Deflating the Australian deflation pandemonium

You might have thought we had more than enough”scare campaigns” this election festival what with Malcolm and Morrison prowling the streets of our cities spinning yarns of doom, gloom and desperation if the public even dare think about handing the reins of economic management to anyone else.

Which is not exactly a positive message to be selling…

 “Hey if you think the economy is a bit stinky now just imagine how much worse it could be

..but then fire and brimstone is natural territory for the conservative end of the political spectrum.

However, there is a new scare in town that is growing in spooky power day by day.

Deflation!!!!   – Quick run for the hills the prices are falling !

Listening to the usual suspects – mainstream economists and especially the hot house variety fed on a high protein bank profit diet – one would think that deflation is a scourge worthy of inflicting on a bunch of Pharaoh era Egyptians who broke a promise to a babe from the rushes.coles_down_down2_2-698x400_q85_crop_upscale

Leaving to one side the vigorous debate whether deflation or inflation have important moral lessons to teach simple debt loving consumers, there is a more fundamental issue of where the beast of deflation comes from.

Some argue that it comes from the excess of capacity and the countless billions sunk into commodity production speculation.

Some say it comes from a deficiency of demand as consumers around the world lose interest in upgrading their collection of Bruce Willis movies to 4K and prepare themselves for decades of games of indoor bowls and TV dinners.

Unfortunately most of the”adult economists” as they fancy themselves, refuse to consider the possibility that the deflationary pressure is building because of debt and that cutting rates to stimulate more debt is the very last think that a Doctor who cares for his/her patient would recommend.  But then economists don’t have a Hippocratic oath.

Debt is the deflation dungeon master for a few very good reasons.

  • Even at very low rates – very large debts generate significant interest.   Even mortgage rates of 3% on $1.6T of housing debt generates an annual interest bill of $48B every year!  Yes that is where those bank dividends come from.
  • If the only way of paying the interest on earlier creations of Bank Money (loan deposits) is to create more Bank Money (loan deposits) that also generate interest – you will be always chasing your tail. Which is why the MMT prescription that interest doesn’t matter and you just create more Bank Money doesn’t help either.  Note: To the extent that MMT approves of direct monetisation of fiscal deficits as the solution to the mathematical problem of compound interest on Bank created Money driving deflation it is little different to the positive money / debt free public money crowd – except those crowds are sensible enough to propose abolishing Bank created Money completely.
  • The process of creating Bank Money (loan deposits) inherently requires someone to take out a loan from a bank and that means the banks get to choose

(1)     Who gets the loan
(2)    What they use it for – productive investment or speculating on house prices.

Is it any wonder when so much control over the allocation of economic resources has been handed over to profit seeking banks and their captured regulators that people across the country are calling for a Royal Commission into banking.

The malinvestment when banks create money and hand it over to speculators rather then investors in productive capacity is the core issue that is driving the problems with our banking sector.

The only way to ease the deflationary pressures created by the interest (even very low rates) on the mountains of outstanding debt is to create a supply of non-interest accruing money that offsets those deflationary pressures.

Offset is a critical word because there are a lot of people who seem to think that the RBA creating money is somehow more dangerous than a profit seeking bank pumping out Bank created Money to speculators and foreign buyers. The point is to offset the deflation not drive inflation. The goal should remain stability – neither inflation or deflation – which is even better than a 2-3% inflation target.

That means more Bank created Money is not the solution and cutting interest rates does not help because all that does is stimulate the creation of more Bank created Money.

Pushing interest rates beyond zero into negative territory doesn’t work either because it leaves the broken out sourced money creation mechanism and the ‘thinking’ that created it untouched.

If Bank Economists really want to make useful suggestions they would be better off recommending the government authorise the RBA to purchase a specific amount of 0% non-transferable government bonds from the AOFM at the next government bond sale.

With no other changes by the government that simple measure alone would introduce a supply of non-interest accruing Public Money into the financial system.

But then a Bank Economist might find himself in a pickle making recommendations like that because it may be the start of a very slippery slope.

As the public starts to realise that RBA purchases of these special bonds will not end life as we know it there will be calls to authorise more purchases and as 0% inflation/deflation will remain the object of monetary policy that will inevitably require Bank creation of money to be limited – and there are many ways that the RBA and APRA can make that happen.

The real reason that Banks and Bank Economists are suspicious of government deficits  and simply hate the idea of deficits funded with 0% public money is that it is likely to require (to avoid inflation) close restriction, regulation and eventually the abolition of Bank created Money.

A Bank Economist recommending measures that will surely lead to restrictions on bank freedom to create Bank Money (loan deposits) as Public Money?


“…Their model tells them if they lower the interest rate, inflation should increase, but their model is based from the 1970s. ..”

The following is a response to a comment made at Macrobusiness suggesting that the confusions of Bank Economists dated back to the 1970s.

It is a bit earlier than that.

Lowering the interest rates on debt should increase the demand for debt. As the demand for debt rises banks are able to enter more loan contracts and create more deposits.

More bank deposits means more money because bank created deposits are treated legally as equivalent to public created money – a key difference to the IOUs created by anyone else. That process will normally generate inflation so long as the rate of Bank Money creation exceeds the rate of old loans being repaid and the demand for money due to interest payments.

But once debt becomes so large that the rate new bank money creation cannot match the rate of loan repayment and interest payments there is a problem – especially if the new bank money creation there is happening is going to a select group of people who are squirreling it away.

Australia is a little unusual in that we are experiencing the problems of too much debt but mostly on the private side.

Usually it is the govt that finds itself feeling constrained by too much on the balance sheet. For us the problem of deflationary pressures is growing on the private side.

The big change in Australia was in the 1980s when household debt was let off the leash.

Our 20+ recession free years were largely the result of riding the private balance sheet to the moon. The ride was so sweet that for a while there was so much excess the public sector could pay down its debts.

That game is over – debt on both sides – public and private will continue to rise because the private sector cannot run up enough debt to allow the public sector to run a surplus and public sector will soon be n the same position as the private if it tries to run up debt fast enough to allow the private to pay down theirs.

The only way to solve this problem is 0% Public Money financing deficits – just enough to offset deflation.


Categories: Macrobusiness

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