No alternative to inflation

February 9, 2009

John Kemp Great Debate– John Kemp is a Reuters columnist. The views expressed are his own –

Every budding economist is taught the distinction between nominal variables (expressed in terms of contemporary cash values) and real variables (adjusted for inflation and expressed in constant-dollars).

An oil price of $50 per barrel in 1980 is not the same as an oil price of $50 a barrel in 2009 because inflation has steadily eroded the purchasing power of the currency in the intervening years. Moreover, economists are taught that real values are more important than nominal ones — because “money is a veil” (to use the phrase of the Austrian economist Joseph Schumpeter).

Prices are important because they perform a signaling and allocating function, encouraging supply and rationing demand. What matter are relative prices not absolute ones.

If all prices and wages double, there is no impact on the distribution or quantity of production and consumption because the relative prices remain unchanged. Money is a veil and focusing on nominal values risks succumbing to money illusion — believing that purchasing power or wealth has increased simply because it is expressed in more units of a devalued currency.

When the US Department of Commerce releases its updated National Income and Product Accounts at the end of each month, investors focus on the real growth rate in GDP, adjusted for inflation. You would be hard pressed to find the nominal GDP growth rate on dealing screens, or for that matter in the Commerce Department’s press release.

But surely that doesn’t matter, because we are only interested in how much output is produced, how many cars, how many homes, not their selling value.

Wrong.

Because one set of important relationships in the economy is almost always expressed in nominal terms, not real ones: debt.

If household incomes double in nominal terms, and the price of a representative basket of goods also doubles, purchasing power has not changed. But the proportion of household income spent servicing and amortizing old debts is halved.

Nominal values become crucially important in a dynamic economy where time as well as price is important, and where debt contracts such as mortgages and firm loans are fixed in nominal terms rather than indexed.

Prices have two functions: a static function allocating resources among producers and consumers; and a dynamic function generating incomes, saving and a flow of payments on debt contracts. For the static function, what matters is real or relative prices. But for the dynamic one, nominal prices are more important because they determine the sustainability of the fixed debt contracts.

NOMINAL GDP GROWTH STALLS

The nominal income or cash flow received by households determines how easily they can repay debt contracts fixed in nominal terms. In the same way, the nominal income or cash flow received by companies determines how easily they can repay debt contracts in fixed currency.

At the most general level, nominal GDP is in some sense the “national cash flow” — and determines how easily the economy as a whole can support an overall debt structure fixed in nominal terms. Nominal GDP growth becomes exceptionally important, especially at times when debts are at a high level.

The attached charts show quarter-on-quarter and year-on-year growth in GDP in both nominal and real terms since 1947.

Chart 10 (below) shows the quarter-on-quarter growth in real GDP (expressed at annualized rates). Real GDP growth is very variable. Declines in real GDP during recessions are common. Real output has fallen in 37 quarters since 1947 (about 15% of the time) and risen in 207 quarters (about 85% of the time).

But look at Chart 11, which shows the quarter-on-quarter growth in nominal GDP. Nominal output has only fallen 13 times since 1947. The last quarter-on-quarter decline in nominal GDP was in Q3 1982.

Before that, you have to go back to Q4 1960 to find a quarter in which GDP declined in nominal terms.
Chart 12 shows nominal GDP growth on a four-quarter or year-on-year basis. Nominal GDP growth has not been negative year-over-year since Q1 1961.

From the late 1960s through until the current decade, relatively high rates of inflation ensured that GDP continued to grow in nominal terms even when it fell in real ones during cyclical recessions. Even during the deep recessions of the 1970s and 1980s, nominal GDP was generally growing because the decline in real output was more than offset by relatively high rates of price and wage inflation.

Payment ability for households which experienced unemployment and firms that experienced a sharp drop in demand for their products was often severely impaired. For these few, homes were often repossessed and individuals and companies could be made bankrupt.

But for the majority of households that remained employed, and for companies that experienced only a moderate decline in demand, wage and price inflation continued largely unabated, continued to raise their nominal cash flows, and make it easier to pay off debts incurred during the previous boom.

The combination of falling output with rising prices (labeled “stagflation” ) is usually seen as the worst possible outcome for the economy. Well, the worst except one: debt-deflation.

Because stagflation in the 1970s and 1980s ensured that, for most people, the real burden of debt remained manageable, or even improved, despite the recessions. The misery was borne by the minority of workers who became unemployed and the minority of firms that became insolvent. For the rest, inflation continued to boost nominal cash flows and increase debt-service capacity.

The strong, consistent growth of nominal GDP between the late 1960s and the late 1990s was mostly the product of persistent inflation. Before the mid 1960s, in the 1940s and 1950s, inflation rates were much lower, and nominal GDP growth was much more variable, turning negative on ten occasions between 1947 and 1960.

But in the current lower inflation world, the risk of nominal GDP turning negative has increased. During Q4 2008, nominal GDP growth turned negative for the first time in 25 years. Inflation (essentially zero) was not enough to offset the decline in output in real terms (-0.9% compared with the previous quarter).

Output looks set to decline further in Q1 and probably Q2 2009, and price inflation will probably turn negative. So at some point during H1 2009, nominal GDP growth will turn negative year-on-year for the first time since 1961.

NEED TO REKINDLE INFLATION

It is the sudden shrinkage of GDP in nominal terms which presents the greatest threat to the solvency of the banking system and the rest of the economy in the coming year. Because if GDP starts shrinking persistently in nominal terms, the already high burden of servicing debt contracts fixed in nominal terms will rise further.

Every job that is lost and every factory that is closed or put on short-time reduces real output. But every wage cut and price reduction is also reducing the cash flows which households and firms need to pay their debts, deepening the crisis.

Governments and central banks are now under intense pressure to sustain nominal GDP, and restart nominal growth, by boosting employment and fueling at least a modest pick up in inflation.

The target is shifting from restarting real growth to restarting nominal growth. Economist Samuel Brittan has written previously in the “Financial Times” about the need for the government and the Bank of England to have a target for nominal GDP growth (rather than a narrow focus on consumer price inflation). But the same is true for the other G20 economies.

Fiscal and monetary policy needs to create enough real demand and inflation; sustain employment and wage levels; raise output and prices.

In some sense, rekindling inflation has become a necessary and inevitable part of the solution to the current crisis.

Chart10: https://customers.reuters.com/d/graphics/Chart10.pdf
Chart11: https://customers.reuters.com/d/graphics/Chart11.pdf
Chart12: https://customers.reuters.com/d/graphics/Chart12.pdf

70 comments

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9 Feb 2009 I’m NOT accusing anyone or alleging anything;
merely asking reuters readers; do you think:-
1)There is no need to worry about inflation; the real
worry should be that stimulus packages seem to be
loot,brun and run type of things i.e Bush administration
did exactly loot,burn and run during their last days
and that while Obama is NOT going to run,it is too early
for him to run,he has hardly started, but Obama also seems to want to have some action to benefit him i.e
get some billions ,under the table in his swiss bank a/c, out of trillions thru lobbyist etc representing the beneficiaries??
2) TARP etc seem to merely benefit the very same parties
that brought this crisis by concealing wealth etc??
3) Is it total madness spending trillions?? or not??
in view of the fact such spending plus ten trillion $s
spending on wars, plus expected five trillion $s on war
in Afghanistan.?? I never dreamed of this kind of money?
Americans did not even turn a single stone to spend so
much so fast, what made them deserve so much??

