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A 100% reserve requirement would stagnate the economy? Au contraire

phattonez

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I've heard this question posed many times, and it simply is a myth. A 100% reserve requirement would mean that a demand deposit simply becomes a gold store (or whatever the currency is). You leave your gold there for security and convenience, but here's the thing: you'd probably have to pay a fee to keep it there. So the institution makes money there. So that bank would have a little money to loan.

Is that enough capital investment? Not at all. What's forgotten is the concept of time deposits. Demand deposits could not be loaned against, but time deposits can (if the risk is mentioned beforehand). These would probably secure a very nice interest rate (extra nice if you consider the fact that doing nothing with the money means you lose money because of the protection and storage fees).

This then, would be the source of loans. You can save some money for a fee, and use some other money at an institution that you trust to get some interest. This denies the possibility of a bank run and gets you capital investment which directly corresponds to time preference.

Alternatively, you could also have a blending of time and demand deposits whereby you could just give your money to an institutions from which you can withdraw any time and from where you can earn interest, as long as the risk is known beforehand. Of course, not everyone would be able to withdraw from this bank at the same time, so this type of company would probably give themselves a very high reserve requirement to avoid a run.
 

Goshin

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Should we then set a reasonable minimum reserve limit by law? To avoid cases where loans of imaginary money get out of hand?

What would a reasonable limit be? 20%, 25%?
 

phattonez

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Should we then set a reasonable minimum reserve limit by law? To avoid cases where loans of imaginary money get out of hand?

What would a reasonable limit be? 20%, 25%?
Well if you really think about it, anything lower than a 100% reserve requirement on demand deposits is fraud because not everyone can get their money out of the bank. Some would be denied their money, and banks know this, so technically it's fraud. I'd say that if you're going to engage in this type of activity (the kind of demand deposits that we have today) then you have to let the consumer know of the risk before-hand and let them decide whether or not they want to do it. We'd probably see people put money in banks based on their voluntary reserve ratio and reported interest rates. We'd probably also see time deposits increase in popularity. Right now, with FDIC and not needing to advertise the risk, banks can get away with some really terrible business policies with huge amounts money. The practices will only get worse now that we've bailed out some banks.
 

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I dont know if it would stagnate the economy or not

I do think it could lead to poor resource allocation though

With demand deposits not generally being allowed to be used for loans, banks would charge higher fees then they already do for having an account at the bank. Given that, most people would not be likely to keep a chequeing account at the bank and store that money at home, rather then lose money for keeping it at a bank. This could be significant amounts of money that would no longer be used for extended periods of time.


a benifit of this system would be smaller booms and busts in the economic cycles
 

phattonez

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I dont know if it would stagnate the economy or not

I do think it could lead to poor resource allocation though

With demand deposits not generally being allowed to be used for loans, banks would charge higher fees then they already do for having an account at the bank. Given that, most people would not be likely to keep a chequeing account at the bank and store that money at home, rather then lose money for keeping it at a bank. This could be significant amounts of money that would no longer be used for extended periods of time.
My third option would most likely be used as a checking account. But not a lot of that woud be available to loan. The first option would probably not be very popular, and the second would be no different than current time deposits, except that they would probably get more interest.

a benifit of this system would be smaller booms and busts in the economic cycles
No doubt.
 

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I suggest studying the "shadow" banks in the US. They are funded entirly by money markets, of course they do not have a reserve requirement.
 

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hmm.... well reserve requirements are a good topic of discussion, and i'm all for restricting credit away from malinvestment.

but a gold standard? how is that not deflationary.
 

phattonez

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Because deflation as a definition has been warped by modern economists. Deflation represents a rising value of the dollar. However, it is attributed to a falling CPI. These are not the same things. So it would cause the dollar to be worth the value of more goods in general with time, but so what? When did deflation become a bad thing? Deflationary spiral is bunk because it doesn't make any economic sense and we have not always had panics or recessions during deflations (Long Depression).
 

Lord Tammerlain

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Deflation itself is not badan

If the amount of money in an economy was constant, as production increased deflation would occur

During the early 1900's the price of autombiles dropped constantly, today with electronics, the price of them drop constantly as the quality goes up.

