I keep reading about all the wrong reasons to fear deflation. Deflation, in itself, will naturally find a bottom. Risk takers and fools will see to it. At some point, risk takers and fools simply cannot help themselves. They will buy stuff, and lots of it, whether it be stocks, raw materials, or cheapened labor.
The problem with our deflation is not the falling prices, per se. It's the deal making that drives the prices downward. Viz: Bank A has debts coming due soon, for which Bank A needs liquid capital. Plus, it also must satisfy its regulatory capital requirements. Bank A has two options, sell good assets for below market, or sell bad assets for way below market. The due date on the debt is a real constraint. The Bank needs the money now. So it sells assets at a loss.
This means Bank A has less money to pay down the same debt. Think of it this way, Bank A probably took on the leverage with a measure of comfort. It held all these assets. In a pinch, Bank A could sell some off without hurting its overall position. But, what if there are more sellers than buyers?
There is a cascading effect on the price of assets. Meaning all debtors have less money to pay an unchanged amount of debt. So, despite making a debt payment, banks' debts are actually growing relative to their ability to pay.
As cash positions shrink, more liquidation ensues. Prices drive down further. Now, bear in mind that this is all occurring in the rarefied air of Wall Street. M3, M4, and M5 in monetary terms. Nothing you or I would ever touch.
But, as banks' lose money and shave down their assets, they have less to lend with. This means diminishing revenues, which also means the top line is smaller -- thus hitting the bottom line. And so their share prices should also drop.
And because they aren't lending, that means businesses can't obtain credit. One of the biggest reasons for use of credit by corporations is simply to make payroll. Corporations go into the money market (repos and other short term commercial paper deals -- big banks and investment houses are the counterparties, and many of these transactions are leveraged), or they take out short term loans (like one week long) so that their employees' checks don't bounce. Without these credit options, corporations will continue to shed jobs.
That's when Wall Street's V.D. spreads to the rest of us.
Now on sale: deflationary cold sore cream. Always at a discount.
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