Posted by jjmk4546 | Report as abusive

Of course inflation can help people their relative dept to look smaller and smaller. On the other hand there are people who worked hard and saved money for their old day or did not borrowed money. They will see i.e. their old day reserve dissapear. Why should they pay for somebody else his/her irresponsibility? So a policy of zero inflation is the most fair to everybody. Although I am afraid though governments will use inflation (print money) because it is hidden tax to those with some money left on the bank.

Inflation destroys savings invested in fixed assets like bonds or savings accounts. Two cents saved in the 1930′s with an eye to buying a postage stamp in the year 2009 would only pay for the projected increase in the cost of stamps, now that 2009 has arrived.

Retiring baby boomers are keenly aware that their pensions have lost value drastically in the last year. Will inflation help them, or hurt them? What is the balance between money invested in the equities (which are helped by inflation) and the total invested in bonds? As the balance shifts towards bonds, the desire of bond holders will be prevent inflation and the pressure to prevent inflation will increase.

The tension between folks who benefit from inflation and the folks who lose from inflation must always be balanced.

Posted by Roger Sparks | Report as abusive

With globalization do you really believe wage inflation is possible? We need only to look at other aging, post industrial countries like Japan and Germany for what is expected in the future–continuing wage pressures which translates into less demand.

Posted by DR | Report as abusive

The greatest threat to the economy and the banking system is the credit card collapse that will happen when the newly unemployed miss payments, trigger penalty fees, and simply stop paying at all.

Expect Chase, CitiBank, and even BOA to come hats-in-hand to the Federal government this fall.

Expect them to get exactly nothing.

Expect Great Depression Two.

Posted by John Bannick | Report as abusive

It seemed to me that the household example was aritifcial because most people don’t have fixed debt. As inflation rises, so do central bank interest rates, which means that the cost of servicing their debt rises too. Even if they have a “fixed rate” mortgage, that rate is reset every few years, so it’s not really fixed.

A large business issuing bonds may have fixed debt (I think… I’m not economist!), but small business financed by bank lending also don’t have fixed debt and can’t benefit from these arguments.

Posted by Ian Kemmish | Report as abusive

While inflation is not “fair” to the savers. Inflation is necessary for us to get out of the current situation. If you look at the balance sheets of many of the companies raising funds in the bond market, many of them have current liabilities that are greater than their current asset. That means, they have to sell some of their long term asset to pay off their current debt or refinance their current debt. Even though the deflationary spiral of wages and costs may help these companies reduce cost, the shrinking of their revenue will take out their power to repay their debt (the author has a valid point) — which in turn increases the spiral of bankruptcy and contraction. If we do keep shrinking into a depression, even the bond investing and savers will get impacted, many of the AAA bonds and municipal bonds may go into default. In fact, the savers and bond holders’ current portfolio is indirectly propped up by the government. The printing of money (stimulus) is what is propping up many of the bonds. If the government stops the printing of money (which will get rid of the inflation issue), the bond holders and savers may lose a lot of their money due to defaults and bankruptcy. If the government stays on its current course, the bond holders/savers may lose their purchasing power due to inflation (but they will not have lost much from company bankruptcies)- thus feeling that life is unfair.

We are all in the same boat – connected in many ways – we are all hurting when we see portfolios go up and down – just be ware of the intricate connections and start hedging against inflation in your portfolio. Inflation is the only way to get ‘us’ out of the mess of high debt. We should make sure once we get out of the current situation, we will remember to influence our policy makers to start paying down the debt so that we won’t be more vulnerable the next time things contract.

I have to agree that there is no alternative to inflation. When the top 20% of wealth holders in this country control 91% of the financial wealth while the bottom 80% control 9% of the nation’s wealth, inflation and fixed debt is the only way that 80% can stay afloat whether GDP is measured in nominal or “real” dollars. As far as I’m concerned, the much revered growth in GDP is illusory for the vast majority of people in this country so they are forced to borrow fixed debt – if available – and hope for wage inflation. Otherwise, they are simply out of the running.

Posted by Ray | Report as abusive

I respect what some people are saying about their savings. But the die was cast; now it’s a matter of national security, to my mind. So take your nest egg and buy a home you can live in on Social Security!

I’m starting to learn something. The quality of automobiles has tended to be very poor, because the slobs will buy the bad ones, and that’s where the money is. The quality of software has tended until recently to be abominable, because the slobs didn’t know the difference and that was where the money was. Now, the slobs didn’t save, didn’t lobby against deficits and for prudent regulation, ran up huge debt, and now all of us (maybe except the odd billionnaire, I’d guess) are going to come out of it with little more than the clothes on our backs. I wish I knew what the moral was. I can guess one moral: Several investors who have taken a smug attitude in the past may suddenly be realizing that everything was NEVER under control!

Posted by Pete Cann | Report as abusive

High inflation usually translates into a giant transfer of wealth from older people (low debt, fixed incomes) to younger people (high debt, dynamic incomes).

This can be managed but this is also the type of environment that historically has been the breeding ground for change and revolution – both good and bad cases abound.

Posted by John | Report as abusive

There is no quick and easy way through this. Inflating the currency will indeed reduce debt load on the debtors, however it has many other consequences. Those extending credit will be forced to eat much of it — can you say banking crisis… again. It also creates a moral hazard. Why not take out debt that you cannot afford, take risks that you cannot afford. This is the kind of thinking that got us to the point we are now. It is for that reason I fully expect this administration to inflate the currency. Once they start down that path it will run out of control. Those countries holding our debt will not stand for it. Can you say China? Can you say hyper inflation/depression? (sort of like Jimmy Carter’s economy on steroids).

Better to ride this deleveraging to the bottom; where it belongs and will end up no matter what is done. Try to contain the pain with some nominal safety net programs. This would make the crisis last the shortest time possible and in the end be the least painful.

Either you have a inflation c.q. “Printing Press War” between nations or you have an other possibility?

Deflation is on pricing goods side, goods or houses go down in price and for the consumer houses actually get cheaper to buy. You have more purchasing power with the same amount of money.

Inflation is on the monetary side your money is worth less. So, you get less goods for the same amount of money as you used to get yesterday or the week before.

These two can domestically balance each other by going hand in hand. So if for example houses get 10% cheaper but the inflation at the same time is also 10% your purchasing power stayed exactly the same.

