Credit, Debt, Inflation, And Deflation: The Four Horsemen Of Economic Apocalypse

I seldom see any serious discussion of these four concepts in the main steam media.  If anything, the terms are glossed over and the commentators act as if these four concepts aren’t terribly important.  Of course inflation, for those who lived through the years of 1974 through 1982, was seen as a severe problem.  But few understood why the high rates of inflation couldn’t be contained.  Seniors were losing their homes due to increasing property valuations (not values) that led to a rapid increase in property tax assessments.  Homes that might have cost from $5,000 to $10,000 new in 1947 and has seen a slow appreciation in price could now sell for ten times their original cost.  For many who were receiving a low income from pensions or social security this increase in taxes along with the rapidly rising cost of living drove many out of their homes.  Some states, like California, passed reform measures that were designed to protect people from this injurious inflation of tax rates.  Instead, it merely caused more problems than it solved.

First I think we need to understand the idea of Credit since it is usually the first step in a series of mishaps that can lead to economic ruin.  Credit comes in many different forms.  For example, if a major league baseball player has a batting average of .335m he is given credit everytime he comes up to bat at being able at least a third of the time to get a hit.  He has earned that credit by his ability to hit a ball with a baseball bat.  You may have a childhood friend that would ask to borrow a quarter, spend it on something, and then later on give you another quarter for the one he borrowed.  He earned his trustworthiness by his actions.  He always showed that he was good for it, when it came to credit in money matters.  When we apply for and obtain employment the business world assumes we are capable of establishing credit.  So I get a job making more than minimum wage and I want to obtain a credit card or open a charge account at local store.  I am applying for credit, the privilege of borrowing money I do not personally have based on my ability to repay such funds.  Well, at least that was the way it was done in the old days.  If you wanted to rent an apartment and you had not established credit yet you needed to find a way to get people to trust you.  Maybe your prospective landlord wanted references from people who had good credit and would vouch for you.  Opening a utility account for electric, gas, and water usually meant that you would need to put down a deposit.  Your landlord would want first and last month’s rent and perhaps a security deposit.  Obtaining credit used to be a big deal back in my younger days, now, not so much.  Credit is given so freely that it no longer signifies a trustworthiness.  There was a time when obtaining a mortgage on a house meant that only one income was counted if you were a couple, that your current debts such as credit card payments and auto loans did not exceed 25% of your net income, and that your mortgage and tax payments would not exceed 25% of your monthly gross income.  And you had to show that your employment was stable, meaning you had worked for the same organization of five years or more.  Obviously if everyone had to meet those requirements today there would be far fewer home sales.  Placing such restrictions on the issuance of credit keeps most individuals living within their means.  Do we have those same strictures today?  No, credit has become extremely easy to obtain.  As America moved into the industrial age the strictures on credit were relaxed and by the time the roaring twenties came credit was easily had to the point of ridiculousness.

Debt is that thing you owe.  If you did me a service that I needed or required and it was not an easy thing for you, then I am in your debt.  My car broke down and I needed a ride to work.  You go out of your way to take me to work, pick me up, help me get the car into the garage and maybe loan me a few bucks for the repair, all at a time when I had no way to do all that for myself, then yes, I am in your debt.  I owe you one, This is how cooperation works, we do favors for each other without paying too much attention to how much is owed and if payment was received in full.  Money, of the other hand, that medium of transaction, is a different matter.  Money is not a favor, it is a unit of measure.  A child without a dollar in the candy store has no power to buy anything.  Whatever he receives comes from someone else.  But if he has a dollar then he has the power of choosing for himself, of making a decision to make a purchase and a decision of what he wants to purchase.  It allows us to go from I want to I have.  And one way to obtain money is to go and borrow it.  I want to purchase a house with so many bedrooms, bathrooms, and square footage but I do not have the cash.  The only way I can turn my want into I have is to borrow the money, to obtain a mortgage that will purchase the house for me.  I may be listed as the owner on the deed, but I am not the only owner.  The people I borrow the money from are co owners with me.  They own the amount paid by the loan and if I am reliable, they will own less of my house every year.  So each year I pay the amount due with earnings from my future.  Each year that I work part of my earnings go to pay that debt.  You see, the mortgage isn’t just on my house but on my future earnings.  A debt is that bet I have made with others that I can borrow money and repay it before I die.  I am telling those people from whom I have borrowed funds that part of my future earnings belongs to them, part of my life in the future belongs to them.  Ok, so I borrow double what I can repay in the future, meaning I have nothing left over for myself and the debt can’t be paid.  Do I lose my life?  Not really.  What you lose is the ability to obtain credit by which you obtain debt.  As for employment, well, that could be a problem.  The courts may take as much as 75% of your earnings.  And if you went into debt with the intention of not paying the debt, then that is fraud and you won’t have much of a future as you sit in the big house next to Bubba.  The excessive debt structure is what led to such a long depression.  It was made worse by a tax and spend government attitude.  The thinking by progressives and liberals was that we could spend our way out of debt.  Funny thing was, it took a war to spend enough money and we racked up one huge debt that has yet to be paid back.

