either.


Thank you, Professor Roubini, for being brave enough to challenge orthodoxy before the crash, and for being generous enough to share your forum so that we can collectively address the causes and consequences of financial excess today.

Hattip: Robert Dimand, Department of Economics Brock University St. Catharines Ontario Canada for all of his efforts to rehabilitate Fisher’s debt deflation theory.

Hattip: The Federal Reserve Bank of St Louis for making Fisher’s entire 1933 paper from Econometrica available online in PDF.

Hattip: Guest on 2008-07-29 21:10:21 for the debt/GDP chart.

Hattip: SWK/Kilgores for suggesting a post on Fisher.

Hattip: Steve Phillips for tracing the Mills quote back and demonstrating it wasn't JS Mill as I originally attributed it.


hazleton said...

London Banker, through introspection, you are taking some responsibility for your actions. How refreshing.

In the year 2000, the Dalai Lama said in simple terms, that whatever expands, must contract. It is finally happening.

Anonymous said...

Firstly, a quote which I find chilling:

From Atlas Shrugged:

"Watch money. Money is the barometer of a society's virtue. When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing - when you see that money is flowing to those who deal, not in goods, but in favours - when you see that men get richer by graft and pull than by work, and your laws don't protect you against them, but protect them against you - when you see corruption rewarded and honesty becoming a self-sacrifice - you know that your society is doomed... Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked: "Account overdrawn".

Secondly and partly related: would you mind explaining to me the mechanism whereby banks turn value increases in "mark to model" assets into dividends and salaries? How precisely does one cream-off from a mirage - and who's pockets are being rifled?

Many thanks for putting your blog up here!

Jesse said...

A fine essay with a refreshing admission of humanity and we all thank you for it. It's been quite a while since I have read Fisher and intend to remedy that in the near future.

The only disappointment is that your revision was not more extended, bringing your own analysis to bear on Fisher's thoughts, updating them in light of what of course is the most significant change between then and now. It is of course that the Fed has been loosed from external standards, at least nominally, and that creates some interesting twists possibilities that Fisher may have anticipated but did not expound upon.

And thanks to Anon for that all too pertinent quote from Ayn Rand.

clark said...

What terribly good work you are setting about doing. Bravo! Please do keep at the "good work" for all of us. The realities of the deflationist camp are rather stark. It is summed up in the idea ..."no one listens, no one hears."

Gary Shilling and Robert Prechter have written books on the subjects of deflation; and, before them, the irascible convicted gold miner C.V. Meyers who did much good work - apart form his conviction perhaps.

Best to you,

From Jim Pupalava's interview with Robert Prechter Feb. 1, 2003. (Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression")

"Number one, the money supply hasn’t contracted. You are absolutely right. Now in recent weeks, it has contracted, but it has done so a few times, and they haven’t turned into outright deflation yet. As some of my critics have said, they think this is evidence that we will not have deflation. Of course, what we are discussing here is not current reality but the future. I think the slowdown in money supply growth is very ominous for a change to deflation. I think the markets are telling us that we are going to see another big impetus towards deflation, because the stock market is now heading down again. Gold, silver and commodities benefited from the liquidity that the Fed pushed into the system last year when it dropped interest rates a record amount, but I think their rallies in are probably tired.

The final argument I hear from inflationists is that the Fed will print money. We recently had a Fed governor promise that that is exactly what he would do, and the chairman is hinting the same thing. But there are many roadblocks to doing so. First of all, the kind of money printing they are talking about at this point is illegal. They would have to get Congress to let them do it. I think that Congress isn’t going to do that until a crisis is staring them in the face, and I don’t think that will happen until deflation is really raging. More important, I think the people in the Fed who say that all they need to do is turn on the printing press don’t realize that they don’t have a machine in front of them with their hands on the levers. What they have is a sea of people. People act differently from machines. They can get afraid. They can become excited. We have quite a bit of transparency these days, so people will know what the Fed is doing, and whatever the Fed does, I think, in this direction is going to panic the credit markets. We have 30 trillion dollars worth of credit out there. That is if you don’t count things like Social Security and Medicare promises, unfunded pension plans of corporations and a lot of other things that could probably double that figure, but let’s say $30 trillion. If you are a bond holder and you have, say, several million dollars’ worth of government bonds, and suddenly the Fed governor says he is going to turn on the light in the basement of the printing press office and start running the machines, what the heck are you going to do? You are going to sell your debt paper. If that were to happen on a large scale, it would cause a contraction of the overall supply of credit, the value of the credit, which would be deflation. So strictly in my opinion, the size of the outstanding credit we have today is so great that it would dwarf any initial efforts to keep the money supply inflated. Ultimately, once credit collapsed, purely printing paper would certainly have a hyper-inflationary effect. But first, you have to get past the credit markets. I don’t think they will stand idly by while some Fed governor prints cash.