But thirdly you have something close to inflation but not exactly the same. Well known but not so much mentioned in the mainstream financial press lately namely a “The Devaluation War.” Every country devaluates it’s coin, like Russia recently did, in a controlled 2 percent a day step-by-step ruble depreciation which was quickened at the end as the central bank sold more foreign currency to manage the decline.

Quote Weafer from Jan. 22 (Bloomberg) “This devaluation needs to be ended quickly or we’re going to see much bigger falls in reserves”

Could it be that instead of the U.S. going the Japanese way is in fact going the Russian way?

Posted by Youri Carma | Report as abusive

I opinion that the article makes sense in normal times, but we are not in normal times. The banks presently are in deep s***, and a factor of two or four one way or the other is not going to make much difference. For example, if I have no money and cannot repay a loan to a bank, it doesn’t make much difference if the the current or nominal value of the loan is $100,000 or $200,000.

Excellent piece of expository writing! My hat is off to you Mr. Kemp.

The one piece that you leave out is the essential fraudulent underpinnings of this whole central bank mediated economic system. When the central bank can print money at its discretion and with no consent from the citizens or their representatives, that is, in fact, taxation without representation since it devalues the currency that people already hold. In other words it takes your money without your consent.

This ongoing dis-appropriation is the greatest larceny in the history of the world. Its pretty amazing that they aren’t throwing central bankers and economists into Boston Harbor!!

Posted by Jonathan Cole | Report as abusive

Management guru Peter F. Drucker pointed out the dangers of inflation. Those who think inflation is part of the solution are part of the problem.

Posted by Jane Smythe | Report as abusive

Inflation may hurt savers fixed in long-term fixed assets, but inflation will also eventually lead to higher interest rates, which will allow investors to reinvest their earnings at higher coupon rates. Also, TIPS have been around now for 10+ years. If safety of principal and protecting against inflation are concerns, TIPS are one example of how to protect yourself against eroded purchasing power.

Posted by JJM | Report as abusive

The classical economic theory that is the basis for the economy and the basis of the theory that inflation is the only cure for this economic collapse are both demonstratably flawed. The sources of this collapse are pretty clearly corruption , over production of undesirable unneeded products , and out of balance inflation created by the banks , financial community. The corruption is fairly clear to see and any one who can’t see it is not worth arguing with. Over production can be clearly established when you realize for example that their are already more licensed cars on the road then licensed drivers hence the auto industries inablility to sell more cars. Then take for example the rise in property values and stock values in comparison to the real wages of the majority of people and you will see a marked contrast. In other words the banks and investment community has aquired so much more money then everyone else that they are driving values up with out any relation to real new wealth being produced doing so through sheer speculation. Deflation is absolutely called for prices should come down to reflect the elimination of the wealth gap created by the wealthy through the financial speclulation in the stock and real estate markets . All personal debts should be restructered by the government to reflect this contraction of of paper money . Then the economic system should be restructured to relfect stability and sustainability . Negative economic activity should be counted against the GDP such as disaster relief and enivironmental damage and resoration. The entire work force should be allowed to unionize and be allowed to negotiate minimum and maximum wages and benefits for the enitre work force with the government and business’ . This would increase the wealth of the workers , allow any one who wanted a job to have one , and controll inflation created by job surfing. The financial markets should be heavily regulated. End speculation and short term profit taking , the point of corporations is to allow the investment of money in new business with limited liability to the share holders in case the people running the business do something crooked . It is not meant to be a casino fixing the odds and generating profits for the already wealthy which is how it has been operating.

Posted by urban | Report as abusive

This inane statement in this article ignores one minor detail. Namely, that the price of oil was never and never had been at $50 per barrel in 1980. It reached an all time high of %35 per barrel during the first gulf war in 1990. Then the price retraced to under $20 and was around $23 when W came into office. Given the facts of the price history of crude oil, I can’t make any sense of the article. It’s entire premise is base on information that is inaccurate.

Posted by Jim | Report as abusive

Germany tried inflation to solve the debt from WWI. This led to disaster amd WWII. Inflation leaves the old who have worked all their lives in poverty and early death.

Posted by steve langston | Report as abusive

We were warned, when despite “GDP grows at record levels, stocks up, 401 jumps, put you money in for 10-20% ROI,,yet that “elephant in the room”..was trumpeting, THE SAVINGS rate was negative”. and none seemed to care. Fact is I only saw ONE article where rate was I thing MINUS 2.3% in 2007 and not another word. M3 became redundant or whatever and was canceled. THE REAL WORLD was REAL INFLATION, but now what the “Experts” saw as inflation’s.,..it was the new “2000′s inflation’s” where a $50K/year worker could ARM or zero down etc a $360K home for next to nothing per month, and NO ONE asked. Hey what happens when ARM “adjusts” or other such reality?
The same was done to Credit cards, auto loans, “seconds” on homes, you name… “2000′s inflation’s games” took off, and the fee folks made billions as they were the ONLY ones dealing “2000′s reality” AKA they got paid in cash!
The billions were ade by others” was not reality or in truth and honest GDP. Those BILLOWS based on INFLATED VALUES created by economic alchemists, bearing little real world relationships to the terms “inflated prices-wages or money:. If one can see the difference between them, which no doubt rattles some econ 101′rs, simply address one is perceived, and allow the economy to cross wire that which was perceived and which was reality..and you end up with the messes we have now..Toss in bit of “But it was legal” larceny, political systems, that are, call it as you may but in truth are rotted by bribes of lobbyists, a dumbed down populace the thinks money management is “what is min payment” and real dealers are those that can select the correct case for a million and compound interest is several people watching the big screen and commenting. Out “experts” and media was not exactly world class, as in truth this thing was obvious from nearly day one when ads ran “ZERO down, interest only, min payment, lease, etc.. It was all our there in plain view..So let’s be real careful about what type of GDP, inflation, deflation, stagflation etc, as it seems most of it is best maybe described as Bull-Flation. When we hit the 1-3% control the wealth, and bottom end failed while top fiddled and wallowed..we were and are fed GDP and financial, employment and other data that simply gets “adjusted” to what some might say are in violation of most RICO standards. The only way to fix the mess is to put the USA to work, as banks can have even more of our money “to lend”, but if we cannot pay it back, we just arrived at where we started.. negative savings.. again and the fee folks will do well, inflation,deflation etc. are N/A in this one.. as we have yet to address the reality of the GDP et al.. we now address what we “perceive”.. Score Perceive trillions, Reality zero!

Posted by chuck | Report as abusive

NOTED
Germany tried inflation to solve the debt from WWI. This led to disaster amd WWII. Inflation leaves the old who have worked all their lives in poverty and early death.

NOTED Germany was destroyed by retaliation from winners via the Versailles Treaty, there was simply no way they could come out even, and were ripe for the Hitler and Gobbels as are most nations when they hit that sort of wall..
BUT HOW true on the old, and USA was not exactly up on top in treatment of older citizens… and further down now.. Most will not accept the hard data the of those 65 or older, most live on less the %18K per years, unless of course they are a retired congress person. where for a little as six yeras of “service” at age 62 they get full medical and at min about $18K PER YEAR.

