The way society becomes wealthier is through productivety improvements. When we can do more for less, we have more resources (time and money) left over. We get richer.
Let’s assume your village doesn’t have a truck, you take out a loan to buy one, and now you bring produce to market. This loan is a benefit to society. The lender gets repaid with interest, the borrower has access to new markets, etc etc.
Two perspectives on borrowing and lending are that both feel richer. The borrower feels richer: I have a truck to travel around with. The lender feels richer: I have collateral plus the interest and principal payments.
However let’s assume we upgrade this truck to a luxury model and it makes the driver more comfortable on the ride, but the capacities are the same. Lets also assume the price is much higher than the basic truck. This would be a scenario where this loan is not adding to society’s wealth.
This in many ways is an example of the way in which huge amounts of debt in the world are potentially deflationary. Current estimates of public + private debt in the US to be around 50 trillion dollars. As the world develops, the marginal returns of productiveity on that debt decreases. Think micro finance in Bangladesh. When people are really poor, a loan of 200 dollars is really helpful. Buy livestock, plow the field, manageable debt payments, etc etc. High return from small dollar amounts. If a wealthy US citizen uses much larger quantities of debt to buy a luxury truck or a larger house, this doesn’t make him or her more productive. This is one of the problems with having 50 trillion in debt. It takes a long time to pay off, and it doesn’t go anywhere soon.
While the gut reaction to reading about 800 billion dollar bailouts is that “the government is debasing the value of our money by just printing it,” this is an incomplete analysis.
First off, the total losses on the stock and real estate bubbles are somewhere in the neighborhood of trillions of dollars. If you thought you had 200,000 USD in your 401k plan, and the stocks went to 120,000 USD, you really did lose 80k. Likewise with the value of real estate. It turns out that despite 60 years of no more than a single digit % drop (late 1980s) in real estate prices, we have shattered the illusion that real estate is a stable commodity. It could well continue a slow and gradual decline, particularly in market segments that are overbuilt relative the potential market demand for such property.
Remember, for every decline or loss, a bank is even more apprehensive about loaning out new money. Creditworthiness definitions change (Citibank raised 2 million cardholders to a 30% interest rate on Credit Cards – many if not all are current on payments). Any losses also shrink the supply of money to loan back out. Lastly, cash stimulus and welfare merely maintain the status quo. They essentially keep peoples’ heads above water, but essentially the government spending 1 trillion on stimulus can’t possibly cause inflation in the near term. (debatable though 5 or 10 or 25 years down the line)
The issue I have with the massive leverage is that all of the borrowing and debt can feel like inflation and prosperity. However, the folks that borrowed excessively will likely take many many years to ultimately pay off this debt, and Japan is a perfect example of this type of debt driven deflation that drags on for decades.
Analogy to explain Debt Deflation
The way society becomes wealthier is through productivety improvements. When we can do more for less, we have more resources (time and money) left over. We get richer.
Let’s assume your village doesn’t have a truck, you take out a loan to buy one, and now you bring produce to market. This loan is a benefit to society. The lender gets repaid with interest, the borrower has access to new markets, etc etc.
Two perspectives on borrowing and lending are that both feel richer. The borrower feels richer: I have a truck to travel around with. The lender feels richer: I have collateral plus the interest and principal payments.
However let’s assume we upgrade this truck to a luxury model and it makes the driver more comfortable on the ride, but the capacities are the same. Lets also assume the price is much higher than the basic truck. This would be a scenario where this loan is not adding to society’s wealth.
This in many ways is an example of the way in which huge amounts of debt in the world are potentially deflationary. Current estimates of public + private debt in the US to be around 50 trillion dollars. As the world develops, the marginal returns of productiveity on that debt decreases. Think micro finance in Bangladesh. When people are really poor, a loan of 200 dollars is really helpful. Buy livestock, plow the field, manageable debt payments, etc etc. High return from small dollar amounts. If a wealthy US citizen uses much larger quantities of debt to buy a luxury truck or a larger house, this doesn’t make him or her more productive. This is one of the problems with having 50 trillion in debt. It takes a long time to pay off, and it doesn’t go anywhere soon.
While the gut reaction to reading about 800 billion dollar bailouts is that “the government is debasing the value of our money by just printing it,” this is an incomplete analysis.
First off, the total losses on the stock and real estate bubbles are somewhere in the neighborhood of trillions of dollars. If you thought you had 200,000 USD in your 401k plan, and the stocks went to 120,000 USD, you really did lose 80k. Likewise with the value of real estate. It turns out that despite 60 years of no more than a single digit % drop (late 1980s) in real estate prices, we have shattered the illusion that real estate is a stable commodity. It could well continue a slow and gradual decline, particularly in market segments that are overbuilt relative the potential market demand for such property.
Remember, for every decline or loss, a bank is even more apprehensive about loaning out new money. Creditworthiness definitions change (Citibank raised 2 million cardholders to a 30% interest rate on Credit Cards – many if not all are current on payments). Any losses also shrink the supply of money to loan back out. Lastly, cash stimulus and welfare merely maintain the status quo. They essentially keep peoples’ heads above water, but essentially the government spending 1 trillion on stimulus can’t possibly cause inflation in the near term. (debatable though 5 or 10 or 25 years down the line)
The issue I have with the massive leverage is that all of the borrowing and debt can feel like inflation and prosperity. However, the folks that borrowed excessively will likely take many many years to ultimately pay off this debt, and Japan is a perfect example of this type of debt driven deflation that drags on for decades.