Bank lending policy

what about if wages also dropped? Would that fit your ratios better? In a servere depression wage deflation would be assumed.

I must admit, I've been stunned by the rises in prices in houses over the last few years. I didn't believe they could have got any higher about 2 years ago, then they went into overdrive! It's been a good education for me on the irrationality of markets (or maybe human behaviour). Do I see them going any higher? hmmm, I doubt it, but I can't rule it out, i've been wrong before!

ps - a good analogy I've come across is this....the further you pull a piece of elastic, the faster it springs back when you let go....and the more it hurts.

analogy's are gumf though as far as I'm concerened ;-)

Assuming that wages don't fall, which is precisely what happens in a deflation.

FoFP

There was one crash in the late 90's, which affected shares and housing

9and in fact things such as art and other collectibles) and there's only one crash now, which has so far mainly affected shares.

Part of the dynamic has been that property continued to go up after the Tech Stocks crash precisely because of rotation from one asset to the other, but that's a normal thing in a bubble. Sooner or later the real underlying bubble, the *credit* bubble, bursts, and this bursts all the markets which still depend on the credit flow to keep inflating.

As I keep trying to explain: it's not houses, or shares, or classic cars, or tulips that are the cause, it's the *credit*. The credit bubble is what matters. The rest is just froth.

Unless you can figure out a way to bid up houses from current values when buyers can't get loans?

FoFP

"Jo Reed" wrote

You mean, say instead of average house price dropping to 100K with average wage 25K (ratio 4.0), you have a drop of price to (say) 20K with average wage 5K (ratio still 4.0)??

Isn't that just like a change of currency - something that most of europe went through recently, changing to the euro? [If 1 Euro = 4 'old currency', then prices suddenly dropped to a quarter of their previous number & wages similarly dropped to a quarter of their previous number - 100K 'old currency' became 25K euro...]

Similarly, if prices & wages dropped to a quarter of their previous amounts, then a four 1 coins minted in year 2000 (say) should be equivalent to one

1 coin minted in 2010 (say). Just a "change" of currency!!

Yeah, something like that, though if we had 80% deflation over anything less than a decade, I suspect the ramifications would go a lot further than falling house prices.

Pretty much, except in a deflation, if you owed 50K on that 100K house that went to 25L, you still owe 50K and it's now ten years of your wages. This is why it's bad to be in debt when a deflation starts.

FoFP

"M Holmes" wrote

But if you agree that the four 1 coins from 2000 become equivalent in value to the one 1 coin from 2010, then I would imagine that a bank a/c with a 4 balance in it in 2000 would have *negative* interest applied (somewhere) over the period 2000-2010, to get it closer to 1 in 2010.

Similarly, any debt (assuming it is variable-rate, not a fixed-rate loan) should have negative interest applied to it as well - reducing a debt of

50K in 2000 to a debt of more like 12.5K in 2010.

Or are you trying to suggest that lenders would try to "pull a fast one" and continue to charge high rates of interest that wouldn't be warranted?!

but no one would stand for this, they'd hold it in cash instead

I'm not sure this ever happens. I've heard that banks occasionaly lend to each other at -0.5% because it's cheaper for a larger bank to hold the cash, than it is for them. Even in Japan I'm not aware of interests rates going negative during deflation. Look at is this way, if the bank was going to apply a negative interest rate to your mortgage, they'd be better off asking for it back (which they can) and stuffing it under the bed themselves! As far as I'm aware, negative interest rates just aren't feasable.

Maybe not high, but I think certainly +ve

Except nobody is going to keep their money in a bank at negative interest rates. They'd just keep it under the mattress and watch it appreciate in value. This is in fact what happens in deflation and it's part of the reason banks quit lending money and try to get back what they're owed.

So who's going to loan you money if you offer them a negative interest rate?

Floating rates would go to zero, but assuming deflation, any debts would get more expensive despite the lack of interest being applied.

Those on fixed rate loans would be really shafted.

As I said though, that's just how it works (it's called the Zero Boundary Liquidity Problem by the wonks). Basically it's down to the borrowers to ensure that they don't have debt when we go into a deflation (and the lenders to try to recover their loans before the borrowers default) and that they don't have assets which will go down in value because they rose in value during the inflation.

There's a Fisherite theory that you can get around the problem by printing money (or "increasing liquidity" as it's called these days) and basically causing inflation to offset a deflation (or a post-crash one anyway - there are different sorts of deflation). Bernanke reprised this in his 2003 paper on how to avoid a Japanese style deflation in the US, when they believed that was exactly what was about to happen.

Ironically it's been largely the Japanese and Chinese who have printed the money (though massive borrowing by the Bush administration did its bit). This didn't stop deflation in Japan, but by buying up US Treasuries to keep the trade game going, they effectively reflated the US.

Whether that's just stored up another blow through massive foreign accumulation of US debts, remains to be seen. It looks to me like the uS could be hit by a more severe deflation that they would have had, because most of that credit flow went through mortgage-backs in some way setting the stage for a house price collapse (and subsequent deflationary hit to consumer spending) there. However, if the Japanese and Chinese were to flood bond markets with US debt, there's an argument that this would cause inflation in the US through currency effects.

I'm with the deflationists though. If the latter happened, I suspect we'd see 2% to 4% immediate hikes in US rates as the Dollar collapsed and as Argentina showed, debtors have it worse if they don't save their currency. Needless to say such rate hikes would bring on the house price crash everyone fears.

Maybe then Bernanke would get to drop money from helicopters...(*)

The short form is that deflation isn't the same as a currency change. It's simply the opposite of inflation.

FoFP

• The Japaneese figuratively tried this. It didn't stop the deflation. Anyone would think the Austrians were right.