We must bring our politicians back from career class to the what the founders had planned..for them and military.. Come briefly serve you nation then go home.. as they feared a permanent ruling class as we have now. I for one shudder when I hear from DC, “In ALL my many years here I have etc etc etc” echo from the “hallowed halls”..

Posted by chuck | Report as abusive

If I can figure this out with no economic background, why are governments looking at stilumus packages instead of this?

For those who say “What about those who have assets? They are getting penalized?”

Consider that if the economy fails completely, the assets will still have no value.

Do a poll of the people you know: Is your balance sheet positive or negative? Something tells me 9 of 10 will answer negative.

Posted by Sean | Report as abusive

Sorry, I figured out the answer.. the people in power have savings, whereas the middle class they are claiming to be looking out for are the ones with the debt. Serious conflict of interest issue here. We’re doomed.

Posted by Sean | Report as abusive

Question for the Author:

If inflation is a good thing since it helps since “the proportion of household income spent servicing and amortizing old debts is halved”

Please show me one bank that lends its money at LESS than inflation. They would be losing money then.

Posted by Kazimieras | Report as abusive

Why is it that every economist interlocks inflation with GDP growth, and therefore argues that it is a good thing provided it is at a reasonable rate? The reason is because that is how economic theory has been taught through the decades. Well we now know that economic theory is just that – theory. Practicality paints a very different picture for us every day, and the last year has provided some valuable lessons regarding the fallibility of economic theory – for one, markets are not self-regulating, as economic theory instructs.

So I argue that in practice, there are certain periods of time in any nation’s economy in which deflation is desired, and I believe that now is such a time. Following the author’s similar argument, if our nation can sustain a slow, steady deflationary period, particularly in relation to other nation’s economies, it will serve as one of the healthiest financial rebalancing phases that our nation has every experienced.

There is no doubt in any economist’s mind now that, prior to the recent economic downturn, losses in the the nation’s cumulative wage earnings has been due to an overall loss of jobs and wages to competing nation’s workforces. The outsourcing of jobs to Asia, and the influx of ready immigrant labor to the U.S. has seen a proportionate reduction in real wages earned for U.S. workers due to an oversupply in labor relative to the demand for labor from U.S. firms. This results in a net gain in wages earned, and GDP, for those countries providing the outsourced labor, and an equivalent net loss for the U.S.

In order to offset that GDP difference, the U.S. must sell debt, typically long-term debt, to finance that deficit. As the U.S. buries itself in ever-increasing sums of debt, U.S. taxpayers, the wage earners whose cumulative earnings are diminishing, are bearing the burden of that debt. The only way that the government has been able to offset this increase in debt has been to devalue it through inflation, essentially by printing more money that can in part be used to pay foreign debt. This ostensibly should then have the effect of making foreign goods more expensive, but we can all see the opposite practicality of that as other nations such as China fix the value of their currency.

This cycle of demand for increased efficiency, further outsourcing of jobs and goods, increasing deficits, and inflation to keep debt in check has been going on for years and decades now, with no sign of abatement unless a contrary course of action is taken.

Perhaps now is the time to allow natural deflation to take its rightful place in economics. With natural deflation, prices and therefore wages, take a general downward trend until a new equilibrium is reached for any given good or service. Most economists rail against the evils of deflation because “consumers will be stuck in an endless regression of waiting for prices to lower further before buying, and therefore all purchasing comes to a stop.”

Really? If a consumer is hungry, I doubt very much whether that person will hold off indefinitely before buying food to consume. The same holds true for someone looking for shelter, warmth (or cooling), safety, entertainment, or for that matter, any other possible consumable. The consumer will however look for the best value available at the time that the good or service is needed. Such a sustained natural deflation results in a lowering of the cost of goods, and a resulting lowering of wages required to produce that good or service.

Assuming that other nations do not partake in such a natural deflationary trend, then the resulting lowering of wages here in the U.S. puts U.S. jobs at a more competitive price position relative to foreign wages. The net effect is an increase in total jobs here in the U.S. (or fewer jobs being outsourced), with a net increase in cumulative wage earnings, and over the long term, an increasing GDP due to more goods and services being produced here in the U.S. This in turn results in a lower deficit, and less foreign debt needing to be serviced in the future. With less foreign debt, there is less need for the U.S. to synthesize inflation in order to pay that debt. The net plus is the gradual increase in GDP and the paying down of U.S. debt over the next couple of decades.

So inflation does indeed have an alternative – it is natural deflation.

Posted by Steve | Report as abusive

Kazimieras, it’s the principal. If you owe $100,000 and cumulative inflation adds up to double, then in dollars of today (or bread, milk, whatever) you now owe half what you did. You’re paying interest on half; maybe at twice the nominal interest rate you were, so that’s a wash; but if you ever have any intention of paying down the principal, it’ll cost you half what it would have.

Posted by Pete Cann | Report as abusive

so what you are basically saying, is inflate away the problem and inflate away the debt. destroy the value of the currency in the mean time and destroy savers, the very thing that is morally commendable and is the starting point for the recovery.

its this reason that i am buying gold, cause i dont even trust the currency anymore when people like yourself suggest devaluing it purely for the sake of bailing out all those silly people with 2 cars and plasma tvs!

Posted by david | Report as abusive

My view is that for quite a few decades our economy has been a bit like a pyramid sceme. More and more money(inflation) had to be poured into the pyramid to keep it going. It obviously was not sustainable.

Posted by Juan Ray | Report as abusive

Hm. So printing money works… Dunno, read the news much? Inflation, Zimbabwe, ring a bell?
What we want/need is income growing at a greater rate than prices. That is real growth. Everything less is, well, less.
BTW, wasn’t inflationary monetary policy tried following the 1974 oil crisis? AND FAILED, miserably?
P.S. I have a gazillion Monopoly dollars. How about I buy your lousy uninflated US ones at, oh say, 50 cents on the dollar ;)

Posted by Laz | Report as abusive

We are in a severe recession. Rather than rekindle inflation, perhaps a more sustainable economy would be preferable. An economy that is not based on asset-inflation and cheap imports quite simply has not worked. The part played by the Fed and banks has been the single major cause. Prop-ups, bail-outs, mail-outs, budget deficits, trade deficits are not the way of a healthy economy.

Posted by Brian | Report as abusive

A typically solid analysis, Mr Kemp. My thanks.

The only shift in emphasis I would make, to compare thoughts, is that, as the fundamental crisis we face is one of vast over-leveraging throughout the economy, and that this process, having reached its limits, is now inevitably and inexorably de-leveraging itself, is that we have already in a sense created inflation in the form of these assets which are carried at inflated values — rather as if one were dealing with potential energy, as it were.

We have, at least in theory, political limitations aside, the possibility of exercising some control over the process, but those inflated assets will be marked down through contraction, inflation, or a combination of both.

