# Deflation



## clowboy (13 February 2006)

I was first thinking this in regards to the sharemarket but it would become quite complicted what with shorting of stocks and so forth so I will use property to simplify the example.  I still think the same would hold true to shares though despite shorting and other wonderful techniques.

In a rising market prices go up becuase people are willing to pay more for them.  The price paid for the asset is real money and comes from somewhere despite that more often than not being a loan.

Using only one house to keep it simple I assume that someone has bought a $100 ,000 property (cheap I know) and a year later they decide to sell it.

The market has stalled and the highest offer that they recieve is $90,000.
Assuming that there is no other factors influencing the transaction (selling/buying costs/ rent/tax/mortage etc) for simplicities sake.

The owner of the house sells it for the $90,000 releaseing a $10,000 loss.

My question is this......where has the $10,000 gone?

In the event of a recession/depression vast sums of money are lost?  Where does this money go?

Using sydney property as an example, if at it's peak all property in sydney was worth $10 billion and it has since devalued by 10% to $9 billion, where has that $1 billion gone?

Any thoughts and/or explanations would be appreciated.


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## Smurf1976 (13 February 2006)

To my understanding it simply disappears back to where it came from - literally thin air. Using the property example, let's assume that a net 10% of all property owners wished to sell. That is, the number of sellers exceeding the number of buyers by an amount equal to 10% of all houses physically in existance. The bottom line is that in practice they could not sell and the keenest sellers would drop prices to chase the available buyers. A classic house price crash situation. It's happened before and IMO will at some point happen again since nothing fundamentally has changed to prevent it.

All those properties collectively worth, say, $10 billion are then unsellable at any reasonable price. The physical wealth is still there, the houses still exist, but the financial wealth is gone. In real estate terms this is known as "negative equity". It's when your mortgage debt is higher than the property is worth in today's market. Your debts are bigger than your assets.   If that happens in business then it's called "bankruptcy". The term "negative equity" is, however, more socially acceptable (though not necessarily to those with the debts once they realise what the consequences are).

Fiat currencies (eg Australian Dollars) are literally borrowed into existence. The money is backed not by gold, silver or some other "hard" asset but by debt. The debt in turn is _partially_ backed by other assets including those themselves backed by debt, confidence and other "soft" things. Some of that debt is of course backed by physical assets such as property, but then property prices are a matter of opinon which changes in both directions and are themselves backed largely by debt and the ability to obtain it. The backing of the money can thus literally disappear in a financial sense and, in the case of debt used to fund TV's, holidays etc does exactly that almost from day one. Such debt is backed by the assumption of future earnings only which in many cases are themselves dependent on the debt cycle continuing. So overall it's backed by basically nothing apart from confidence that the system will continue. Hence why central banks pay so much attention to inflation _expectations_ since this is effectively a measure of confidence in the money itself.

So it's entirely possible to my understanding for very large amounts of financial wealth to literally disappear simply because of a change in opinion. In recent times the opinion of Sydney house prices has already been reduced by about 10% and with a steep slide in January 2006 (source Commonwealth Bank) it seems that more is to come. A similar story is unfolding with sliding house prices in parts of the UK and US. Many other parts of Australia look (on a chart) exactly like Sydney but with a time lag. 

Property prices went up with money from thin air and they're going back down again the same way. No surprise here since houses are still being built at a cost not much higher than before the boom. Hence supply will rise until such time as either building costs rise to match selling prices (that would take a massive rise in building costs) or selling prices fall so that building "on spec" ceases to be profitable. A normal house price cycle only this time the general low rate of wage inflation means that rather than the falls being only "real" with prices flat in nominal terms, outright nominal price falls are occurring. This is happening without large interest rate rises, high unemployment or a recession and IMO the real estate market is in for one almighty shock if any of those things occurs in the next few years.