Deflation is only bad when the amount of debt has built up to unsustanable levels, as deflation makes debt more expensive
 

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Well if you really think about it, anything lower than a 100% reserve requirement on demand deposits is fraud because not everyone can get their money out of the bank. Some would be denied their money, and banks know this, so technically it's fraud. I'd say that if you're going to engage in this type of activity (the kind of demand deposits that we have today) then you have to let the consumer know of the risk before-hand and let them decide whether or not they want to do it. We'd probably see people put money in banks based on their voluntary reserve ratio and reported interest rates. We'd probably also see time deposits increase in popularity. Right now, with FDIC and not needing to advertise the risk, banks can get away with some really terrible business policies with huge amounts money. The practices will only get worse now that we've bailed out some banks.
of course the comsumers are told of risk when they open their accounts, and that's why the FDIC exists. consumers know full well their deposits are not covered over a certain amount. you would hamstring banks' ability to lend money with a 100% reserve requirement.
 

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Because deflation as a definition has been warped by modern economists. Deflation represents a rising value of the dollar. However, it is attributed to a falling CPI. These are not the same things.
i agree. that the CPI is a poor measure of long-term measurement of inflation; science advances, and new goods are added. then suddenly it costs more one year to buy a laptop than it took to not buy one the year before (somehow this always shocks people) and we have to listen to caterwauling about the falling real wage.

So it would cause the dollar to be worth the value of more goods in general with time, but so what? When did deflation become a bad thing?
that's not the only thing that happens when you see deflation. among those 'goods' which is now worth less money is people; this means that deflation serves as a constant source of malinvestment on the edges as employers have to dance down a shrinking money supply per worker; either pushing through pay cuts (difficult) or letting people go (sometimes less difficult). Hayek declared he was against deflation, just as he was against inflation; hard to get a more Austrian figure than that short of maybe Von Mises - who as i recall declared both terms too simplistic and therefore too confusing to be useful. Friedman makes a powerful case for deflations' effect in the 1930's.

For a brief while, everything is wonderful; your dollar buys more at the store and you are 'rich'. but then it turns out you cost too much. if you have a mortgage (or a car loan), the real debt you are in increases beyond the price of the property, creating powerful nation-wide incentive structure for foreclosure (and the subsequent bank losses) while at the same time making it harder for individuals facing ever-rising real monthly payments to avoid it. ditto for those who might have been looking for capital for start-ups; and there slows innovation and all the wonderful creative destruction that goes with it.

Deflationary spiral is bunk because it doesn't make any economic sense and we have not always had panics or recessions during deflations (Long Depression).
yeah. how'd deflation work for us in the 1980's and 1930's?

Deflation itself is not bad.[/url]

au contraire, it is in it's own way as damaging as inflation.

If the amount of money in an economy was constant, as production increased deflation would occur
exactly, which is one of the reasons why return to a Gold Standard isn't plausible.

During the early 1900's the price of autombiles dropped constantly, today with electronics, the price of them drop constantly as the quality goes up.
exactly; but that is driven by changes in technology, not monetary policy.

Deflation is only bad when the amount of debt has built up to unsustanable levels, as deflation makes debt more expensive
again. exactly. taken a look at the debt balance (private and public) of the US lately? ;) a policy that drove our real debt higher every year at or faster than the rate of interest would require intense tax increases and extreme cutting of governance. the incentives would be for our political class to attempt to once again seize all the gold in the country; replacing it with an undervalued paper script in an act of theft every bit as wide-reaching (though perhaps more immediately intense) as inflation.
 

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i agree. that the CPI is a poor measure of long-term measurement of inflation; science advances, and new goods are added. then suddenly it costs more one year to buy a laptop than it took to not buy one the year before (somehow this always shocks people) and we have to listen to caterwauling about the falling real wage.



that's not the only thing that happens when you see deflation. among those 'goods' which is now worth less money is people; this means that deflation serves as a constant source of malinvestment on the edges as employers have to dance down a shrinking money supply per worker; either pushing through pay cuts (difficult) or letting people go (sometimes less difficult). Hayek declared he was against deflation, just as he was against inflation; hard to get a more Austrian figure than that short of maybe Von Mises - who as i recall declared both terms too simplistic and therefore too confusing to be useful. Friedman makes a powerful case for deflations' effect in the 1930's.