I am of the opinion that inflation is likely the preferable course. That, however, is rather like saying I’d rather crash land an aircraft in a farmer’s field than into Wall Street — it’s still an unpleasant choice.

In any event, it seems to me that the organic political process inevitably leads to an unwillingness to accept the reality of vast bankruptcies and write-downs and that this unwillingness leads to the present course wherein we are inevitably generating the inflation expected a few years down the road.

In that sense I think we’re looking at a combined effect: First, a good bit of collapse, bankruptcy and write-downs, most of it not yet having occurred. Then, secondly, a wave of inflation leading to an effective write-down of much of the remaining debt overhang. A critical question, of course, is the degree of that inflation, and whether the government in its present form will survive if it proves catastrophic — my guess is that it will be severe but not catastrophic, but who knows, really?

In a sense these things, like a forest fire, have their own logic, and their own need. As in a Nature documentary film they are ‘all for the best’.

They’re just a bit rough on those maimed or slain in the process.

Posted by Big Al | Report as abusive

Inflation may be good for borrowers, but it is disastrous for lenders, typically retirees living on their savings.
I live in an apartment block of 100 apartments. About a third to a quarter of the owners are retirees who will have to sell their homes and move out. Inflation has reduced their income below the level needed to pay for needed repairs to the building.
The best price level is stable to a very low inflation rate – long term average of not more than 1% – anything else transfers too much wealth from producers to financial system insiders.

Posted by MoFromMelb | Report as abusive

The total aggregate amount of existing real wealth, in fundamental terms, has remained largely the same before and after this financial crisis. The only thing that has changed, is the distribution of the claims to the existing real wealth. By dramatically inflating the nominal prices of various “assets”, including those that are now called “toxic assets”, many of which were substantially created out of thin air, such as various derivatives, the banks, various financial institutions, and other holders of these assets, have essentially laid claims to a much larger proportion of the existing real wealth. The bank rescue plans, in substance, aim to sustain those claims to a much larger proportion of the existing real wealth.

Posted by real | Report as abusive

No really. Lets just bump up the FDIC to about 4 million. Watch all the billionaires become millionaires and then offset the difference to the impoverished, then tell everyone under 62 to get their asses to work.

Posted by Tyler E. | Report as abusive

Mr. Kemp should stop pretending to understand Austrian economics because he has no understanding of it. He would like to place us in the position of Japan. Deflation causes malinvestment to liquidate. If you prop up failed businesses then you will stall any recovery and prolong the misery. The reason that there is unemployment is that the economy has not yet created productive jobs to replace unproductive ones that collapsed with the bubble economy. The economy can’t do that when capital and resources are caught in failed businesses and investors fear nationalization of investment. Creating more jobs through the government just diverts current and future employment. Remember, there isn’t an unlimited amount of credit in the economy.

Talking in terms of “real output” really misses the point. You can’t solve the unemployment problem by degrading capital goods to produce things that people will only buy with temporary government created demand (printed money). You have to make products people want and can afford in the long run. The fear of deflation comes from those who don’t want to face the consequences of their actions. All Mr. Kemp seems to want to do is punish responsible people by devaluing their savings and reward irresponsible people who took on more debt than they could pay back.

Mr. Kemp starts out sounding sensible in that he can distinguish between nominal and real prices but then Mr. Kemp proceeds to ignore the fact that nominal growth isn’t a sign of real growth and instead warns us of nominal decreases in GDP. Maybe he is just one of those people who are buried in debt like our federal and state governments. They don’t want to even think about what will happen to their credit rating like everyone else who can’t pay back all the money they borrowed.

Inflation got us into this problem with the help of the Fed and inflation is not how we will get out of it. Some of the macroeconomic indicators may change in desirable ways but we won’t be any wealthier. All people like Mr. Kemp want to do is reflate the bubble economy. We have the housing bubble because we tried inflating out of the tech bubble. Two-thirds of the bubble economy consisted of consumer spending. I’m not a fan of fantasy economics myself. To see this problem as lack of demand is really quite laughable. All that Americans do is spend money. We have a cumulative trade deficit that is trillions of dollars. Is the solution to print more dollars to pay for more Chinese imports? I guess Mr. Kemp would like us to all get a job at WalMart.

Posted by Matt C. | Report as abusive

I believe inflation is inevitable something like what happened after the 70′s oil embargo accept larger in scale and more prolonged.

We might correct if someone spools up enough alternative energy input into the us economy but I doubt it.

Posted by Robert | Report as abusive

I am not an economist, and am often more impressed with their analyses than I should be. Some things seem clear to me, however. The economic wars will be fought between the forces of the wealthy, with their vote-buying power, and the electorate, whose strength has eroded due to their weak participation in the democratic process. The battle has usually gone to the dealmakers over the producers, so something has to be done about fees, commissions and indefensible risk-taking at all levels. Globalization will continue to weaken the positions of most Americans, but is inevitable. With our freewheeling spending and lack of savings/investment in our own industries and workforce, we have made ourselves easy targets. That said, it\’s always a mistake to count out the USA.

Posted by Phil Roth | Report as abusive

Bad idea from Kemp.

Inflation is NOT the way out of this mess.

The present system has failed. It needs to be discarded.

We need to find a new economic way.

Posted by Karuna | Report as abusive

It is acceptable to think that moderate inflation is necessary for sustainable economic growth on two grounds:(1) deflation is harder to control than inflation because interest rates cannot go negative,
(2) anticipating inflation help spur consumption.

An easy way to cause inflatio is to print federal notes and spread them across the economy, as Mr.Bernanke’s nickname suggests. And the FRB and other central banks all over the world are doing it by purchasing CPs and other kinds of assets, and sooner or later this will eventually lead to increased prices.

If fiscal and monetary policies could successfully restore credit creation, and create enough consumption demand, the future inflation will be a good one.

However, if enough real demand cannot be induced, the newly printed money will stay within financial institutions, and will eventually flow into some real assets or commodities such as land, oil, corn, beans, etc., making only a minority of people/countries rich. The rest of the people will be left with increased prices, without equivalent income hike.

Japan’s quantitative easing wasn’t effective because the government failed to stimulate consumer demand.
The result is that those cheap money flew abroad, facilitating some asset bubbles over the world.(e.g., in some countries in europe, yen-denominated home loans are/were popular.)

So, just printing money won’t be enough.

Posted by H.Arita | Report as abusive

I think ‘real’ makes a very valuable point: Nominal valuations, such as those assigned to mortgages, CDOs, stocks, whatever, in many ways constitute relative claims upon the actual assets. It is the assignment of these nominal values that went, increment by increment, year by year, quite unsustainably mad.
A reckoning, imperfect and likely vicious, in proportion to the madness, is effectively unavoidable.
There is still much attempt to avoid a writing down of nominal valuations to more realistic and sustainable levels, and much of these attempts, as illustrated by the TARP plan, is essentially an attempt to maintain relative position within the game as the game threatens to collapse.
I agree that inflation is inevitable, given the process, as is some degree of explicit write down. The degree to which we are able to manage these factors intelligently will determine to some degree the outcome.
I am not optimistic.

