[msandford]

2% annual inflation isn't a big deal, but 2% annual deflation would make all the money disappear in less than a year? How can that be so?

I do understand that for double-digit losses and gains things are nonlinear, in other words a 50% loss means that you need a 100% gain to offset it, and a 90% loss needs a 1000% gain to offset. But in the single digits, this is very close to linear. If you lose 5%, then gaining back 5% leaves you very close to even.

If 2% compounded deflation is the end of society, how can 2% compounded inflation be the savior?

[jsprogrammer]

I'm not saying inflation is the savior. I'm saying that in the current system, deflation can evaporate the money supply quickly and is a huge risk factor.

The reason is that ~90% of the money that exists needs to be continuously rolled over into new loans to maintain the total supply (and it actually needs to increase a bit [ie. inflation]). At any given time, only a small fraction (~10%) of the total supply is available to make the upcoming interest & principal payments. If new loans don't roll out in time (to replace the money destroyed by the principal payments), you can enter a situation where there is no legally manifestible currency (banks are completely insolvent) without some seriously disturbing hackery and deception.

You begin to hit serious problems (many individual actors will fail due to 0 flow) before you even get to that point. This is just the ultimate fate of our economy.

Edit: What we really need are accurate and accessible simulations of our economy so that everyone has a chance to understand it.

[msandford]

> to replace the money destroyed by the principal payments

The money isn't destroyed. It's back in the hands of the lender, available to do whatever they'd like with it. Perhaps they'd invest it into a factory or a business that they own, instead of just loaning it out. That would mean it'd be spent on real things in the real world, thus meeting the criteria of not being destroyed and being spent.

[jsprogrammer]

The lender cannot withdraw true capital if it has any outstanding loans.

[msandford]

How can you just make all these assertions without anything to back them up? What is "true capital" anyhow?

[jsprogrammer]

To start a bank, one must collect the initial capital on which to fund the bank's loans. The Federal Reserve requires that the bank must hold capital in excess of 10% of its assets. A bank cannot withdraw capital that would cause its assets to become greater than 90% of its net value. The capital that cannot be withdrawn is what I refer to as "true capital", as all of the other value exists solely as reflection of the true capital.

[msandford]

> The capital that cannot be withdrawn is what I refer to as "true capital", as all of the other value exists solely as reflection of the true capital.

What? How does that have any bearing on reality? The values of mortgages a bank has on its books aren't a reflection of how much reserves it has, it's a reflection of the dollar values attached to the loans.

How many loans a bank can write in a month is of course dependent upon how much money the bank has sitting around in excess of the reserves it is required to keep. But again, that doesn't dictate the dollar values on the loans. Those were fixed at signing and in the absence of problems, get smaller at a predictable rate. What do reserves have to do with the loan equations?

[thaumasiotes]

> 2% annual inflation isn't a big deal, but 2% annual deflation would make all the money disappear in less than a year? How can that be so?

There's no symmetry between inflation and deflation. Your incredulity is unwarranted.

Money is an accounting method to enable easy trade. Ordinarily, it's worthless, which makes it available to be used in transactions. Under deflation, money gains an inherent value -- you can multiply your worth by holding on to the money you have now. This means that much less trade occurs, because the gains from that trade are less than the gains from holding on to your cash while it appreciates. But the gains from cash appreciation are in an important sense hallucinatory -- on a system level, they don't exist -- and the gains from trade are real, so the economy just ends up being crippled.