A fractional Reserve

[Copernicus]

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Deflation rewards savers. If you save your money you will be able to buy more goods and services with it tommorrow. Inflation rewards debtors, so it is no wonder why the US has steadily become the largest debtor nation in history.

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Wouldnt this lead to less spending---> less production ---->less jobs?

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In addition this leads to devaluation of inventories-->lower profits ---> falling stock prices -----> layoffs----> lower individual net worth -----> lower spending----> recesssion that can quickly spiral into depression.

With deflation, putting your money under the pillow carries zero risk, raising the premium needed for capital formation which quickly stifles economic growth.

The present value of existing fixed rate bank loans (their liabilities) skyrocket, because current interest rates are much lower than what they are paying out, so the banking system is hurt.

Interest rates get so low that banks would want to pay you to borrow their money, because you would be paying them back in more valuable dollars..ie interest rates would theoretically go negative, obviously an untenable situation, because loans still carry risk of default. A bank would be better off just holding the money they have and not lending any out. Thus the credit markets dry up totally again crippling economic growth and the housing market.

[lehighguy]

Wrong

Before 1913 the US experienced deflation at it became an unprecendented economic powerhouse during that time.

Obviously, huge increases in the moeny supply followed by huge decreases has massive ramifcations (see Great Depression). However, the problem here is caused by the original rapid increase in the money supply! And trying to continually paper over it eventually leads to hyperinflation (Ben's current strategy).

If have constant money supply and we experience deflation of 2% and a strapping young capitalist believes he can turn $1 today into $1.02 next year through investment then the bank will lend him $1. After all, the banks rate of interest just sitting on the money is 2%, but if it loans it out that becomes 4% (deflation plus gain on loan). All we need for this to be possible is for our entreprenuer to be able to increase productivity 4% or so.

Now if you rapidly increase the money supply and it then collapses and you have deflation of 15% there is no way loans can take place. The entreprenuer will borrow the money and then have to sell his goods at prices 15 lower. It's going to be impossible to service any kind of interest on a loan, so he will end up not borrowing and everyone will keep thier dollars under thier mattress....Great Depression.

[tolbiny]

[ QUOTE ]
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Deflation rewards savers. If you save your money you will be able to buy more goods and services with it tommorrow. Inflation rewards debtors, so it is no wonder why the US has steadily become the largest debtor nation in history.

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Wouldnt this lead to less spending---> less production ---->less jobs?

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There are many factors working in opposite directions, and while common sense may point to this possibility there are many reasons why it doesn't happen in actuality. Take inflation for example- inflation means that money must be either invested or spent or lose its value, there is risk in simply holding money (ie capital) which in turn makes risky investments appear relatively less risky (when compared to holding dollars), the result of this is many more businesses would be expected to fail under inflationary standards. Anecdotal evidence in the US? generally accepted numbers for small businesses are that 70-90% of them close within 5-10 years, with the majority closing because they are unprofitable (2/3rds is often quoted, no data or links to back that up right now). In the short term thats a lot of jobs, in the long term thats a lot of mis allocated resources. In a deflationary (due to fixed money supply) setting investors are more cautious with their money, fewer businesses will be started, but one would expect those businesses to have far higher success rates, short term growth is slower but with out the corresponding liquidations of unprofitable businesses so available resources are greater. A deflationary scenario can lead to lower overall productivity when measured in total units, but much greater efficiency when measured in actual utility, mush steadier growth and more security for the individual.

[Copernicus]

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[ QUOTE ]
[ QUOTE ]
Deflation rewards savers. If you save your money you will be able to buy more goods and services with it tommorrow. Inflation rewards debtors, so it is no wonder why the US has steadily become the largest debtor nation in history.

[/ QUOTE ]

Wouldnt this lead to less spending---> less production ---->less jobs?

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There are many factors working in opposite directions, and while common sense may point to this possibility there are many reasons why it doesn't happen in actuality. Take inflation for example- inflation means that money must be either invested or spent or lose its value, there is risk <font color="red">risk is a poor choice of words here, because it doesnt mean what you are applying it to in financial terminology. </font> in simply holding money (ie capital) which in turn makes risky investments appear relatively less risky (when compared to holding dollars), <font color="red">I disagree with this characterization. There is no "appearance of an investment becoming less risky". You are compensated for risk by a greater return on your investment then you can get from risk free investments. You are also compensated in the risk free rate of return for inflation. </font> the result of this is many more businesses would be expected to fail under inflationary standards. <font color="red">that doesnt follow at all. In an inflationary environment the risk free rate of return and the risky investment return both increase to compensate for inflation. the net result is that the discounting of the asset and liability offset each other and the effect on investment decisions is minimal, and is a residual of timing differences. If returns could be immunized by exact cash flow matching there would be no impact at all on invesment decisions from higher or lower inflation. </font> Anecdotal evidence in the US? generally accepted numbers for small businesses are that 70-90% of them close within 5-10 years, with the majority closing because they are unprofitable (2/3rds is often quoted, no data or links to back that up right now). <font color="red">It is my understanding that under-capitilzation, not long term prospects for profitability, is the primary reason for business failure. Even if it is profitability, that is an error in business judgement that is minimally impacted by inflation as shown above. </font> In the short term thats a lot of jobs, in the long term thats a lot of mis allocated resources. In a deflationary (due to fixed money supply) setting investors are more cautious with their money, fewer businesses will be started, but one would expect those businesses to have far higher success rates, short term growth is slower but with out the corresponding liquidations of unprofitable businesses so available resources are greater. <font color="red"> wrong, since your basis for this is by assuming the opposite of incorrect conclusions regarding the impact of inflation on investment decisions</font> A deflationary scenario can lead to lower overall productivity when measured in total units, but much greater efficiency when measured in actual utility, mush steadier growth and more security for the individual.

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[tolbiny]

There are many factors working in opposite directions, and while common sense may point to this possibility there are many reasons why it doesn't happen in actuality. Take inflation for example- inflation means that money must be either invested or spent or lose its value, there is risk
in simply holding money (ie capital) which in turn makes risky investments appear relatively less risky (when compared to holding dollars),

I disagree with this characterization. There is no "appearance of an investment becoming less risky". You are compensated for risk by a greater return on your investment then you can get from risk free investments. You are also compensated in the risk free rate of return for inflation.
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Risk reward calculations are made to weigh options against each other, they have no value in absolute terms, only in relative terms. Under inflationary pressures your options are (highly simplified) invest with risk reward X or hold with the expectation of depreciation. Under deflationary its invest with risk reward of Y or hold with the expectation of appreciation. Because the relative option under deflation is far superior investments must have a better risk reward ratio to be considered.

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Anecdotal evidence in the US? generally accepted numbers for small businesses are that 70-90% of them close within 5-10 years, with the majority closing because they are unprofitable (2/3rds is often quoted, no data or links to back that up right now).

It is my understanding that under-capitilzation, not long term prospects for profitability, is the primary reason for business failure. Even if it is profitability, that is an error in business judgement that is minimally impacted by inflation as shown above.
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It hardly matters the reason for failure since all reasons for failure are figured into risk reward scenarios.