Posted by Not Silent Not Bob | Report as abusive

The bloated gas-guzzlers, which is all that the Big Three US automakers can produce, are going the way of the horse and buggy. Protecting jobs and companies is futile, delaying the adjustments which US manufacturers need to make and increasing the damage they cause to the environment.

Harold Wilson tried playing Canute in propping up British coal miners long after their expiry date of their industry. The electorate replaced him with Maggie Thatcher. Will Obama repeat or learn from Wilson’s mistake?

Posted by Colin | Report as abusive

Will Mr Kemp take his payment for this article in Zimbabwe dollars?

Posted by Theseus | Report as abusive

Very, very good. (much better than my english, sorry).
All economists should know that.
But in the whole European Community they do the wrong. In the European Community One tries, to hold the inflation rate on a very low level. This is a big mistake. This will prevent any economic upturn.
Investments will be avoided because they are not able to pay, but by a depreciation it leads to an loss in value of investments. So no one will do investments, no new buildings, no private investment in Cars or electronic equipment, because everyone is expecting lower prices….
Please send your Text to the new German Minister of Economics….
Sincerly your Roland (economist, master)

Posted by Roland | Report as abusive

The excellence of the analysis does not render is right. Mr. Kemp,should undetake an analysis of Zimbabwe to give an illustration of government increases of money supply (printing money).

The banks are short of cash and Mr. Kemp’s analysis aims to influence public opinion into thinking that it is ok just to have a pile of cash printed and delivered to the banks to increase money supply to begin lending again and thereby give a boost to increase nominal GDP.

The real reason for printing money is not that nominal GDP is declining but rather that the banks have made a mess of their business and are out of cash, period.The proposed solution of increasing money supply and funneling it via the banks into the economy is an old trick of economic elite: socialise costs (lossess) and privatise profits.

And the bonus is that the banks are gonna charge INTEREST and FEES to lend out the fresh cash. Isn’t this just great?

Posted by Gregory | Report as abusive

This argument, especially with regard to debt see FT, has been presented many times before. I see it’s validity, but it appears to be an economist’s equivalent to accounting trickery.

On the long view, there is nothing wrong with a market correction and the sustained growth following today’s correction will be much more “real” than what you have proposed here.

Posted by lex | Report as abusive

the credit governance system, rooted in the government, will never allow such kind of “healing inflation”.
“quantitative easening” i.e. printing money and giving it to the consumers would taking place only until the debt burden of the citizens would become more berable

Posted by mittag | Report as abusive

What people should ask is what is alternative to inflation? That would first mean cutting budget deficits of the states and the Federal Government dramatically. This in turn would mean cutting on social and defense spending, efectively dismantling the welfare state (how about ethnic riots)? Pulling out of Iraq and Afganistan fast (remember the run from Vietnam) and curtailing most of the weapons programs. Stopping supporting “failed states” like Georgia, Ukraine and many others and closing many overseas bases. Secondly, that would mean the shrinkage of the US financial sector probably by half. As this would effectively mean the insolvency of the banking system (which is insolvent already now), there will be no other option, but to nationalize it. There will be other consequences, but that alone would probably cut US GDP by third and will get the rest of the world into economic chaos, because US will not longer be importing as much and US national debt will be unstatinable and will probably have to be defaulted on. Those who stupidly shared losses from the US tech and mortgage booms (European banks mostly) will go insolvent as well. Dollar will have to be devalued and will likely cease to be THE reserve currency of the world. The last Great Depression ended up in the World War II. Now you still want to save the savings of those few who really saved (as you know, US savings rate has been negative, so there is more debt than savings anyway)?

Posted by Dmitry | Report as abusive

Mr. Kemp, Let me take you back to a little Era known as the Carter Years. Rampant inflation, 21% interest is common, and no milk at the breakfast table. My father, a union pipefitter, a well respected, well paid job, struggled to purchase milk for our family in the late ’70s. Why? Because his union contract negotiated in your NOMINAL dollars was not able to keep pace with your REAL dollars, meaning, that because of inflation, his paycheck stayed the same, while prices rose far to quickly for families (read: REAL PEOPLE) to adjust. Fast forward to today. I’m a now a Computer Administrator, a well respected, well paid job. I can buy Milk whenever I want because my pay has been able to outpace the low levels of inflation and prices remain relatively cheap. Now, you expect us to buy a tired argument that inflation is good and repeat our mistakes of the past? Your economic math just doesn’t jive with my real world experience. What you propose, from my point of view, is to make sure that I can’t afford milk for my kids, so that a bank or other lending institution (read: FEDERAL RESERVE BANK) can stay solvent because they ran up their debt and can no longer reliably service it? Sorry, your Carter math didn’t work then and it isn’t going to work today. Besides, my kids and I rather like having milk around.

Good article Kemp, The inflation period of the 70′s, was the 1st. period I can remember and my parents can remember when housing prices really went up. I made alot of money in that period. The inflation rate was double digit while the loan rates were half of the inflation rate.. You simply borrowed money and bought more realestate..Sound familar, just like the roaring 90′s, except one big difference. “Volker”. Volker in the late 70′s went a little mad at the Feds and raised rates until it killed inflation and brought in the deepest recession since the 30′s. The 80-82 recession was deep but very short lived.Greenspan unlike Volker dimissed inflation, because America was importing Chinese deflation. The “CPI” number showed NO inflation, that the Feds wished to see, while anything made in America, was inflating at HUGE levels.. (Housing, Stock market,Land prices were all going through the roof)Greenspan just kept the foot on the gas, unlike what Volker did in ’78 and what the Feds did in ’28 to stop the roaring 20′s. Greenspan’s lack of action has passed on this recession, with deeper and more severe consequences, but Big Ben Brenanke continued to carry the torch of Greenspan, as the Feds are trying desparately to keep the US economy inflated.This will result in even more prolonged recession, because the Feds are taking the place of the US comsumer, by spending borrowed or prined money.The US consumer eventually ran out of credit, and the result was that any of these consumers assets,( house prices, stock prices,uaed car prices), all fell in value. Any asset the US consumer held, fell in value. The same will be true of the US Feds as they try to borrow America’s way out of debt. The Feds and the US Treasury, only have 2 assets, the US dollar and US treasuries. Both of these aseet will fall in value as the US runs out of credit..A German economist once said that Government is the only entity that can take perfectly good paper and ruin it with ink..

Posted by Bull Run | Report as abusive

If you have high debt and little savings, inflation sounds great. It gets rid of your liabilities at the cost of your non-existent assets.

If you have high savings and little debt, inflation is a disaster. It gets rid of all your hard earned and accumulated assets at the cost of your nearly retired liabilities.

What type of behavior do we want to reward?