For a brief while, everything is wonderful; your dollar buys more at the store and you are 'rich'. but then it turns out you cost too much. if you have a mortgage (or a car loan), the real debt you are in increases beyond the price of the property, creating powerful nation-wide incentive structure for foreclosure (and the subsequent bank losses) while at the same time making it harder for individuals facing ever-rising real monthly payments to avoid it. ditto for those who might have been looking for capital for start-ups; and there slows innovation and all the wonderful creative destruction that goes with it.



yeah. how'd deflation work for us in the 1980's and 1930's


au contraire, it is in it's own way as damaging as inflation.



exactly, which is one of the reasons why return to a Gold Standard isn't plausible.



exactly; but that is driven by changes in technology, not monetary policy.



again. exactly. taken a look at the debt balance (private and public) of the US lately? ;) a policy that drove our real debt higher every year at or faster than the rate of interest would require intense tax increases and extreme cutting of governance. the incentives would be for our political class to attempt to once again seize all the gold in the country; replacing it with an undervalued paper script in an act of theft every bit as wide-reaching (though perhaps more immediately intense) as inflation.
Remember that the US was using the gold standard in the early 1900s when the cost of the automobile dropped in price drastically.

A steady deflationary rate is no more problematic then a steady inflationary rate to an economy. Rapid swings one way or another is a different story.

Currently though deflation for the US economy would be a bad thing due to the debt levels of all involved. Which does mean that you will see debt monetization in the US as a means to combat deflation, which is going to occur when the second leg down hit
 
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cpwill

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cpwill, you have an unfounded fear of deflation. Been reading a lot of Friedman lately? Read this for a more accurate analysis of deflation based on human action rather than faulty empiricism.
i'd like to see your explanation of Hayek's stance, then.

and faulty empiricism. dude. when you start accusing reality of being illogical, in order to defend an economic thesis...

but i would like to see some kind of countering from you, explaining why my points are irrelevant or incorrect.
 
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Ahlevah

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cpwill, you have an unfounded fear of deflation.

http://mises.org/journals/qjae/pdf/qjae6_4_3.pdf
I can't speak for him, but I think there is validity to Irving Fisher's work on depressions and deflation. (Debt-Deflation Theory of Great Depressions) I hear people like Peter Schiff talking on CNBC about all of this money the Fed is "printing" and that hyperinflation is lurking around the corner. What money? The monetary base is not money:

The monetary base, bank reserves plus currency... does not constitute money.... The nonbank public – nonfinancial corporations, state and local governments and households - cannot use deposits at the Federal Reserve Bank to effectuate transactions. Moreover, currency is not sufficiently broad to be considered a temporary abode of purchasing power. For Friedman, high-powered money can be properly regarded as assets of some individuals and liabilities of none. So, let us be clear on this subject. In 2008, when the fed purchased all manner of securities, to the tune of about $1.2 trillion, the fed was not "printing money". Bank deposits at the fed exploded to the upside, the monetary base rose from $800 billion to $2.1 trillion, yet no money was "printed". Deposits did not rise, loans were not made, income was not lifted, and output did not surge. The fed could further "quantative ease" and purchase another $1 trillion in securities and lift the monetary base by a similar amount yet money would still not be "printed". It is obvious the fed authorities would like to see money, income, and output rise, but they cannot control private sector borrowing. If banks were forced to recognize bad loans and get the depreciated assets into stronger more liquid hands, it could be debated on how much reserves should be in the banking system. Until that cleansing process is completed it will be a slow grind to cure the one factor which makes the fed "impotent" and unable to "print money"....overindebtedness.

Quarterly Review and Outlook Second Quarter 2010
Read this for a more accurate analysis of deflation based on human action rather than faulty empiricism.
I read through your link and the I've got issues with a few things. For example:


Demolishing the prevailing view that falling prices would have a depressing effect on business, Rothbard asserts that

[w]hat matters for business is not the general behavior of prices, but the
price differentials between selling prices and costs (the “natural rate o
interest”). If wage rates, for example, fall more rapidly than product prices,
this stimulates business activity and employment.
(Rothbard 2000, p. 17)

http://mises.org/journals/qjae/pdf/qjae6_4_3.pdf
Ultimately, what matters for business is customers--demand for goods and services. If I'm a businessman and I'm running at 60% of capacity and I see my customers losing their jobs and struggling to repay debts and people with money sitting on the sidelines with their T-bills, why would I hire any additional workers? :confused: What if I am in hock up to my eyeballs and the faster I repay my loans the more I owe because overall demand is dropping faster than the debts can be repaid because everyone else is in hock, too? Will I be in a hiring mood? :confused: Or what if I still want to borrow money to hire workers but I can't get any additional credit for because my "partner"--the bank--doesn't want lend me any more money? :confused:
 

