Inflation or deflation, what will hit us first?

In order to keep an economy in great working conditions, it is commonly agreed that there should be an inflation of about 2% per year. This means that the average prices for goods and services tend to increase every year by a little margin.

In the present situation a lot of people are fearing a hyperinflation because central governments are printing a lot of money to distribute to the people and the companies. They try to prevent a total economical meltdown at a local level. We might face a hyperinflation but I'm not so sure about it.

The lockdown all over the world has a direct impact on prices but also on the monetary mass (the money in circulation). We can see a steady decline for both demand and offer.

How is money produced?

For every dollar in circulation, there is somewhere a dept of one dollar. Let's say a bank loans you 100'000 USD to buy a house. They will create an account and they will deduct 100'000 USD from this account. They will transfer this money to your savings account.

There will be:
One account with –100'000 USD and one account with +100'000 USD.

Did we create money? No the amount of money stays the same. If you add both accounts together you still get 0 USD. However the bank needs to have a part of the money that they give away as a collateral. It's somewhere between 7 and 9% of the money that they give away.

You want to pay this 100'000 USD to buy your house. It goes from your account to the account of the house seller. Now the bank of the seller has 100'000 USD more on it's accounts and it can be used as collateral for further loans. This is how money can be produced. In normal conditions 90% of the money mass increase is produced by commercial banks and not the central banks. They produce only about 10% by printing new money.

The circle of economical destruction

Let's say your country is in lockdown, the future of companies and people is much less secure than before. Will jobs be lost, will the income be lower? These are all questions that have to be asked. How can companies deal with the losses that they generate when they can't do business?

We will see many different effects like less investment, less consumption and defaults. All this means that people will spend less and slower. In order to sell goods, companies will have to lower their prices because the demand drops. Companies might also have to decrease salaries and this will again have a negative impact on the demand. The circle of deflation is started. People will get aware of it and instead of buying today, they will wait till prices drop even more. For companies and people it will become more and more difficult to adapt to the situation.

Since everybody will earn less, your dept will increase relatively in value and even if interests are low it will be more difficult to pay the rates. This will make the real estate sector come crashing down. Let's now go back to your house that you bought. The bank gave you 100'000 USD loan. At the time, the house was worth 150'000 USD but now it is worth only 80'000 USD. The bank is scared that you can't pay back your dept and they will foreclose your house. They will make 20'000 USD loss and you will keep this dept on your shoulder but you won't have a roof to sleep under...

My opinion is, let the governments help the people and the companies

If we are lucky we will manage to turn things around but I believe that we shouldn't be afraid to let governments help their economies. It's maybe the only thing that can still avert the economical catastrophe.

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