Deflation

Two years ago if you wanted to buy a house the amount you would have paid would certainly be higher than the price you would pay today. If you wanted to put gas in your car, you would have paid as much as $2 more than today. In most retail stores, while there were items on sale, the sales were neither as broad nor as deep as they would be today. It is also likely that the salary or starting pay you could get would be higher than you could get today, however there are a lot of variables there.

So have we experienced Deflation? One of the things that is worrisome about deflation is that since the currency is worth more, debts become more expensive. Also, since prices are declining there is a disincentive to buy since there is an expectation that whatever it is you want to buy will be cheaper tomorrow.

This may sound sort of like the situation facing us today, yet you hear a lot of talk about the return of inflation because the Government is creating money. Is it really? When the bank reserve requirements increase, you are taking money off the street. If you don't replace this money somehow, you have less money, not more. So is more money being created than has disappeared?

When you consider the idea that the Government is creating money, some seem to think they just turn on the presses and print a bunch. They actually create money by borrowing with a promise to repay. The money created this way can be considered as a "dilution" of the money supply but that is only true if the amount of money in use is greater than it was before the borrowing. It should also be noted that when banks use assets to loan money at multiples of those assets, they also either create or remove money from circulation. So is the value of those assets go down and therefore less loans can be made, there is less money. In fact, as we move more and more to electronic transactions, the need for money to ever get printed diminishes.

So, if we have had trillions of assets lost because of falling valuations in housing, stocks, inventory and commodities, isn't that a whole lot of money that went out of circulation since the banks had to reduce loans and replace the lost assets used as the basis for future loans. Has the Government borrowed enough to replace all this lost money? One problem in measuring this is that the money supply measurement that would be meaningful here includes the value of the assets on the banks books. While it looks like it has increased, that depends on whether the bank assets are properly valued. Since we dropped the "mark to market' rule it is more likely these assets are valued at hopeful amounts. This is of course why the reserve requirements have been increased, and is assets recover value, the hopeful valuations may end up being correct, but it is doubtful to me that there is really more money available.

I think worrying about inflation right now is a bit premature, we should be worried about deflation.