A couple of times yes, slightly negative. Once for the reason above, and once for some technical reasons to do with bond trades.

Indeed. The Japanese banks have been withdrawing loans and investing cash in government bonds paying less than an eighth of a percent. The government got such a great deal it has Italian level debt of 160% of GDP.

There have been some technical papers on dating money, so that if you don't spend it by the Spend-By date, it's worthless. In that sort of regime you could set up a negative rate.

I doubt it'd really work though. It's hard to imagine a better temptation to repudiate a currency and go for shiny metals.

FoFP

"Jo Reed" wrote

There'd be no point - because it would be the same whether they held it in cash or in a bank a/c. If they "held" it in cash (say as 1 coins minted in 2000), then in 2010 they'd need to swap 4 of those coins to get back a single 1 coin minted in

2010 - per our pre-requisite above.

"Jo Reed" wrote

In which case, similar to the case above, they'd need to swap their year

2000 coins/notes into year 2010(etc) coins/notes and they'd still lose-out in the same way!

The fact that the bank's systems didn't prevent the loan suggests that there's more to it than just `is this person likely to be able to pay us back`. The old joke is `if you owe the bank £100 you have a problem; if you owe the bank £1,000,000 the bank has a problem` doesn't apply if the bank can sell the debt on to someone else, and if more often than not the bank does get its money back.

"M Holmes" wrote

Please see my other post to Jo - it'd be just as bad under the mattress!

"M Holmes" wrote

It may have happened that way in past deflations, but who's to say the next one won't be handled in a "better" way (as suggested earlier)?

"M Holmes" wrote

Someone who would lose-out at an even more negative rate, if they didn't loan me the money??

"M Holmes" wrote

Agreed!

"M Holmes" wrote

With (positive) inflation, interest rates & investment returns generally keep around a couple-of-percent above the inflation rate - eg inflation at

3%pa, interest rates around 5%pa.

So, if I take your comment "[deflation is] simply the opposite of inflation" to mean that it is the same as negative inflation, then interest rates again oughta stay around a couple-of-percent above the (negative) value of inflation -- eg inflation at -4%pa (negative, ie deflation), interest rates around -2%pa (ie negative).

In message , M Holmes writes

I thought you had given up on that idea after looking at the relative house price to earnings ratios.

In message , Jo Reed writes

Taking the analogy there would be a hysteresis[1] loop and so the elastic on its return would end up slightly extended compared to when the stretching started.

[1] My speel chucker doesn't like that.

Ah, I see. You're basically proosing the idea that money has a sell-by date.

The trouble is people wo't accept money working that way. If they have a

2000 one Pound coin and it gerts spent in 2010, they'll want it to be the same as a 2010-minted coin.

Remove that feature of money and people will start using metals or some other repository of value instead.

These ideas are interesting from a technical point of view, and multiple variations have been theoretically explored. However, like battle plans, they have the feature of flying to the Four Winds when faced with the enemy.

Paper money is a relatively new phenomenon, and Fractional reserve Banking and Fiat Money newer still. Our currency is very much a fiction and many crises have shown that if that little suspension of disbelief gets punctured, people will resort to trading in precious metals or even barter. It hardly needs saying that a Country that depends for much of its invisible earnings on the fiction of fiat finance being maintained can't afford to take too many risks with the folks being expected to continue believing in Tinkerbell.

FoFP

Sorry, I misunderstood you. See other post answering this.

Which doesn't happen due to the Zero Bound constraint we've been talking about.

Unless deflation gets realy out f hand though it's not usually a big problem other than at the changeover ponts. For the last 4 centuries, England has spent as many years in deflation as inflation. The recent giant inflation is historically very unusual.

FoFP

"M Holmes" wrote

Why not in the sort of regime that I imagined? The money doesn't have to become worthless after a 'Spend-By-Date', just have a different value depending on when it was minted....

To try to avoid confusion, let's say coins & notes are minted in "guineas" (rather than pounds sterling), whereas bank accounts are held in pounds. Let's say that a "guinea" is worth 1.05 GBP (at the time it is minted). Let's suppose there's a constant negative interest rate of 12.945% pa.

A bank account with 420 GBP in it in 2000, with no deposits/withdrawals, will end up with 105 GBP ten years later in 2010 after the negative interest rate has reduced the balance to a quarter of its previous amount. Four hundred "guineas" minted in 2000 (then 'worth' 420 GBP) will, in 2010, be taken to have the same value as *one* hundred "guineas" minted in 2010. So they'd be 'worth' 105 GBP in 2010.

Same situation in the bank or under the mattress - both fall from 420 GBP to

105 GBP!

Effectively, in 2010:

1.05 GBP 'in the bank' is worth 1.05 GBP. 4.20 GBP 'in the bank' back in 2000 has reduced to 1.05 GBP, and is now worth 1.05 GBP. Four '2000' guinea coins are worth 1.05 GBP. Four '2010' guinea coins are worth 4.20 GBP. [Obviously, the rate at which the guinea coins "devalue" could be set differently to the (negative) interest rate prevailing - say much like the rate-of-change of value of coins could be 0%pa, when interest rates are say 4%pa - but the principle is (hopefully) clear.]

M Holmes,

very interesting stuff, can you recommend any reading on these subjects?

it's funny, i've always sort of felt this existed, it's nice to know the "experts" have a name for it (i'm not an economist). It's the weird thing about interest rates, really for the system to function they *should* be able to go negative, and that would cure many problems, but that just donesn't seem to be a viable possibility, without the dating of money idea (new one on me) which as you say has it's own problems.

Thanks to both of you, i'm surprised to find such enlightening people on usenet....i've always regarded it as something of a backwater!