Addendum per Mr. Prechter’s review of this transcription -

I am, let’s say, 70% confident about deflation. But I am fully confident about crash and depression, because even if the Fed were somehow successful in creating inflation, it would not help the economy. “Printing money” seems to imply value creation, but printing notes just transfers – i.e., steals and distributes -- monetary value from savers to others. You can’t grow an economy by printing notes because it’s just a transfer of monetary value from people who are conscientious to others who are not.

You might be able to grow inflation that way but not the economy. Credit is different because the lender thinks he still has the value and often does. Credit inflation is what we have had in recent decades, not money printing. It’s a key difference. So while the government and the Fed might be able to ruin the monetary unit, they can’t prevent the developing depression from taking place.

kilgores said...

Thank you for an excellent piece, and for the handy link to Fisher's paper.

Despite your misgivings about your potentially misspent efforts as a central banker who may have unwittingly contributed to the credit inflation that led to our current crisis, at least you began to see the potential problems far earlier, relatively speaking, than did Fisher.


Anonymous said...

London Banker,

You have been consciously pondering the implications of the worldwide credit crisis through your excellent analysis and writing here and on RGE. I have followed your progression for nearly a year now and this piece is indeed your metamorphism. You have “seen the light and the truth shall set you free”. Caterpillar to butterfly.

I just love this …”macroeconomical financial instability”. Instability meaning the lack of reliability? Dependability? No, that definition does not suffice because this is about the most dependable and reliable downturn in the history of the modern world. Rich H had the answers last fall. The lack of equilibrium (instability) was recognized and it has since been managed. I am utterly and completely dumbfounded by the actions of this past year. Is this the work of mad geniuses or complete idiots? The jury is still out, but this dumb southern hick thinks that maybe, someday, future generations of economists will look back on this era with awe and amazement.

IMO the stock market is being sacrificed, but it will take a while to reach the end of the slaughter. Tick by tick by tick, a little at a time to lessen the pain. We are in for tough times, no doubt about it, but we will learn about ourselves and our society and whether we have the” right stuff”. It’s the American way. We are after all, a nation of renegades and cowboys.

By the way, hubby’s leading economic business indicator is telling me that this is (thus far) an L shaped recovery. Bill count good, weight down, revenues don’t count because of the fuel surcharge. Question is….. how far does the flat line travel?

Love your blog,

Anonymous said...

Obviously thinkers not the blinded sheeple living in their detb based fantsy world visit this board.

In this environment what are some of the best areas to invest assets?

fedwatcher said...

London Banker,

Could you please post a link to Fisher's .pdf.
I tried searching the St. Louis Fed's site and could not find it but plenty of references to Fisher's other works.

Thanks In Advance

Anonymous said...


LB posted the link in the piece, you must have missed it

This is Africa? Maybe, maybe not.


Peter J. Bolton said...

Good work LB.

Now perhaps some who don't, will, comprehend the ways of economic forces. This is a start; the review; too bad it is history but now it must become part of the future.

The fundamentals are not sound! Hymen Minsky's work is also most important and most crucial for the future systemic build.

ho hum

Anonymous said...

Thanks for posting the link to Fisher's debt deflation paper. That got downloaded fast, before it dissapears.

For the curious, Fisher's Booms and Depressions is only available as a 'rare book' selling for about $2500 unless you buy the academic library of his works (slightly less). I'm surprised it hasn't been reprinted, but then again, not quite.

Have followed you for a while on RGE. Fire or ice? Fire or ice? I think that either will suffice....

So now it is first ice, then fire.


Independent Accountant said...

