Debt-Deflation Theory
A 70 year-old paper by Irving Fisher and its debt-deflation theory still hold water in today’s complex intertwined system of finance.
Yale economist, Professor Irving Fisher is known for a lot of economic principles such as the Fisher Equation, the Price Index, the Phillips Curve, the Money Illusion.
The interesting thing in his bio is that although he did warn of the 'permanently high plateau' of stock prices only a few days before the great crash of 1929, he believed a recovery was just around the corner and as a result, managed to lose most of his personal wealth and his reputation in the multi-year selloff during the great depression. Following the destruction, Fisher analyzed the Great Depression and came up with his debt-deflation theory.
His opinion is that in the great booms and depressions, each of the named factors (over-production, under-consumption, over-capacity, price-dislocation, maladjustment between agricultural and industrial prices, over-confidence, over-investment, over-saving, over-spending, discrepancy between saving & investment) has played a subordinated role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after; also that where any of the other factors do become conspicuous, they are often merely effects or symptoms of these two. In short, the big bad actors are debt disturbances and price level disturbances.
The two diseases act and react on each other. Pathologists are now discovering that a pair of diseases are sometimes worse than either or than the mere sum of both, so to speak. Just as a bad cold leads to pneumonia, so over-indebtedness leads to deflation.
And, vice versa, deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed. Then, the very efforts of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. The more the debtors pay, the more they owe.
The following table gives a logical order of nine events of a depression, with reaction and repeated effects:
Yale economist, Professor Irving Fisher is known for a lot of economic principles such as the Fisher Equation, the Price Index, the Phillips Curve, the Money Illusion.
The interesting thing in his bio is that although he did warn of the 'permanently high plateau' of stock prices only a few days before the great crash of 1929, he believed a recovery was just around the corner and as a result, managed to lose most of his personal wealth and his reputation in the multi-year selloff during the great depression. Following the destruction, Fisher analyzed the Great Depression and came up with his debt-deflation theory.
His opinion is that in the great booms and depressions, each of the named factors (over-production, under-consumption, over-capacity, price-dislocation, maladjustment between agricultural and industrial prices, over-confidence, over-investment, over-saving, over-spending, discrepancy between saving & investment) has played a subordinated role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after; also that where any of the other factors do become conspicuous, they are often merely effects or symptoms of these two. In short, the big bad actors are debt disturbances and price level disturbances.
The two diseases act and react on each other. Pathologists are now discovering that a pair of diseases are sometimes worse than either or than the mere sum of both, so to speak. Just as a bad cold leads to pneumonia, so over-indebtedness leads to deflation.
And, vice versa, deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed. Then, the very efforts of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. The more the debtors pay, the more they owe.
The following table gives a logical order of nine events of a depression, with reaction and repeated effects:
Labels: crisis
posted by Jiu Zhuang at
4:15 PM
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