Our old friend Inflation always seems to be in the news one way or another.  In Japan the Abe government wants inflation in its economy so that growth is stimulated and the government bond debt can be paid back with cheaper money.  Why should inflation make money cheaper?  Well, let us turn to an even older friend by the name of All Things Being Equal.  In an economy that experiencing inflation the prices for goods and services increase historically.  That is, what cost a nickle yesterday now costs six cents today and will cost seven cents tomorrow with yesterday, today, and tomorrow being relative terms.  Normally, if all prices and costs rose at the same exact moment and by the same exact percentage then no one would really notice.  All things being equal, only the numbers change.  But for fixed amount contracts such as debt, the amount stays the same.  If your income is increasing relative to your debt, then you are paying a smaller percentage of your income to the creditor.  In a world with rising inflation being a creditor is not a happy situation.  But this All Things Being Equal is a two edged sword.  That is, if you invest part of your income in fixed rate securities such as bonds, then you lose money in the sense that you have suffered an opportunity loss.  If you had been able to put the funds into a higher rate investment you would not be losing money, except that this thing inflation tends to continue for a while before it stops.  Of course the cost of the new car you wanted to buy just went up again.  Prices tend not to rise automatically, they jump up after some length of time.  And the rise is not very even as some prices need to rise more than others during any particular period.  Your wage might be linked to union contracts, in which case you will need to wait until the new contract to try and make up for your part of wages that have been lost to inflation.  An economy can also experience several varieties of inflation.  Increasing wages in response to inflation may cause wages to push the cost of other goods upwards.  The cost of goods rising can also pull wages up.  And then we can have that wonderful problem of stagflation.  The economy becomes stagnant while inflation affects the cost of goods and services.  In other words, the economy is not growing by the usual measurements.

Inflation is also a tax upon the poor.  With an ever increasing standard of living it costs more to leave poverty.  If a dollar would feed a family of four for a week and it took three or four days work to earn a dollar then that family was relatively well off.  But when it takes five work days each week then that family is only staying even.  One the number of days exceeds the normal work week the poverty ensues.  Back about 1970 you might have been able to search enough sidewalks and pick up enough pennies to buy a meal at McDonalds.  One could get a small softdrink, small fires, and a regular size hamburger for 98 cents.  That same meal might cost you over four dollars today and I doubt you could search enough streets in one day to find enough pennies to pay for your meal.  It is a matter of proportion.  For the rich, such as millionaires, the proportion of income they spend on meals relative to their wealth is very small.  For the poor man, it’s everything.  Inflation does not increase to size of zero, it’s still a constant.  Now usually inflation comes from too much money competing for too few goods and services.  If only one man can afford to pay the cost of a diamond necklace for his wife and only one diamond necklace is made the price will always be the same.  But is there comes another man who can afford to pay for that same diamond necklace then the price will rise until only one of them has enough money to pay for it.  The one man is able to outbid the other.  This is called supply and demand.  But if that new man is the government, then the government is now causing an inflation in the price of diamond necklaces.  Well, you and I don’t care that much, it’s not like we want to bay a diamond necklace.  When the government starts consuming more it puts inflationary pressure on the economy.  You see, the government doesn’t make anything per se.  It only consumes.  Yes, we may depend upon it for our defence and a couple of other services that normally come about when populations become very large, but it literally makes nothing one could sell to another country that that country doesn’t already have.  We make the armaments our government sells or gives, but those sales come out of our taxes one way or another.  Besides, making tanks and assault rifles for sale to other countries diverts goods and services from our own consumption.  Consumer goods and military goods compete for many of the same resources and that means that the more the government consumes of one type of good and service the more it will cost the consumer and that is inflationary.  Back in 1965 until about 1974 we were fighting a war, limited as it might have been, going to the moon, and fighting both drugs and poverty.  Is it any wonder we had horrible inflation.  But the one thing we did not do was stop government spending until almost the eighties.  That allowed the consumer side of the economy to catch up, if you like.  Of course the other action that happened is that the government debt kept growing.  Balancing the federal budget does not mean paying down the debt load, only matching revenues to spending.  And we must take into account the fact that often it isn’t tax revenue that is used to balance the budget, it is interagency borrowing, such as using funds from the Social Security Trust Fund.  A great deal of government spending is what is known as off agency, liabilities are not listed as debt.