"While the problem is usually expressed as one of confidence, a more honest conclusion is that credit extended in the past has been employed unproductively and so will not be repaid according to the original terms. In other words, capital has been betrayed into unproductive works". The Misean term is has been diverted into "malinvestments" which are revealed when the "credit expansion" stops. Austrian economics does not accept equilibrium states merely the tendency towards them. I have said the US and UK have been engaged in over-consumption and under-production since 1980 when gold hit $875 and I concluded we will face two choices: gold remonitization at a high figure or hyperinflation. I first saw your "scary chart" in 1980. Franz Pick, 1898-1985 once called goverment debt certificates, "certificates of guaranteed confiscation".

PeterJB said...

I have been musing this post for awhile now and it seems to me that the mistake that Hank and Ben et al are making is that they are treating the global economic dynamic(s) as a brick and concrete system rather than a living force phenomenon.

Hank and Ben are taking on the free-market-economic system in favour of their static cow milking machine shed, where, this beast, the free-market cow, has had enough of the manipulation, torture, abuse, rape and pillage and is preparing to kick the s%#* out of the milking shed.

Even so, when the dust settles, we have tasted the riches and wealth of infinite possibilities of the economic forces, and we shall try again.

I am all in favour of such activities but warn, that this time around we must get the structural fundamentals correct, a priori. And no flip flop mathematical imagination to be applied here - the fundamental structure must be founded and applied in pure physics! Then the next step will be ours.

Yes, I am repeating what I have been saying for a long time,
"the fundamentals are NOT sound".


Anonymous said...

Fisher includes decreased volume page 343 VII.6. - is there any indication of volume trending down to date?

Susan said...


Like many other laypersons I have been watching the events of the past few years, quietly reading all I can, trying to comprehend where we are going with this. Like many others I want to take a smart position and keep my family safe.

There are a lot of people out there debating inflation vs. deflation. Arguments on both sides can be very convincing, but I still hadn't made up my mind. I have lain awake at night agonizing over this problem.

In these arguments there are loose ends that don't quite make sense. There are just too many complex global factors that exacerbate the problem, leaving my head spinning and leading me back to square one. I am also suspicious of the ulterior motives of the arguers, they usually have something to sell.

Thank you for writing this piece and revisiting Fisher's theory, I am very grateful. It was thoughtful and concise, just as I have come to expect from you. This theory would explain the phenomonon we are experiencing, it ties together a lot of the loose ends, and just about has me convinced.

First by reflation, then deflation, all around the world.

NC Jim said...

Little help please.

"(5) these, in turn, lead (unless counteracted by reflation) to falling prices or a swelling dollar; "

(1) Does "swelling" refer to exchange rate or monetary base?

"(6) the dollar may swell faster than the number of dollars owed shrinks"

(2) Can someone take the answer to (1) and interpret this statement?


Anonymous said...

NC Jim

Swelling simply is "bang for your buck". It's buying power of the dollar. The $700,000 CA Ranch house you can buy for 400,000 is an example... more for your money.

I interpret the last remark to mean that swelling can accelerate at a faster pace than dollar debt is retired. It's what we see now in housing. Again, use the house value loss analogy and mortgage balance owed. If the house was bought in 2006, then the 28 year balance on the mortgage means the homeowner in underwater, seriously underwater.

I've been pondering a lot lately about buying power. In a worldwide deflation WHO is going to have the most buying power? Something to think about.


Tiger Coach said...

Dear London Banker,

Excellent read! With the Fed and Treasury bailing out the financials, your suggestion is that it will bring about a greater crash in the future...

A greater concern is that the U.S. government to an extent is acting more like a Communist-Socialist Oligarchy... a nod from Congress, and stroke of the pen from the President... and the U.S. slips a little closer to the things it hated most.

The premise you make is that the a "Crash-less Depression" is underway. The question becomes How do investors protect themselves aside from having stock piles of gold?

Anonymous said...

Thanks, I'll be back to read all the links but it was interesting to see the dip during Ikes' term. I'm not sure but wasn't he spending money on us? Those days are long past in the US.
The race to the bottom continues

DemocracyFirst said...

