[FoRK] What it means...

Jeff Bone jbone at place.org
Sat Sep 26 09:37:57 PDT 2009


On Sep 26, 2009, at 11:02 AM, Jeff Bone wrote:

> The biggest problem the Fed faces is massive deflation.  It's  
> literally an existential risk for them.  Under a deflationary  
> scenario, all debt actually *shrinks* in value rather than grows.

I should clarify this:  inflation (not deflation) causes the actual  
(not notional) value of regular debt to shrink.  The Fed, however, has  
a different perspective on debt than the rest of us, as an essential  
characteristic of its function.  In general, the Fed is seeking to  
preserve the value of its balance sheet and the usefulness of its  
effectively-infinite credit rating;  as such, deflation is a bigger  
menace to it than steady, low-level inflation --- it is its  
existential dilemma;  deflation implies reduced demand, so even though  
it has more effective notional buying power, the real value of that  
buying power is reduced at some level of deflation.  If you have any  
objections to that simply note the influence of steady, low-level  
inflation --- considered by central banks as a positive thing, of  
course --- throughout the history of central banking in this country  
or elsewhere.  If significant deflation occurred, the Fed would  
actually see a contraction of its own liquidity and hence the value of  
its holdings, greatly impairing its ability to continue to operate.   
Cf. Irving Fisher.

 From a regular creditor's perspective, some level of debt-holding is  
actually a deflationary hedge.  From a banks perspective, and  
particularly a central bank's perspective under fractional reserve  
banking, an increased appetite for debt (as you would see under  
significant deflation) outside the banking system and / or greater  
savings rates vs. borrowing rates at the bank (also evident under  
deflation) would be, beyond some level, bad for the bank --- and  
catastrophic for a central bank.

Talking about things from the Fed's or any bank's perspective is  
fraught with linguistic perils and clarity traps, as the perspective  
is often quite the opposite of what one intuitively thinks something  
means.  My error for not making this clear...



jb



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