As for actual deflation, my guess is that the central banks will keep printing (literally creating money out of thin air) and that money will end up going somewhere (anyone like to play the central banks' "spot the next bubble" game?) such that the total money supply continues to increase. US stocks were done and then popped (Nasdaq especially although the Dow is still below it's highs of six years ago) and now real estate has been pushed to the limit of affordability. Likewise it could be argued that bonds are pretty highly valued by historic measures. So the money will go somewhere else. My guess is commodities and/or wages (general inflation) with the former being the more likely based on recent trends and the political motivation of governments. Either way the currencies continue to lose purchasing power slowly in general and rapidly when measured against whatever the inflating asset of the day is. Until the bubble pops.

So I don't see general deflation, a contraction in the money supply, as being a problem whilst there is still something that can be inflated but IMO the property bubble isn't in for the "soft landing" that many expect. Sydney prices down 10% and the falls are ongoing on increasing volume whilst even the media, which helped fuel the boom in the first place, is starting to turn bearish with TV property programs now being more about "how much to drop the price to find a buyer" than "how to double the price with a "reno"". Meanwhile repossessions in NSW are hitting record levels and rising. NSW tends to lead the rest of the country...

Now, where's that next bubble I ought to be investing in? Or is it wages after all? Tassie bus drivers are going on strike tomorrow wanting a 33% rise over 3 years and I've heard of a few others getting big (over 20%) rises lately too. So the next one might be wages after all. That could moderate the property situation somewhat although it would also lead to general (CPI) inflation and upwards pressure on interest rates so it's somewhat complex...


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## rederob (13 February 2006)

clowboy said:
			
		

> In the event of a recession/depression vast sums of money are lost?  Where does this money go?
> Any thoughts and/or explanations would be appreciated.



It went where it came from - the banks - via a fractional reserve system.
You actually answered you question with your question.
Let's review it:
When the person bought the home for $100k did they get out bank notes and count each dollar handed to to the seller?
Doubt it.
The bank probably approved a loan of $100k and transacted that amount electronically to the sellers account. Better still if both parties used the same bank.
When did you ever see truck loads of money being deposited into any particular bank?
When the house sold again, same deal.
If there ever were to be a run on the banks, get there very early because the reality is, they won't be able to give back in currency what people have as holdings via lifelong deposits etc.
Ever wonder why the price of gold has being going up recently?


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## clowboy (14 February 2006)

Yea,


It is a worry.

The value of an asset detirmined by opinion.

The problem really hits home when the banks are owed all this money and have security worth didly sqat.

Thanx for the replies guys, very profesional response smurf.


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## Aussiejeff (2 December 2008)

With WORLD DEFLATION (barring a few pockets of Mega-Inflation) well underway, it's time to resurrect this thread methinks.

Interesting to see it has been almost 3 years since the last post!

Speaking of "the last post", that is what may well be being played at the next crisis meeting of the G-Whizz20.....

Oh dear, that Big Balloon called Planet Earth appears to have been pricked well and truly. It is deflating at an alarming rate


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## Nick Radge (2 December 2008)

Jeff,
This is an interesting indicator listing all the commodity prices. I have only ever seen it completely red across the board once before (about a month ago) but last night was a close one. Certainly looks deflationary. 

I see Gold remains the safe haven...not. Just another asset going down the toilet like the rest of them.




Here is the link if anyone wants to watch it in the future:

http://www.marketwatch.com/tools/marketsummary/futures/contracts.asp


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## Aussiejeff (2 December 2008)

Nick Radge said:


> Here is the link if anyone wants to watch it in the future:
> 
> http://www.marketwatch.com/tools/marketsummary/futures/contracts.asp




Does it come in any other color other than red?

I prefer green


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## Bronte (2 December 2008)

LOL Great link that one Nick...
Thank you


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## Indie (2 December 2008)

Lean hogs at 65.63, mmmm gotta get me some lean hogs.