May God have mercy on your soul because ignorance is not a defense. For ages people have known the impacts that central banks have on economics. They distort the free movement of capital and cause market forces to be short circuited. But, what is most abhorrent is how central banks create a self-fulfilling environment where a country's wealth is ultimately destroyed through misappropriation of capital that ALWAYS is in the best interests of financial institutions as opposed to society. That very fact has masked the underlying deterioration of the American economy for decades.

Anyone who has a basic understanding of mathematics clearly understands there was never enough money and wealth in the global economy to pay back all of the global debt built up over the last thirty years. Therefore, the only possible outcome is via massive default.

I expect it is highly plausible we could get to the point where the government must default on some level of responsibility. Especially, if the Fed must monetize much of the default in order to keep the wheels from falling off. Were that to happen, I would expect the Fed would possibly default on foreign held debt.

A "for profit" central bank is an oxymoron. Central banks should be used as an engine for wealth in the underlying economy. Until this fact is recognized, we shall repeat this cycle again and again and again.

London Banker said...

@ All
Perhaps I should have noted that moments after publishing this piece I was headed to a week of cold, wet, windy fun at the British seaside. It seems I am missing the best discussion I have ever provoked on this blog and over at RGE, but I hostage to family and friends here. I am also limited to a half-hour a day on the public library internet, although no doubt that can be overcome with some searching about for wifi.

If I do not respond immediately here, it is not because I am not grateful or impressed with the comments offered. This is a great response, and I'm deeply moved.

I may respond to select comments in a follow up for this Friday.

Anonymous said...

Thank you for the update, London Banker. I look forward to reading your thoughts.

Gloomy said...

Great post LB. So what happens when Godzilla (deflation) meets Mothra (inflationary printing presses)? Which one wins?

Gloomy said...

Deflation can't defeat the unlimited power of the printing press can it?

Anonymous said...

"In short, I wonder whether I contributed - along with a countless others in regulation, banking, academia and politics - to a great misallocation of capital, distortion of markets and the impairment of the real economy."

In short, yes.

In short, go hang yourself.

Anonymous said...

"I am all in favour of such activities but warn, that this time around we must get the structural fundamentals correct, a priori. And no flip flop mathematical imagination to be applied here - the fundamental structure must be founded and applied in pure physics! Then the next step will be ours."

I was frightened before but now I'm terrified! You really should learn a little physics before you make an even greater fool of yourself.

DemocracyFirst said...

Deflation can't beat the power of a printing press? Ask the Japanese. Ask the Fed during the 1930s. And, as far as printing presses, the Fed has not monetized any of this. Those blathering statements spewed by perma-bears are cluelessly inaccurate. The Fed has not bailed out anyone nor has the American taxpayer........yet. Blogging allows clowns to become subject matter experts to those who know even less. ie, The majority of people reading blogs.

The Fed's printing presses can't be fired up without a willful act of Congress for all of the conspiracy theorists who believe the Fed is some secretive private organization. Although it is secretive the government controls its charter. That means you control it.

The Fed can stop deflation about as much as I can. Unless, they just decide to monetize government spending ad infinitum. That is never going to happen in the U.S. as revolt would occur. Frankly, no one in the government has a death wish nor would they ever do so beyond what is perceived as necessary in serious crisis. This is not Zimbabwe and all of those writing it will become as much, are freaking idiots.

Get ready for the great deflationary bust. A global one.

kilgores said...

LB -

Unfortunately, it seems, every blog of any substance inherently seems to serve as an open invitation to self-righteous fools, who imagine their hindsight is 20-20 and that they have some sort of monopoly on truth, to post unnecessarily caustic comments. Thank you again for sharing your insights and wisdom.

If you will tolerate a bit of mock Latin, illegitimi non carborundum, my friend.


kilgores said...

OK, LB, the preceding comment merits some REAL Latin for you:

Noli nothis permittere te terere.

And for our Anonymous friend, I have a bit of French:

Va te faire enculer, espèce de cochon!


DemocracyFirst said...

Just like a central banker to delete my last post. You live in a world where you restrict the free flow of capital to elitists so in the real world why would you allow freedom of speech? Blogging while restricting speech is your attempt to control the responses. While there was sarcasm in my last post, it was clean. And, in it contained factual data on the relevant topic. You just lost a reader...........and you just started this blog.

normal being said...