Posted by Luke | Report as abusive

Amazing, This is the first time I have actually heard someone in the media utter these economic fundamentals on debt burdens vis-a-vis inflation. The only way to save the banking system and the American way of life is for the Federal government to inflate the banks out of their debt burdens (skajillion dollar stimuli anyone?). Anybody who thinks the government won’t ‘make money’ on their TARP investments is naive (they just made 700 billion of it right before your eyes) – the Federal government easily controls the nominal value of money when the direction they want inflation is up. Down the road, getting it to come back down is the unpleasant part.

Spot on. I was a little surprised you didnt refer to the concept of “Quantative Easing” (a euphemism for printing money as you’re aware) or the giddy rate of change of M2. The Treasury will issue a tsunami of debt and the Fed will buy it. The creditor nations such a China will dump Treasuries and spend their cum-devaluation dollars as soon as they can or they’ll buy hard assets such as gold (or large stakes in the likes of Australian commodities heavy wieght Rio Tinto). The yield curve will never have been steeper. Why would anyone own 30 year treasuries?

Posted by Simon | Report as abusive

With all due respect, your concept of inflstion is twisted. The governement has used inflation for over 50 years as a way to pare down their debt to outside interests. Paying debt of with cheaper dollars than you boorrow sounds like a wonderful idea except for one small, and obviously insignificant factor, the American worker and taxpayer. Inflation is also refactored every year. A 5% inflation rate this year means we have have a reduced buying power of 5% of what we have left of our wages – which were only 95% of the year before – thanks to inflation. Inflation reduces the wage earner’s capacity to support his family. It’s only friend is our illustrious overspending government. The same government that feels fine passing along the bad debt of fat greedy financial institutions to the very people they steal from. Banks that got TARP money charging 24+% on credit cards when they got the money at 2%??? Government sponsored extortion! Capone is apparently the new standard of excellence todays bankers try to emulate. So of the debt we are been given and deflating my buying power to pay for it, I say this. Burn the TARP plan. Let badly run businesses die and the the conservative solid survivors pick over their bones. Do it before you make a bigger mistake. Once the governemnts of the world start trying to pay for this mess with “inflation backed” currencies we’ll be lucky to be able to afford to live in this Carteresque government sponsored inflationary nightmare.

Posted by Bill Anderson | Report as abusive

Like many others, I question the logic of encouraging consumers to spend borrowed money , even at low rates, as a solution to the crisis. How does more debt solve the problem? Worse, such spending results in overvalued homes, cars, etc…

Posted by ross perilman | Report as abusive

I had this same conversation yesterday with co-workers.

On the one hand, inflation solves our nation’s issues, and bails out the financial institutions globally.

But of course, as noted above, all of this comes at the detriment of the global workers’ quality of life. And just as we saw this financial mess snowball, there is no telling that inflation rates would come down with any rapidity.

The ivory tower economists see this is a macro solution, but this mess has affected too many at all levels.

Lest we forget Germany in the post WWI years, the Carter era disasters, etc. we need to seriously evaluate the pros and cons of hyper-inflation as it affects the working families of the US and the world.

The US government can’t loose! They are “The House” and the reserve currency of the planet. They are spinning pure gold! Chips aren’t worth anything until you cash them in. However, if your circumstances force you to redeem those chips at a predictable rate over time for such predictable expenses as food, shelter, health care, etc…, then you are but a puppet on a string.

Posted by anonymous | Report as abusive

People need to remember that the Carter era was brought on by the sudden doubling+ of gas prices by the newly formed OPEC.
.
A lot more lasting economic damage was brought on by Reagan who more than doubled the national debt. The only reason his admin did not go up in flames is that the Iran-Iraq war brought a tremendous reduction in gas prices.
.
It really irks me that the Republicans when they have the presidency run up the debt, but as soon as a Democrat is elected they become born-again balancers. See:
http://www.lafn.org/politics/gvdc/Natl_D ebt_Chart.jpg
http://www.cedarcomm.com/~stevelm1/usdeb t.htm

Posted by jmmx | Report as abusive

The second to last statement of this article is a very dangerous one “Fiscal and monetary policy needs to create enough real demand and inflation; sustain employment and wage levels; raise output and prices.” I am not convinced of this simply because I believe this will eventually lead to hyperinflation and a total loss of confidence in our currency.

Posted by libertarian | Report as abusive

A very well thought out analysis but I must disagree for the following reasons:

(a) If inflation increases, we’d all better hope that our incomes also increase accordingly. For some, this will be so somewhat right away. For others, there will be a lag time in which their real purchasing power will drop off sharply. For the rest, there will be no income increase at all!

(b) Even if inflation and incomes generally increase to relatively the same levels, such that real purchasing power is unaffected, it’s a myth to conclude that debt servicing capacity will improve. The X factor in debt servicing is interest, and if inflation increases, even if incomes stay stagnant, you can bet interest rates will also increase. Otherwise, the simply truth is that no one would lend money, since lending is for gain, not a public service. No one is interested in recouping, in real terms, less than they lent out. So, in fact, there is ALWAYS an externalized compensation with debt, which corresponds to the interest rate plus a portion for real profit. Since the indebted will have to pay the higher interest rates, based on the specifics of their contracts, they will either see their debt servicing cost forceably increased, or they will end up with more debt generating yet more interest to pay in the future.

So, all in all, it’s a zero sum game. Sorry.

You want a recovery and a lessened debt burden? Find a successful way to stimulate real economic activity while keeping inflation as LOW as possible. People will generate greater incomes and pay off their debt faster in real terms as a result. Look into Canada’s statistics. We’ve combined frenetic economic activity with low inflation for years, and were doing quite well until this global recession hit.

The only hope I can see in your arguments, and if it is the substance of your arguments you didn’t make that clear, is that some lag time exist during the current crisis between the uptick of inflation (and wages) and the uptick of interest rates. In that brief nirvana, debt repayment would be … like butter. The resulting restored capacity, on the part of lenders and borrowers alike, would aid in the recovery.

Good article. As one who has been through many years of cycles, let me add that inflation also “steals” what has been earned over the years. Fixed incomes go down in real value, long term gains that are only the result of inflation are taxed, yielding a net loss. It is true that only real wealth creation will bring back prosperity and solve debt problems. We used to import low cost materials and add value through manufacturing and development. It has changed in that increases in costs have been skimmed at so many levels that the apparent value is artificial.

Posted by John Harnec | Report as abusive

The author of the article is correct about keeping prices constant. Falling prices don’t encourage stability in the marketplace.

However, I think all of you miss the point. We have had 30 years of declining real wages for the vast majority of the population. What are the other types of incomes? Royalties, Rents, Capital Gains, Dividends

The problem is that Joe Average, including Joe the plumber, purchases goods and services out of wages, not out of capital gains, rents, royalties or dividends. So as the wage pool decreases, so does Joe Average’s ability to purchase products, pay off his debts, pay off his mortgage.. purchase a home etc.

