The downside to deflation in a debt-based monetary system?

[seraphson]

New Version:
Okay...

Not sure how this exploded into 18 pages but perhaps I should rephrase the question.
What exactly does deflation do in a debt-based money system?
Is it any more different than say a gold standard money system?
Deflation is usually considered a balancing behavior to reach equilibrium in an inflated free market system; so just enough deflation to reach equilibrium is good; too much is obviously bad.
In our current deb-based money system why does Bernanke want housing prices back up? Is it because at the current pricing levels they don't pay back the money that was credited into existence with their construction?

Old version:
I was curious (after doing an advanced search for 'deflation collapse' with no results) why is the deflationary market pressures so bad for our inflationary debt-based system?

I recall housing prices being very low and Greenspan mentioning that burning the 'extra' houses down from the housing bubble was a swell idea to get the prices back up.

Is the reason deflation is so bad (from a Bernanke point of view) because the value of items decrease making it easier to pay for them; which is bad in our inflationary model since paying off debt is actually akin to "destroying" "money"? But I thought wages go down as well as prices so that confuses me. Any answers would be appreciated. Thanks!

[cubical]

I would say to sum up the mainstream economic thought, that deflation causes people to not spend their money because they know if they wait they will be able to afford more in the future.

[Steven Douglas]

I would say to sum up the mainstream economic thought, that deflation causes people to not spend their money because they know if they wait they will be able to afford more in the future.

That describes one perspective of a hyperdeflation. Whereas hyperinflation causes shortages of goods, because everyone knows they will get more tomorrow than today, hyperdeflation causes a shortage of currency for the opposite reason; namely, money will be worth more tomorrow than today.

But that ignores the extremes. Hyperinflation is where a currency supply increases toward infinity, its value moves toward zero. Hyperdeflation is the opposite, because as the supply approaches zero, its value goes toward infinity.

The ultimate problem with hyper-deflation is that it causes people not to have any money to spend in the first place, without regard to whether or not they want to spend any. In hyperdeflation feeds on itself, because the value of whatever scarce currency you have increases, but so does the value of your DEBTS - the nominal value of which stays the same.

All of this is based on a fatal design flaw of the debt-based system itself.

A debt-based monetary system can only be inflationary, and can only survive for a time - as when an economy is productive and the population is growing. Perpetually. This is because the principle is created, but not the interest to pay any of the debt. The interest has to come from the prior existing currency. This makes banks a wealth siphon. In a very short time, all the claims on existing currency outnumber all the currency in existence, and often by orders of magnitude. This in turn makes it physically, mathematically impossible to pay down the aggregate debt, because if you even tried, the money supply would disappear entirely (as interest siphoned away), long before all the debt was paid. So there would be no currency in existence, and the outstanding debts would still not be paid.

Hence, the system must expand, exponentially, as a perpetual inflationary spiral -- FOREVER -- to survive. Once the system can no longer expand, no long take on new debts (new principle to pay down the old principle plus interest), the entire system implodes. This is because all that remains are claims on currency -- again, which forever outnumber the currency itself.

It has nothing to do with people wanting to spend or not. There's an old saying from the Great [deflationary] Depression, that "Anybody who had two dimes to rub together was king. The problem is, nobody had two dimes to rub together."

That is not a case of people hanging onto their money during the TRANSIENT deflationary crash. That is a case of nobody even having a medium of exchange to work with AFTER the crash. After all prices have already hit the floor.

[mightymatt]

But that ignores the extremes. Hyperinflation is where a currency supply increases toward infinity, its value moves toward zero. Hyperdeflation is the opposite, because as the supply approaches zero, its value goes toward infinity.

If interest rates go up by n%, the available credit available credit goes down. Suppose you were going to take out a 20k car loan at x% and now the interest rate for that loan goes up. You monthly payment was going to be $300 per month, and that's the most you could afford. Now the interest rate goes up by n% so your monthly payment would go up by (20k)*e^((n+x)*time). Suppose this makes your payment go to $350 per month and you can't afford it so you don't buy the car. This causes a deflationary force and now the car maker must lower the price of cars because there is not enough credit around to purchase cars at $20k.

This is my limited understanding of economics. If you let the market determine the interest rates, there's nothing wrong with inflation or deflation. They are normal market forces. But the issue is that the federal reserve is price fixing by controlling the price of interest rates.

Please correct me as I am an newbie at this lol

[seraphson]

Excellent responses guys. So in short, Benny is scared of deflation because when deflationary pressures (as what's to come with higher gas prices and another deeper deep into the recession) become too strong all prior debt that needs to be paid off (principle + interest) becomes overwhelmingly expensive, correct?

[mightymatt]

The higher gas price is an inflationary force as I understand it. The increase in the money supply due to artificially low interest rates is causing the price of gas to go up.

[Steven Douglas]

If you let the market determine the interest rates, there's nothing wrong with inflation or deflation.

...in an economy with sound money, and no fractional reserve lending.

Interest rates act as a control on the rate of inflation in a debt-based economy. The greater the interest rates, the more expensive the currency, which discourages frivolous borrowing and malinvestment, but it also increases the rate at which currency is siphoned out as debts are paid.

They are normal market forces. But the issue is that the federal reserve is price fixing by controlling the price of interest rates.

Absent a central bank or artificial inflationary mechanisms (counterfeit meddling with the currency supply in any form), both interest rates and inflation/deflation are normal market forces, as natural and healthy as inhaling and exhaling.

[Zippyjuan]

I would say to sum up the mainstream economic thought, that deflation causes people to not spend their money because they know if they wait they will be able to afford more in the future.

And since people are not buying then companies not selling as many goods start laying off people so they have less mone to spend and so consumption falls further so companies lay off more people.....

This is why major deflations are typically associated with high rates of unemployment.

[The Gold Standard]

And since people are not buying then companies not selling as many goods start laying off people so they have less mone to spend and so consumption falls further so companies lay off more people.....

And you have the deflationary death spiral that destroys an economy. Remember the 1920 depression? Those imbeciles cut spending in half and the Fed didn't inflate and the 1920s were a decade of misery. Oh, wait...

[mightymatt]

I would say to sum up the mainstream economic thought, that deflation causes people to not spend their money because they know if they wait they will be able to afford more in the future.

Maybe I'm confused, but It's my impression that you would rather spend money in a deflationary environment. In a deflationary environment, your money has more purchasing power. Think of gas. You were able to buy gas for less money last week than you could this week...