Monetary Realism

Understanding The Modern Monetary System…

Debt and Deflation

Lars Syll rounds up two great quotes on the interaction of inflation with debt, one from Keynes, one from Fisher, and they both point out something which should be obvious, but not many people understand.

Deflation makes the nominal value of debt larger relative to current incomes, and increases the difficulty of paying off that debt.

Here’s Fisher:

“6) the dollar may swell faster than the number of dollars owed shrinks; (7) in that case, liquidation does not really liquidate but actually aggravates the debts, and the depression grows worse instead of better, as indicated by all nine factors; (8) the ways out are either laissez faire (bankruptcy) or scientific medication (reflation), and reflation might just as well have been applied in the first place.”.

I’d say this hold even for low levels of inflation. How many real world assets depreciate in value at only 2% per year? I’d like to own a car or house where I could put zero money into it and have it depreciate in value at 2% per year. It’s recommended you spend between 1.5% and 3% per year on a house to keep it in top shape.

The world of money and the real world  must have some meeting point, some place where they agree on terms. Since most lending is done against real estate, and much of the worlds wealth is held in real estate, a prime candidate for this point is at the depreciation rate of real estate values.

What are these debts Keynes and Fisher speak of, these debts which will throw sand into the gearbox of commerce? They are real estate lending debts, at least in todays society.




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11 Responses

  1. Oilfield Trash says


    The fundamental cause of instability is the feed-back loop caused by debt use to speculate on rising asset prices. As an asset price rises, which makes the asset a better form of collateral, in turn increases the demand for more borrowing based on that collateral, which in turn boosts the asset price.

    This feedback loop requires fuel to maintain and or accelerate its growth. As with all debt the main fuel is income, but this is always relative to amount of leverage a lender will allow the borrower to have on the collateral and the rate of interest they charge for the debt.

    It IMO should not be surprising that RE has collapsed. Real household income growth peaked in 2000, but household debt outstanding increased from approx. 7 trillion in 2000 to 14 trillion in 2008, which allowed RE price according to Zillow Home value index to appreciate from approx. $115,000 in 2000 to a peak value of $193,800 in May of 2007.

    Of course we could not stop ourselves and be happy with the asset appreciation, so we embraced more leverage with HELOCs by telling homeowners it was foolish for them to sit on their equity and deny themselves the things they wanted or needed today. The government even got in on the party by allowing deductions for RE interest payments, RE taxes by local government and legalizing the expansion of securitization by FREDDIE and FANNIE.

  2. beowulf says

    “Is most real estate debt issued by a bank or bank-like entity? If so, is that the central bank’s preferred way to get more MOA/MOE into the economy?”

    Banks (and not just directly, many non-banks fund mortgages with their line of credit at a bank), and to paraphrase Vince Lombardi, its not the central bank’s preferred way, its the only way. OK, that’s a bit of an exaggeration, but 70% of bank lending is for mortgages of which more than 95% is guaranteed by the federal government.

    It’d be better for the taxpayers if Uncle Sam was either all out or all in, either leave the mortgage market to sink or swim on its own or, in the alternative, have Tsy fund mortgages directly (just like it now funds student loans directly) and collect the hundreds of billions in mortgaging interest from the winners instead of just eating the losers.
    Curiously only the first is considered socialism, the second is just good old fashioned crony capitalism.

    • JKH says


      Do you happen to know where corporate lending shows up here?

      (e.g. L110 page 78)

      • beowulf says

        I’m glad Ramanan knew what you were talking about. :o)

        I thought you meant non-financial corporate lending as opposed to bank lending. Once you subtract REITS and REIMCs (which aren’t corporations, they’re trust funds), you’re left with nonfinancial corporate business, F 102 and L 102, for flows and levels respectively. Once again, Advantage Ramanan!

        • JKH says

          maybe something in the range of line 27 to line 29 in L102

          boy, this is a messy data area

      • Ramanan says

        This one on page 6 seems to come closest to L.100 (lines 9-14) but the totals don’t exactly match.

        Assets and Liabilities of Domestically Chartered Commercial Banks in the United States

        • Ramanan says
        • JKH says

          thanks, R.!

          that’s more like it in terms of the kinds of numbers I expected

          the combination of commercial and industrial loans (including real estate loans) is about $ 2.5 trillion, which is substantial, and makes more sense

          and its amazing how little of the residential real estate lending on the books of US banks is non-securitized – that’s an underlying problem with their mortgage system – insufficient bank balance sheet commitment to residential mortgage lending, translates to inadequate credit analysis through the securitization pipeline, translates to financial crisis (different system and different result from Canada, as example)

        • Ramanan says

          Yeah the securitized outstanding is about 4-5 times as large.

          Plus investors kept buying them – I think due to peer pressure. When they were making returns such as in early-mid 2000s, others felt pressured to buy them so as the beat the competitors.

  3. Fed Up says

    “They are real estate lending debts, at least in todays society.”

    Is most real estate debt issued by a bank or bank-like entity? If so, is that the central bank’s preferred way to get more MOA/MOE into the economy?

  4. Fed Up says

    “[Price] Deflation makes the nominal value of debt larger relative to current incomes, and increases the difficulty of paying off that debt.”

    1) For the lower/middle class, the idea is get them so far in debt they can never pay it off and therefore either never retire or retire a lot later so the economy “won’t be running out of workers”.

    2) Next, if there is no private debt and no gov’t debt, then there is no debt to worry about “paying off”.