You're essentially implying the US will default upon the Chinese and Saudi-Arabia, who will have no recourse and might not even admit it openly.

This amounts to protection money.
And yes - this would eventually lead to a nasty global deflation.

In this case I'd rather prefer an impartial rule of law than the "democratic" rule of a reckless people.

normal being said...


buying power:
In a deflation buying power is transferred to people whose outstanding credit is not defaulted upon or who own "hard currency".
Most people who work 40 years and plan to retire one day have outstanding credit, even if they don't realize it, because this credit may be in the form of a guaranteed government pension.

Hard currency is more difficult, because ultimately neither the dollar nor gold is a hard currency. Really hard currency is either an essential production factor or can be exchanged for the essential production factors even under adverse circumstances.

That means the dollar will be considered a hard currency in a deflation period as long as it is not defaulted upon. The moment the default happens, it will become essentially worthless and the dollar-holders will lose buying power.
Ditto for gold. In the very extreme case that one day you are hungry and want to exchange your gold into a nice meal and find that the owners of meals don't respect your shiny gold as decent currency (default upon you), you will suddenly realize that you have lost buying power by not holding hard currency.
The difference is, the default upon gold is very unlikely and would only happen in some kind of "mad max" world.
A default upon the dollar would mean to prohibit foreign ownership of US production factors (companies, property, etc.) or simply prohibit the import of dollars into the US. Extreme but at least thinkable. More likely is a simple default upon treasuries or agency debt.

normal being said...

I'm sorry, it's "outstanding debit" in English of course, not "outstanding credit". We're using one and the same word for both.
Best regards

Leila said...

As another layperson who thinks from a household finance point of view, I'm interested in this: "USA and UK decades of under-production, over-consumption, over-spending and under-investment"

It's the under-production and under-investment that interest me. Few economists talk about it much. And yet any housewife in America can see that we don't make our stuff here anymore - good luck even getting home-grown garlic, it's all from China now, as we've paved over our California garlic fields with McMansions.

We also are not taking care of the stuff we do have: our public schools are falling apart, our bridges falling down. The American Society of Civil Engineers warned three years ago that America needs to spend over a trillion dollars just repairing the infrastructure we've got.

My parents used to talk to me in the 70s about families who drive expensive cars bought on credit while failing to pay dentists to care for their children's teeth. Better to drive the old, paid-for car, maintaining it well, and protect the children's health and well-being. Buy books and nutritious food with cash on hand rather than plasma TVs and Hawaii vacations on credit.

It has seemed to me for some years now that the USA functions like the profligates my parents warned me against. We spend $ on wi-fi and cable networks for our cities, but the schools molder, bridges collapse, and levees leak. We invade Iraq to the tune of a trillion (adding all the funny accounts) but we don't have money to keep hospitals open. And of course we don't have money to provide basic healthcare to everyone but we do have billions to give insurance companies in profits. Oh yes, don't forget that our public health system has been gutted in the last generation, making us extremely vulnerable to plagues and pestilences, with no network of doctors or administrators to monitor and react.

Yes, America drives SUVs, lives in enormous houses made of vinyl and paper, and watches TVs the size of movie screens, but we don't have money for our basic needs. And we're broke.

Under-production and under-investment, indeed. But I suppose investing in infrastructure and decent public health care is socialism, dirty European-style socialism, and we can't have that...

Anonymous said...

Right, so let's assume the whole world is headed towards deflationary spiral. That means that cash is the king. And this leads to very interesting question: which cash? US dollar is not necessarily the currency of choice given that US is way over-leveraged to compare with Germany.
The reason I'm asking opinions on this is simple. I think it's very difficult to predict the currency rate - so why not stick to real money? Gold?

Lara Johnstone said...

Citori (01 August 2008 11:05)

Interesting comment 'Cowboy' :-), and agree with 'stock market is being sacrificed, but it will take a while to reach the end of the slaughter......'

In terms of your statement re: 'this is (thus far) an L shaped recovery... Question is ... how far does the falt line travel?'

Does the 'L' graph at GeoPolitics101 provide an interesting perspective?


Anonymous said...



Anonymous said...