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## wayneL (2 December 2008)

Nick Radge said:


> Jeff,
> This is an interesting indicator listing all the commodity prices. I have only ever seen it completely red across the board once before (about a month ago) but last night was a close one. Certainly looks deflationary.
> 
> I see Gold remains the safe haven...not. Just another asset going down the toilet like the rest of them.
> ...




It wasn't that long ago that folks were looking for grain ETFs so they could "invest" in wheat.... IIRC Chicago wheat was a $12 a bushel at the time.

A classic sell signal.

Indie,

A contract is 40,000 lbs worth. I'll go you haves... unless of course you have a reeeeeeeally really big freezer.


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## wayneL (3 December 2008)

FYI

http://www.telegraph.co.uk/finance/...all-further-than-during-Great-Depression.html



> Metal prices fall further than during Great Depression
> The price of key industrial metals has fallen further over the last four months than occurred during the worst years of Great Depression between 1929 and 1933, according to research by Barclays Capital.
> 
> Kevin Norrish, the bank's commodities strategist, said the average fall in the price of copper, lead, and zinc has been roughly 60pc since the peak in July this year. All three metals were traded on the London Metal Exchange in the inter-war years so it is possible to make a comparison.
> ...


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## numbercruncher (6 December 2008)

Better get all those industries a Gov bailout , they obviously need it ...


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## Aussiejeff (6 December 2008)

numbercruncher said:


> Better get all those industries a Gov bailout , they obviously need it ...




Pfffft! BRING IT ON I SAY!!!

Big deal. Smart US investors backed by the US Treasury have caused a HUGE rally on the DOW in response to the worst economic news in a zillion years.

Cop that bears.

Bulls are feeling feisty again....

*pop*

Oh, am I having a wet dream????


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## wayneL (6 December 2008)

A quick whip around the new sources shows the authorities with their fingers stuck in their ears singing LA LALA LA LA, whenever the big D is mentionted.

Meanwhile, contrary to these overt denials, they are literally warming up the printing presses... and I mean physical printing presses for a direct paper cash injection.

Houston, we do indeed have a problem.


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## noirua (6 December 2008)

wayneL said:


> A quick whip around the new sources shows the authorities with their fingers stuck in their ears singing LA LALA LA LA, whenever the big D is mentionted.
> 
> Meanwhile, contrary to these overt denials, they are literally warming up the printing presses... and I mean physical printing presses for a direct paper cash injection.
> 
> Houston, we do indeed have a problem.



An ice cold wind is blowing from America across Europe and Aussie Interest rates should be 1% as demand for commodities crashes.
China are set to sell coking coal at the same price as power station coal.
In these circumstances Australia needs a parity exchange rate with the greenback.


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## shaunQ (6 December 2008)

Interest rates in the UK are now 2%. I saw a report that it hasn't gone below 2% since 1694 or something... which I find amazing. To think that it is quite possible to go lower than almost 100 years before Captain Cook came to Australia.


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## noirua (6 December 2008)

shaunQ said:


> Interest rates in the UK are now 2%. I saw a report that it hasn't gone below 2% since 1694 or something... which I find amazing. To think that it is quite possible to go lower than almost 100 years before Captain Cook came to Australia.



They're suggesting zero in the States shortly as rumours gather that Ford or General Motors could file for bankruptcy. UK will probably hit 1% in January.
Some thoughts that negative interest rates could hit some types of inflation bonds.


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## IFocus (6 December 2008)

noirua said:


> An ice cold wind is blowing from America across Europe and Aussie Interest rates should be 1% as demand for commodities crashes.
> China are set to sell coking coal at the same price as power station coal.
> *In these circumstances Australia needs a parity exchange rate with the greenback*.




Noirua I don't understand what you mean highlighted in red I though a lower AUD was the go

cheers


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## noirua (7 December 2008)

IFocus said:


> Noirua I don't understand what you mean highlighted in red I though a lower AUD was the go
> 
> cheers



Sorry Ifocus, I mean't AU$2.00 to the US$1.00.  Nearly hit parity back in May and I mixed myself up. There I was thinking I'm perfect, drat


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## chops_a_must (7 December 2008)

Indie said:


> Lean hogs at 65.63, mmmm gotta get me some lean hogs.