Although Henry Ford had some unusual ideas about politics, including birthday cards to Adolf Hitler, his economic thinking was really sound. He wanted his workers paid enough to purchase the products they were making on the assembly line. We have lost our way by ignoring the sound advice of this economic genius. Our companies going abroad seeking cheap labor, and violating the spirit of the XIIIth amendment, has really served no one. Too bad it takes a virtual depression for sense and some ethics to be restored to corporations, the american people, and government.

Yours

Stephen

Posted by stephen | Report as abusive

Mr. Kemp’s article presents an oft repeated remedy to our nation’s overwhelming public and private debt. However, it ignores an important factor. Our monetary system is entirely composed of bank credit. There is no “real” money in the economy. In other words, from our monetary base to whatever measures of money supply one wishes to use our entire “money” supply is bank credit generated either by commercial banks or the Federal Reserve. We literally borrow every single dollar spent to run our economy. Thus “inflation” is merely the increase in the overall level of our nation’s debt.

The reason that “deflation” is such a problem is that saving and paying down our debts literally reduces our “money” supply since the only source of “money” creation is bank loans. If we don’t increase our borrowing GDP can’t grow since GDP growth and credit growth are directly correlated.

So the argument that the only remedy for the current deflation is inflation is just another way of saying that we need to devalue old debt by taking on ever increasing loads of new debt. That game may have worked in the past but credit is confidence and confidence is in short supply. When it runs out hyperinflation ensues and we are growing dangerously close to such an outcome.

Posted by Robert | Report as abusive

mr. Robert is correct in his commnent. it is short, but explained the real situation of ecomic problem we are in right now. John Kemp is wrong on everything. does he know about fiat money, or it is just that his readers are ignorants of the economic system, and he is enterteining them with nonsense. there are several alternatives to inflation indiviudally speaking, and for the entire economic system if you will. indiviudally, there is the alternative of gold, silver and commodities.(silver and gold are not just commodities but also real money). if one want to keep the value of our own money, better start traiding in commodities, silver and gold.
do not save in any fiat money!! by SAUL.

Posted by saul | Report as abusive

mr. Robert is correct in his commnent. it is short, but explain the real situation of ecomic problem we are in right now. John Kemp is wrong on everything. does he know about fiat money, or it is just that his readers are ignorants of the economic system, and he is enterteining them with nonsense. there are several alternatives to inflation indiviudally speaking, and for the entire economic system if you will. indiviudally, there is the alternative of gold, silver and commodities.(silver and gold are not just commodities but also real money). if one want to keep the value of our own money, better start trading in commodities, silver and gold.
do not save in any fiat money!! by SAUL.

Posted by saul | Report as abusive

All that bloviating and I don’t think I saw one mention of the impact of inflation and deflation on savings. No concern or mention about those that don’t recklessly spend every cent they can borrow on things they don’t need. The focus on the careless spendthrifts in this country never ceases, and surely just reinforces their egotistical views. So the only solution is to devalue the money supply, thereby canceling the debt of the spendthrifts, and canceling the savings of the savers? How about letting the spendthrifts drown, so we all have a good example of why it’s bad to spend every cent you can borrow as fast as possible? The two biggest players that have caused the current economic debacle have been spendthrifts and stupid bankers. The stupid bankers have been getting burned without sympathy; let’s see the same for the spendthrifts. Why did the median house in my neighborhood get bid up to 600k? Because dumb people were given easy credit, that they often didn’t work a day for (zero down!). Ever ask the question of what that has done to the outlook for savers? Savers are in the same markets, competing for the same houses, and unless they were willing to spend as foolishly as the spendthrifts, they could not buy a house. Is the American dream owning a house, or is it owning a house by leveraging yourself into massive debt? Is the American dream owning a house by leveraging yourself into massive debt and then having a socialistic government bailing you out with your neighbors’ and your grandchildrens’ tax dollars? Recessions/depressions are horrible things, especially for spendthrifts, but also for savers. But a society that continually coddles foolish spendthrifts at the expense of savers is more horrible. We need to let the spendthrifts burn and let deflation run its course, and when we come out on the other side, our kids will be able to afford houses – once they’ve earned them.

Posted by Nick | Report as abusive

There appear to be two basic forms of economies/governments: (1)Free Enterprise, Non-inteference in economic activity by government,(2) Planned economies, government economists decide what should be manufactured, government economists and politicians decide what the workers should be doing. The greater government interference the less freedom the citizens have, but, as in modern China, development and standard of living may be higher IF THE GOVERNMENT DECISIONS ARE RIGHT! The USA, starting with our Revolutionary War and Constitution opted for more personal freedom and less government interference in our commercial and personal lives. As Karl Marx stated in Das Capital, the ‘Bible’ for Communists/Socialists, “Capitalism, without government controls, leads to overproduction and great depressions and mainly the workers suffer for the errors of their employers”. Nevertheless, I for one, would like to have personal freedom and LET THE MARKETPLACE CREATE ITS OWN CORRECTIONS WHEN REQUIRED, WITHOUT GOVERNMENT INTERFERENCE. We Americans now live in the worst of the two worlds I describe. We have developed too much government interference in our business activities as well as our personal lives. This part is plain Socialism. “Government knows best”. The government does not permit the normal contractions of a Free Market to cure and restore the marketplace. More Socialism. But none of the possible advantages of Socialism, such as good universal medical services, or good public school education, etc. So we are just going down the drain on all scores. This type of incompetence in government, and the rising class of the superrich and then the rest, ‘modestly poor’, will lead to riots in the streets and violent revolution. I predict the path we are taking will lead to revolution and violence and forceful change of government within 50 years. The working people will, sooner or later, demand blood to punish whoever they think brought about their pain and distress. Even now the Country is filled with nasty and crooked law enforcement, army reserves, etc. to keep the public in fear and in line. Only the politicians have any freedom. How long can this last?

Nick – your comment is spot on. However since the system is not about to change anytime soon it would be better to use it instead of fighting it. Take out a big mortgage. Buy a second home as rental property. The more long term fixed rate debt you have the better. Especially at today’s low rates with inflation just around the corner.

Posted by Joe | Report as abusive

Whatever happened to the concept that money simply represents value of an object or service to either another individual or to society at large? When you de-link money from a durable benchmark you begin to see all kinds of smoke and mirror inverted pyramids which are either illusionary, unstable or both. If I bought my house for 50k and it’s values seemed to inflate to 150k over the next 10 years should I expect it to be worth more than 50k when our country hits economic hard times? Unless you allow the virtual economy to return to some semblance of reality there will always be the potential for unacceptable instability.

Posted by David | Report as abusive

Nick, as regards your recommendation to take out a mortgage, would that apply as well to people on fixed incomes–especially a rental unit if one lived in one unit and rented the other. Thanks, Robert

Posted by robert zito | Report as abusive

John Kemp, would your advice to take out a mortgage now–ahead of coming inflation—-hold true for individuals on fixed incomes—if it were a rental income unit and I lived in half? Thanks, Robert PS I erred and sent this to Nick

Posted by robert zito | Report as abusive

[...] Here’s what John Kemp says on the topic.  What do you think? [...]