My Revelation Of A Financial Crisis - Inflation

The meaning of value, contrived from my understanding, is the cost at which someone is willing to exchange one item they own, for an item in question they would like to receive. In the midst of this exchange, there are numerous driving factors that influence the value of an item. However for simplification we'll reduce these factors down to Supply and Demand.

Supply and Demand

Supply and demand are the two parameters inherently that we as human beings use to understand the cost of an item. Throughout the course of history and the progression of modern societies, supply and demand correlate like a scale in our minds to produce different values for various items. Supply refers to the ease of availability of an item, and is usually influenced by external factors that neither party usually controls such as nature. Demand however is influenced by internal as well as external factors and refers mostly to the reasoning for the need of the item, and said item's utility.

More time than not, it's usually beneficial that an equivalent exchange takes place for both parties, in this situation the trade exudes a net value of zero. This is so that both parties reasoning for the trade is satisfied and people become reluctant to wanting to undo the exchange.

The two parameters supply and demand, can have an inverse effect on the net value of an item or a trade, causing it to be positive or minus, deviating from the net value of zero. If the supply is high and the demand is low, then it is reasonable to suggest that the item of interest is of significant low value, because these are 2 negative factors then we'll state this as 2 minus (2-).

However, if the supply for that item is low but the demand is high then in turn the value will be significantly high, and due to having 2 positive factors we'll state this item's net value as being a 2 plus (2+).

Unfortunately, this is now where things get complicated. If the supply is high and the demand is high, then it can not exceed the value of an item that has a low supply and high demand, so this would cause such an item to only have a net value of 1+.

On the other hand, if an item is of low supply and low demand, this would result in a 1- net value. The reason this does not go lower is because scarcity does retain value.

Interest Rates and the role of Central Banks

When money is borrowed it is expected to be paid back in full, but for someone to lend money an incentive is required. One incentive that a loanee can use to entice a lender is to promise a percentage of the total money lent will be added back on to the total amount, and this payment will occur throughout it's duration and in some cases revaluated annually.

This is known as an interest payment, and it also incentivises borrowers of money to want to pay as quickly as possible to reduce the total amount on their loan- due to the powers of compounding interest.

Central banks i.e. the Bank of England or the Federal Reserve, will dictate how the flow of money is regulated in their respective domestic country, including interest rates. Central banks are the only entities allowed to print native currency and distribute the funds in exchange for the purchasing of non-inflationary assets such as governmental bonds held by financial firms on the stock market or by high-street banks such as HSBC, Santander, Barclays, and Royal bank of Scotland. This process is known as Quantitative Easing.

There are 2 main types of interest rates that Central Banks decide annually:

The annual interest rate that high-street banks can issue for lending money i.e., for mortgages or loans for tuition.

As well as the parameters that high-street banks can offer interest rates for borrowing money i.e., the interest rate for saving accounts.

Inflation refers to the supply of an asset. If an asset has a fixed supply this would make it a deflationary asset as over time as the asset will increase in difficulty to obtain due to factors such as hoarding, destruction of the asset via damage or usage, and the loss of the asset via misplacement. The value of a deflationary asset will always increase or be retained due to simple economics. Though the demand may wither over time, because the asset is scarce it will always retain some value because there’s so little of it. Such assets are houses, precious metals, land, digital currencies, existing governmental bonds or shares of a company. However, inflation occurs when an asset has no fixed amount and can continuously be created, thus in turn over time it is devalued.

Interest rates can essentially be net positive or net negative. Central banks set these interest rates at an amount they can use to protect and regulate the economy. A high positive interest rate set by Central banks, for high-street banks to lend, would be to entice banks to loan more money to needing members of the public, and also to take money out of circulation over time as people pay back more than they usually would for their standard loans, in turn this would also stop the domestic currency from being devalued over time as people would aim to pay back their loans before they are compounded with interest.

Furthermore a drop in circulating supply of the currency would make that currency scarce and if the demand for the currency is stable, then it will increase in value. Value for a currency refers to purchasing power.

However, high positive interest rates would likely not apply to savings accounts as people would be likely to hoard their money to allow it to grow over time. This lack of spending would stifle economic growth as businesses receive lower revenues.

Moreover, Investors would not want to put their money towards an economy with lower returns than respective markets over seas. Also, although circulating supply would decrease, therefore increasing the value of the currency due to supply shortages, the cost of living would also increase in hand to accommodate the demand to make businesses still profitable.

Now this is where things get interestingly worrying. A low negative interest rate set by Central banks in relation to high street bank lending, would no longer incentivise banks to loan out money. This in turn would reduce circulating supply and in turn increase demand for hoarding cash. However the cash being stored would be in saving accounts which would be used by the banks invest to increase their balance sheets. However this doesn't stimulate the economy and in turn attracts native investors or businesses to switch markets.

A low negative interest rate for saving accounts on the other hand would be to stimulate spending in an economy. This is because a negative interest rate would stop hoarding as people would in turn be paying the bank to hold onto their money. In this sense it would be better to just buy other assets that might retain value or purchase goods. The circulating money supply would increase and devalue the currency, but in turn the economy would be stimulated due to the freeing up of money i.e., liquidity in the economy, and reduce the need for quantitative easing.

A combination exists amongst these standards of interest rates that will be explored to explain how I believe central banks will try to steer their respective nation out of the upcoming financial crisis... that they made with bad spending policies.

Liquidity Freeze (Scenario 1-4)

A recession is caused by a country showing no growth in their GDP (Gross domestic production) in more than two economic quarters (6 months). To overcome this, Quantitative easing is done by a Central bank. This can be strategic in which the Central bank purchases governmental bonds to exchange with their newly created supply of currency as a means to fight against economic down turn and retain a valuable asset from which they can exchange back into the economy eventually to decrease the circulating supply.