At least with Orange Juice, I've been personally averaging in on Harvey Fresh for the better part of 6 years now.


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## Smurf1976 (7 December 2008)

Nick Radge said:


> Houston, we have a problem...full red today...only the 2nd time I have seen it...



I don't want to turn this into an oil thread, but I can't help but notice that from those figures, unleaded gasoline (petrol) is not profitable to produce since the price of the gasoline is less than the crude oil needed to make it. The only thing keeping refineries going is that other products are still profitable.

Interpret that how you wish, but to me it says that either this is a function of speculation or petrol consumption is declining significantly relative to consumption of other oil products for (presumably) reasons relating to the general economy.


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## ROE (7 December 2008)

Smurf1976 said:


> To my understanding it simply disappears back to where it came from - literally thin air. Using the property example, let's assume that a net 10% of all property owners wished to sell. That is, the number of sellers exceeding the number of buyers by an amount equal to 10% of all houses physically in existance. The bottom line is that in practice they could not sell and the keenest sellers would drop prices to chase the available buyers. A classic house price crash situation. It's happened before and IMO will at some point happen again since nothing fundamentally has changed to prevent it.
> 
> All those properties collectively worth, say, $10 billion are then unsellable at any reasonable price. The physical wealth is still there, the houses still exist, but the financial wealth is gone. In real estate terms this is known as "negative equity". It's when your mortgage debt is higher than the property is worth in today's market. Your debts are bigger than your assets.   If that happens in business then it's called "bankruptcy". The term "negative equity" is, however, more socially acceptable (though not necessarily to those with the debts once they realise what the consequences are).
> 
> ...




You scaring people man, some people will not accept this sort of reasonable logic and explanation..house always goes up, RE agents cant sell property if they don't tell people you cant lose money in property or it double every 7 years.

Doesn't matter if you negative gear, your money goes down the drain each month but no you are not losing money.   damn good logic that one.


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## numbercruncher (7 December 2008)

The house price median for Brisbane has fallen 30pc over the last 3 months, is this deflation ? or maybe just a slight interuption to the flight trajectory ?


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## Aussiejeff (7 December 2008)

numbercruncher said:


> The house price median for Brisbane has fallen 30pc over the last 3 months, is this deflation ? or maybe just a slight interuption to the flight trajectory ?




Speaking of flight trajectories ....  (one could even envisage this in terms of Santa Rudd vs The Evil Recession We Don't Ever Want To Believe In). Whatever, the outcome looks nasty!!


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## numbercruncher (7 December 2008)

ha - excellent toon AJ !


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## Glen48 (7 December 2008)

If house prices are falling will the banks still lend or just ask for a bigger deposit?
What happens to those who go under water will the banks foreclose if they are still making their payments or will the banks want an injection of equity?


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## numbercruncher (7 December 2008)

> *Central banks go nuclear*
> 
> James Kirby
> December 7, 2008
> ...




http://business.theage.com.au/business/central-banks-go-nuclear-20081206-6swd.html


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## robots (7 December 2008)

numbercruncher said:


> http://business.theage.com.au/business/central-banks-go-nuclear-20081206-6swd.html




hello,

another opinion piece

thankyou
robots


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## explod (7 December 2008)

Steel scrap prices have fallen from $500 a ton to $90 in the last three months.

Steel mills across China shutting down.


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## Pager (7 December 2008)

If theres anyone like me  who didnt really know what deflation was , heres a simple explanation 

http://useconomy.about.com/od/pricing/f/Deflation.htm

Question: What Is Deflation?
Answer: The definition of deflation is when asset and consumer prices continue to fall. This may seem like a great thing to consumers, except that the cause for deflation is a long-term drop in demand. Unfortunately, a drop in demand means that a recession is already underway, with job losses, declining wages, and an ongoing decline in the value of your home and your stock portfolio. Deflation is a result of businesses dropping prices in a desperate attempt to get people to buy their products. 