If a house of cards begins to fall and you prop it up, when your done propping it up you still have a house of cards. Even if they can intercede and reflate the deflationary death spiral are we just putting off and potentially exacerbating the inevitable crash/depression.

Anonymous said...

From one of the comments, I don't see that the credit markets selling off bonds prevents a reflation, should money printing occur.

Presumably one of the main ways to get the printed funds into the economy would be to buy back the bonds anyway, thereby maintaining their nominal value. The only escape from bonds would be either another currency or an asset.

If you can rule out another major country then that only leaves you with assets/consumption.

Given that money printing reduces the value of savings, and also the value of debts then money printing is one of the solutions advocated by Fischer because it is the equivalent of default, against the savers wealth.

This is perhaps faulty reasoning, I would be very interested to know some examples of how bond holders would be able to maintain real value, if there is a way.

Steven Spadijer said...

I'm tired of hearing people say "deflation? Just press 'print' on a printing press (sell bonds or securities, whatever) and all will be fine". The reason the "printing press" failed in Japan, failed in the 1930s is the same reason monetarism could not contain inflation in the UK in 1980s: the money supply is endogenous...

So, we print money, and give it to the banks (increasing the monetary base etc).


Who is going to lend to a person who already has HUGE debt, is barely keeping up payments themselves and could loose their job and asset prices are falling (hence, lower collateral values and speculative incentive to investment)?

(Probably) NO ONE!

Who is going to borrow when A) they ALREADY have thousands dollars of debt and B. put deposits toward their bank, even suspecting their bank will become insolvent?


Hey, presto, credit is part of the money supply (and money and liqudity, which is drying up, due to A) no loans being made and B)unemployment is rising due to overinvestment in land is needed to pay of debt). Enter debt deflation - the more debtors pay, the more they owe.

As such, the printing press cannot work. Full stop. No point of increasing the monetary base, if it won't penetrate the market place.

Moreover, even if you dodge financial authorities (through a helicopter...), and literally drop money to people, given debt is 300% of GDP, most people will probably spend the money NOT in the market place, but paying off debt (and it will take a while until banks regain confidence to lend again).

Reflation is VERY VERY difficult once an economy turns downward (and has record high levels of debt).

Vanessa said...

Financial innovation as described by Minsky leads to greater increases in asset prices during booms as it permits greater amounts of borrowed funds to flow into asset markets making asset prices more sensitive to the business cycle. As a result the risks of debt deflation during cyclical downturns increases over time.

mack said...

This is a great post Dmitry. I just had one of the ‘Doh!’ moments and ran back to correct my own site before publishing my comment. You see my own comment form did not match what I’m about to advise. I get less comments than you, so never noticed any problem. I’ve changed it now anyway so here goes.

money and profit

Delwyn Lounsbury - THE DEFLATION GURU said...

Dangerous deep deflation dead ahead! Austrian economics says all credit inflations end in crushing credit deflations. Especially, in a Keynesian, socialism, welfarism one world government world turning ever more fascist. The parasite (big government) always sickens the host (the economy) - deja vu all over again and again. Nature!

It just took a 80 year Kondratiev wave this time instead of a 40 - 50year one like in the 1900's.

PS. Homestake gold mine shares went from $65 in 1929 to S544 in 1935 and paid a whopping $56 per year dividend. Gold to high at $1,600. Additionally, the Anglo financial power elite will want a strong dollar for the next several years to hide $ in.

Lobby for a private gold backed money. Don't let government do the money thing again or they will do us in (again) with all the borrowing, counterfeiting of fiat money and the financial repression.

See my site:
Delwyn Lounsbury - THE DEFLATION GURU.

Anonymous said...

Nice to have a quote from Ayn Rand at the end of the article - for ironic effect.

Ayn Rand's disciples are the ones that got us into this mess. Three decades of the Randisation of the US economy have left us with the kind of inequality not seen since the 1920s. Is our problem really that the wealthiest are being held back by the poorest?

As for a yearning for a return to the gold standard - its adherents need to read some economic history.

StaplesEconomy said...

You didn't follow Fisher all the way through to the Soddy-inspired Chicago Plan to writedown all that zombie debt and replace the liquidity with publicly owned debt-free, interest-free United States Notes.

"To cut the tie between debt and the circulating medium."