It can be reasoned that an increased supply of cash would cause inflation of the national currency and devalue it, and in turn the cost of living increases in a country because to maintain the neutral net value in an exchange of assets more fiat would be required, e.g., A loaf of bread’s value increases relative to a domestic currency if that currency is being constantly devalued by an increased supply and lowered demand.

The people of that country will have a higher cost of living because their wages are fixed and don’t adjust for inflation, therefore they become poorer in the process, this also means they would have to work more just to earn what previously could afford in the past.

Businesses in general may suffer in regard to this, as it means they would require more produce to be sold to maintain profit margins, if not they will have to resort to an increase in the prices of their products. This would mean that some customers would not be able to afford their products and may seek cheaper retail alternatives.

The cost of production for businesses, furthermore would in most cases fail to be met, as the standard required to operate when encompassing tax would hinder their balance sheets.

Inflation may also be detrimental for different countries that may be in possession of another native currency, as that country may be holding onto something that eventually becomes worthless. The removal of a currency from a nation's central bank balance sheet would decrease demand and furthermore devalues it.

These are all signs that a person should pay attention to that there is an incoming wave of heavy inflation.

It is worth noting that when the process of quantitative easing is done, and the created cash has entered a country circulating supply i.e. stimulus packaging or universal basic income, it does not mean it will reach all sectors of the economy that is in desperate need, nor stimulate economic growth as the increased circulating supply may be stored in saving accounts, deflationary assets, and other investments.

This presents a dilemma in which to help stimulate the rest of the economy during an economic downturn, more money is needed to be created to eventually reach the required destination i.e. multiple stimulus packages released. This would in turn lead to more inflation and devalue the currency for saving accounts in high-street banks, but increase the interest rates for loans. To counter this a Central bank will decrease the interest rates for saving accounts in high-street banks, but increase the interest rates for loans, this in turn would make banks more willing to lend out money to the public.

This is a scenario 1 (net value of 2 minus) situation response, by central banks as seen in 2008, and the disadvantage to this was that it lead to higher levels of debt and austerity in the future as people coming out of a recession were not able to afford paying back high interest rates on loans they took to keep up with the cost of living.

This scenario plan will also not work during economic down turns caused by pandemics and high unemployment rates, as seen throughout Covid 19. People would still be in need of money so in turn will hoard fiat in saving accounts yet the economy won't be stimulated.

A possible solution to this would be to provide low interest rates loans, mandating high-street banks to lower the requirements required to be a borrower, in combination with low interest rates for saving accounts. Unfortunately this could not work, because if money is easily given out with low interests rates from banks, every-time it is not paid back banks would carry on more debt and eventually need a bailout.

This was the cause for the housing market financial disaster in 2008 in which banks became complacent in lending money for mortgages to anyone without conducting proper safeguarding requirements that would ensure a loan would be repaid and when the bubble burst they no longer had the money to lend out loans nor write of their debts. This is a scenario 2 situation (net value of 1 minus) and what enticed the housing bubble from 2000-2006.

So now we are left in a situation in which if a Central bank print their native currency to stimulate their economy it would lead to inflation, but if they also lower interest rates for loans it could create debt bubbles and potentially lead to austerity. The only other option is to implement negative interest rates in saving accounts and maintaining a high loan interest rate whilst also performing Quantitative Easing, this would discourage hoarding of money from members of the public and spread money already in circulation to those who need it such as businesses, at the same time banks will feel more comfortable lending to retail knowing that this will eventually lead to a profit.

However, this would mean savings accounts would no longer be good store of value for long term investors or members of the public looking to increase their capital, as well as businesses. Furthermore, quantitative easing means that as money is created it is being exchanged with deflationary assets such as government bonds which are traded on the open stock market. The more money created for stimulus, the more deflationary assets held by the Central Bank.

These deflationary assets would in turn become of higher value because they would be good places for storing purchasing power.

On the other hand if this is the case, an increased circulating supply of fiat caused by quantitative easing and disincentivising of money from saving accounts means the native currency becomes less valuable as people ditch their cash for other assets. If that money can’t be stored and taken out circulation then the currency becomes further devalued because the demand for it has been eradicated. There are numerous signs as stated previously that this leads to heavy inflation, possibly hyperinflation.

This is a scenario 3 situation which in turn leads to hyperinflation. However the inflation of the currency solves problems such as economic stimulation during for example a pandemic, as well as doesn't lead to bailouts of high-street banks and institutions. On the other hand the cost of living will increase for the average person dramatically.

In such a situation, the Central Banks have turned a scenario 1 (2-) and a scenario 2 (1-) into a scenario 3 (1+) that can gradually, through better financial strategy, become a scenario 4, (2+).

In a scenario 4 situation, taking place after a scenario 3, hyperinflation has occurred and deflationary assets increase dramatically in value. Small portions of these deflationary assets will be exchanged into cash to clear national debt levels which don't increase relative to inflation. Central banks due to their quantitative easing have increased their balance sheets and in turn the rich just got richer, and poor just got poorer. Now Central banks will be able to dictate how they want to increase the value of money over time by releasing bonds (scarce in circulation now) back into the public over time. Essentially the Central Banks can reset the standards of the currency and other assets and can revalue the deflationary assets in their possession because they can choose the value at which they would be willing to sell them at. This exchange will swallow up the circulating supply of fiat and they will accumulate more of their native currency on their balance sheet, and over time it's purchasing power will increase and the deflationary assets purchasing power will decrease.