Officially,deflation is measured by a decrease in the Consumer Price Index. However, the CPI does not measure stock prices, which retirees use to fund purchases, and businesses use to fund growth. It also does not measure housing prices, instead using rental equivalent. This often lags home price declines, and underestimates deflation in the CPI. 

To combat deflation, the Federal Reserve executes an expansionary monetary policy. It reduces interest rates, and increases the money supply in an attempt to jump-start economic growth. In addition, the government can offset deflation with expansionary fiscal policy. It can put more money into circulation by lowering taxes, increasing government spending, and incurring a temporary deficit to do so. Of course, if the deficit is already at record levels, that tool may no longer be available.

Like inflation, deflation is very difficult to combat once it is entrenched. As businesses and people feel less wealthy, they spend less, reducing demand further. Prices drop in response, giving businesses less profit.


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## numbercruncher (7 December 2008)

Price of steel was out of control hey, whata drop though, wow !


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## Pager (7 December 2008)

Well after reading about deflation i think its arrived here in Australia 

This weekend after months of ear bashing from the Mrs the beloved 95 Magna is going and i bought a new car but the local Mazda dealer nearly chewed my arm off to get the deal, i looked at the same car about February and it was 15% more expensive than i paid and although keen the dealer had an almost take it or leave it approach back then, now it was including rego, this extra that exta etc etc.

Also bought a new fridge today, again the cost is lower than 6-8 months ago and i got a hefty discount of the ticketed price.

However as ive posted elswere it seems to me many people are opening the purse after the recent rate cuts, although all my purchases were cash many i think are doing the credit thing, so fingers crossed for a speedy recovery for the world economy and all the doomsayers are wrong.


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## GumbyLearner (7 December 2008)

It depends what statistical modelling and stratified sampling of both goods and services are used to calculate either inflation or deflation. 

http://www.moneymorning.com/2008/12/06/why-the-federal-reserve-cant-save-the-dollar/

But, according to the government’s numbers, consumer inflation rose 0.8% in June, the biggest monthly increase since February 1981.

That figure is artificially low because drastic changes have been made in how it’s calculated. Food and energy are no longer even taken into account. In fact, using Consumer Price Index (CPI) calculations in effect during Clinton’s presidency, the CPI would be about 6% now.

"There are three types of lies:
lies, damned lies and statistics"
Mark Twain


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## joeyr46 (7 December 2008)

Pager said:


> If theres anyone like me  who didnt really know what deflation was , heres a simple explanation
> 
> http://useconomy.about.com/od/pricing/f/Deflation.htm
> 
> ...




I always thought it was the opposite to inflation were the government was more honest and stopped the printing presses for a while so the guys could have smoko and our money became more valuable for a short time


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## Julia (7 December 2008)

Glen48 said:


> If house prices are falling will the banks still lend or just ask for a bigger deposit?
> What happens to those who go under water will the banks foreclose if they are still making their payments or will the banks want an injection of equity?



Why would the banks foreclose if they are receiving the routine payments?


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## Whiskers (7 December 2008)

Smurf1976 said:


> I don't want to turn this into an oil thread, but I can't help but notice that from those figures, unleaded gasoline (petrol) is not profitable to produce since the price of the gasoline is less than the crude oil needed to make it. The only thing keeping refineries going is that other products are still profitable.
> 
> Interpret that how you wish, but to me it says that either this is a function of *speculation* or petrol consumption is declining significantly relative to consumption of other oil products for (presumably) reasons relating to the general economy.




Ooooooh, there's that word again. 

I don't dare mention it for fear of another blasting. :


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## chops_a_must (8 December 2008)

Julia said:


> Why would the banks foreclose if they are receiving the routine payments?



Unencumbered collateral or necessary cash reserves.


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