The fact is, excessive debt fuels inflation by bringing forward future earnings to purchase goods, services, and assets.  When we have watched the asset prices of housing rise to excessive and unreal values due to abuses in credit management and over funding of debt we see where what can be described as hyperinflation has occured.  Excessive debt allows for speculation, not investment.  Normally hyperinflation is associated with the physical printing of currency that is excessive.  We should understand that in reality, hyperinflation really means that collectively the people of a currency union, whether it be the EU or the United States, no longer have confidence in the value of that currency and thus the desire to buy any kind of good that may have a possible asset value.  It could be boxes or underwear or toilet paper.  And usually what is collected as assets is bartered for other assets such as canned goods of food.  But never the less, we can see that assets in the world have gone through phases of speculation and the end is not in sight.  And we also see goods and services that really can’t be termed assets, such as degrees in educational study.  One does not sell or trade a university degree, it is non-negotiable.  Yet the cost of earning one has reached extreme highs in a very short time period.  As we can see, inflation strikes in places we do not normally associate with inflation.  The other part of the inflations in the costs of personal education is that it reaches into the job market.  That university or college degree requirement is a discriminator used to eliminate individuals from consideration for employment.  Since the wider spread use of degree requirements we see an inflation in the educational value of a degree for use in employment.  Yet often the skills accorded with a degree go unused.  This is an inflation in employment requirements that does not lead to a more effective distribution of goods and services.

Finally, we have Deflation.  We see examples of deflation when housing that had previously excessive high values could not sell for half that amount.  Simply put, deflation is a lack of demand and when applied to a broad spectrum of the economy, means the consumer is out of money, broke, can’t buy another hot dog to satisfy his immediate hunger.  How does deflation occur?  When business, the government, and the consumer have borrowed excessive amounts from the future earnings until there are no more earnings to borrow against, one finds deflation.  Is deflation really as bad as the politician and economists say it is?  No, its really the reset button being pushed.  What is does do is hurt the borrowers because in a deflated economy wages may retrace to earlier times, the cost of goods and services are lower, but the debt service stays the same.  That means that while your cost of living has been reduced your cost of debt service has increased as a percentage of your present income.  The ultimate form of deflation is when debt is defaulted, that is, when you either cannot service your debts or repay your debts or when you chose not to do so.  Deflation is just as indiscriminate as inflation.  And it is very disruptive in the short run.  Employment may be lost, savings destroyed, whole industries abandoned, that depends on the amount of debt that has encumbered those companies, those industries, those nations.  While many economists prefer inflation they hate deflation.  Yet the argument goes that a little inflation is good for growth.  Unfortunately this has never been demonstrated or proven.  If two percent inflation is good for growth in GDP then one might think five percent or ten percent would be better and what about fifty percent?  Man, that must be a barn burner.  Except inflation is not growth, it is interference in growth.  Inflation perverts the measurements of GDP, it harms those who can least afford increases in cost of living.  Deflation only increases the misery index by making loan service more dear.  It penalizes those who should not have borrowed so much and so long.  Deflation, because it so often increases default penalizes both creditor and borrower.

So what have we learned?  Starting from credit, excess increases the likelihood of increased debt, increase inflation, and increased deflation.  This is not a set formula but merely a description of human behavior.  Human behavior follows probabilities, not exact formulas.  A probability is just that, the mathematical calculation that a certain event will occur, not a promise that it will.  We are not ants that follow a strict set of instinctual behaviors to the letter.  This is why variation plays an important part of human behavior.

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