The Deflation Bug-bear

The Left wants to scare us with the specter of "deflation" because they want the easy-credit party to continue. Their Keynian fantasy is that handing out money makes the economy work: if people have cash they can buy things factories sell stuff, factory workers get paid, and the whole system "works". But doping the economy with funny-money can only help particular and limited situations.

Deflation is not what is going to happen. There is plenty of real value around (more than ever before in the history of humanity!) and the economy, at least in America, is still fairly sound. People are working; there is demand; there  is offer. Our current "crisis" is about money - because government debt is out of hand. This situation is unprecedented and difficult to cope with intellectually. 

Given the current "political culture", inflation is inevitable. It is the only way to balance budgets without "politically difficult" cut-backs (see the Greek riots), even if the end of this road is still a brick wall. It works this way: the government owes $1000, but it also controls the money supply, i.e. prints the money, or - what comes to the same thing - controls the "flow" of "credit". So, when the money "loses value" (i.e. prices go up because there is so much loose cash around) the same dollar amount buys less, or represents less value. So when the government loan comes due, it hands back $1000 to some sucker of a foreign investor. But this $1000 now only buys 10% of what the $1000 loaned bought at the time it was borrowed. Borrow 1000, pay back 100; clever, dishonest, and a bad deal for lenders.

Gietner wants the Chinese will lend us money. The Chinese laughed at Gietner. The Eurocrats are scrambling to guarantee Greek dept, but this is not "calming" "the market".

Each year, like a plague: larger and larger budgets, more and more debt. The game of infinite credit, or “easy money” is now, at long last, over.

The housing crisis and the debt crisis are really the same thing. The government wanted to make home-owning "democratic", or "accessible to everyone", even the bums who can't pay. They made the banks fill lending quotas. Loans for home-buying are a significant portion of all loans, or “credit”. The other major sectors are business loans, and loans to governments. This is where "savings" go, i.e. money people put in banks. The banks lend this cash to home buyers, business and the government (by buying treasury bills). So too many housing loans were driven by fiat and quota, not on the basis of whether or not people could pay back. The accumulation of bad loans (or "bad dept") was aggravated by the newfangled practice of grouping loans into "packages" to buy and sell like barrels of olives, as well as insurance packages on these packages, also bought and sold like barrels of olives. These shenanigans hid the fundamental problem behind a screen of "finance", namely that there were sums like $300,000 loaned to vast numbers of people who could not pay them back. Eventually it was generally realized that no money was coming was in; the "packages", and the loans behind them, were worthless, and the whole thing fell apart. 

Thus IRAs went "down". The money in the IRAs had been lent by banks to home buyers who could not pay it back. The banks could repossess the houses, but the house prices, inflated by th easy credit, fell back down to real values, and much of the loaned money evaporated. 

"Deflation" occurs when prices collapse below “real value”, or where “real value” becomes a meaningless concept because no one has anything to trade, because everyone is destitute and exchanges cannot even occur. Deflation is not when prices return to normal after a bubble bursts.

But the big part of the “crisis” is bad government debt.

People lend money to the government, like the banks lent money to home-buyers. But, like the bum home-buyers, the bum-government (like Greece) can't pay it back. Their liabilities and debts are so bloated that money collected in taxes, plus any new loans they can trick people into, do not even cover the interest on thier current loans. The governments borrowed so much money to pay for massive entitlements: hiring people into make-work jobs, or just handing out money. This, thankfully, is now over. We can sit back and, with a certain bitter satisfaction, watch it all wind down.

So keep your value away from money, and away from treasury bills in particular! In the short term be in real property: land, manuscripts, gold, etc..  There will be massive inflation, and there will be much pain for people "sucking on the government’s hind tit". Small government pensions for older people are probably ok, though inflation will ruin their current real value. Savings will shrivel. People dependant on government largesse will have the worst time. But there is no fundamental problem. And this “crisis” will probably be accompanied by a general weakening of governments, which will allow the civil society to reconstitute the economy more easily.