Comments on: Lending won’t stop if banks go under.

By: Mike

Mike — Mon, 26 Jan 2009 21:08:38 +0000

“Is it possible that you don’t know what deflation is?”

Yes, that must be the issue. Astounding.

By: Maja's Friend

Maja's Friend — Mon, 26 Jan 2009 20:44:41 +0000

Hi Mike,
Is it possible that you don’t know what deflation is? I think you’re thinking of low levels of inflation rather than actual deflation. Do a google search for liquidity trap.
In a recession with real deflation, interest rates on loans would become astoundingly high, causing people to stop borrowing. The problem with this is that most businesses are financed by debt - which would become too expensive under deflation. If this were sustained, we’d see most businesses shut down - because the only businesses that would remain would be those run and owned by people who have enough money to withstand the deflationary pressures. In other words, we’d see a widening of the gap between the haves and have-nots.
The fact that you’re wishing for a deflationary environment means that you don’t fully understand deflation - again, I’m fairly sure that you’re thinking of low inflation.

Once More,
Maja’s friend

By: Mike

Mike — Mon, 26 Jan 2009 19:39:17 +0000

Hey man. Sorry for taking so long to answer this.

Yes, deflation is a good thing. It wipes out the waste accumulated during the bubble and allocates assets to smarter hands who didn’t get caught up in the madness. This is creative destruction, and without it, an economy can get nowhere.

The bailouts and moral hazard cause the instability to begin with. Without moral hazard, bankers would have to actually assess risk because if they didn’t, it would be their ass. The post below gets to the heart of the matter. It’s one of my favorites:

http://sovereignspeculator.com/2008/09/06/greenspan-was-framed-blame-bankers-moral-hazard-not-their-lackey/

By: Maja

Maja — Wed, 12 Nov 2008 09:32:28 +0000

Hey Guys, what do you think will happen when M2 plummets on lower total cash in the system? And do you think that deflation is actually a good thing?
Finally, it seems to me that person-to-person loan market places survive because the average person doesn’t know that he doesn’t know how to accurately price risk and return - this is supposed to be why banks are necessary.
I get your aversion to the moral hazard caused by federal insurance on savings accounts, but its a proven fact that stability helps markets to become efficient. Without things like financial bailouts and FDIC insurance in the US, when we have financial crises the markets would shut down- kind of like what happened in the great depression. By providing less capital for lending, the entire economy(through decreasing M2) it (the economy) would suddenly shrink, and people would be really … upset. And broke.

Love from Basic Economics,
Maja’s friend