Deflation Revisited

Deflation in Action

Back in 2007 I understood that nominal interest rates were to reflect supply and demand for money. As more people demanded loans, the cost of interest should rise by simple economics. The problem? Government proceeds to print money out of thin air. The supply of money increases (inflation) and the price of money stabilizes.
What surprised me was just how much money would be printed.

These are the smartest guys in the room running the show..for example, Carney of Canada was the Governor of both the Bank of Canada and later the Bank of England.

So inflation stems from money printing.

Deflation comes from the exact opposite, shrinkage of the money supply. But how does that happen?

There are events that occur in which assets simply disappear. That is happening today as the US bombs Iran. Each missile costs about a half million or more. When it hits a target the damage can be profound, possibly billions of dollars. Where does the value of these assets go? They go "poof!!"

Money is required to purchase new or replace assets that have simply disappeared. Here there is contension since governments will try to borrow, or, if that is not possible, they will sell gold or borrow against gold to replace guns ammo, missiles, bombs ships and tanks. Iran has to replace its infrastructure.

Liquidity is drained from the economy. Money becomes tight in supply and prices drop because people have less money to spend. This cycle of falling prices, reduced growth, asset destruction and shrimkage of the supply of money is called deflation.

Most governments fear deflationary spirals since it forces them to cut spending. It becomes a self fulfilling cycle in which growth and spending are reduced leading to further cuts in growth and spending.