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i'd like to see your explanation of Hayek's stance, then.
What part of Hayek's stance? He changed his opinion on it over the years.

and faulty empiricism. dude. when you start accusing reality of being illogical, in order to defend an economic thesis...
Finding empiricism as faulty for developing theories is not the same as accusing reality of being illogical. The problem with using empiricism to develop your theories is that it is impossible to show what causes what. You need some kind of way to explain behavior or else the theory is worthless. I can show correlation between ice cream sales and pool drownings. First off, I can't prove if ice cream causes the pool drownings or if pool drownings cause the increased ice cream sales. Either way, both theories are wrong. Both are explained by hot temperatures, which is why there is a correlation. You will have more drownings and ice cream sales on hot days, and less of both on cool days. That is why using empiricism is faulty.

but i would like to see some kind of countering from you, explaining why my points are irrelevant or incorrect.
They're all based on the idea of deflationary spiral from what I can tell, which is a nonsense theory. First you have to assume a constant deflation which would not happen, and even if you did not all economic activity would stop. The deflated currency would eventually be abandoned or transactions would occur with the expectation of deflation. Either way, for deflationary spiral to be true, you have to assume all economic activity to stop which is nonsense. People would still buy food and clothes and cars. They may save more for a while out of fear, but this is temporary and eventually people will want to stop saving for the future at the expense of satisfaction now. Time preference is never exclusively in the future.
 

phattonez

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Ultimately, what matters for business is customers--demand for goods and services. If I'm a businessman and I'm running at 60% of capacity and I see my customers losing their jobs and struggling to repay debts and people with money sitting on the sidelines with their T-bills, why would I hire any additional workers? :confused: What if I am in hock up to my eyeballs and the faster I repay my loans the more I owe because overall demand is dropping faster than the debts can be repaid because everyone else is in hock, too? Will I be in a hiring mood? :confused: Or what if I still want to borrow money to hire workers but I can't get any additional credit for because my "partner"--the bank--doesn't want lend me any more money? :confused:
This is the problem with looking at aggregates. We may be running at 60% capacity. Okay. so one business will be at 40% capacity. I say that business should sell off until they are at a profit again. They will be leaner, but at least profitable. This opens up capital goods then for businesses that have a demand that exceeds capacity. They need to grow to fill demand. Just looking at aggregates, we would say that we need to increase demand until we get to full productive capacity, I say nonsense. We need production to go to those areas where consumers are demanding it. If business A was at 40% capacity and business B had demand that could fill 120% of capacity, and you raise demand temporarily by some kind of stimulus, then you'll have 60% capacity for business A and 140% capacity for business B (I realize that the math is off, but it doesn't really matter for the example). The result is that consumers will be overserved in one area and underserved in one area. Allow company A to shrink so that company B will grow; that will allow for the greatest increase in consumer satisfaction.

Aggregates are too general to do any kind of useful economic analysis.
 

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We need production to go to those areas where consumers are demanding it.
What if consumers' real wages are stagnant or declining and they're so far in hock that all they want to do is rebuild their balance sheets? :confused: What if the only things they can afford are essentials, like food, medicine, and shelter? :confused: We're kind of screwed in that case, at least for some period of time, are we not? :confused:
 

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What if consumers' real wages are stagnant or declining and they're so far in hock that all they want to do is rebuild their balance sheets? :confused: What if the only things they can afford are essentials, like food, medicine, and shelter? :confused: We're kind of screwed in that case, at least for some period of time, are we not? :confused:
You're basically arguing an economy with no profit possibilities. That's utterly unforeseeable except in a philosophical construction.
 
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Kushinator

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This is the problem with looking at aggregates. We may be running at 60% capacity. Okay. so one business will be at 40% capacity. I say that business should sell off until they are at a profit again. They will be leaner, but at least profitable.
I know you don't do economics, but this is just embarrassing. Firms liquidate (short run) based on revenue/variable cost = or < 1. :shrug:

This opens up capital goods then for businesses that have a demand that exceeds capacity. They need to grow to fill demand. Just looking at aggregates, we would say that we need to increase demand until we get to full productive capacity, I say nonsense. We need production to go to those areas where consumers are demanding it.
What is the user cost of capital in a recession relative to an expansion? If interest rates and prices remain stable or heaven forbid decline, that signals that there is not a vast competition for credit/resources/labor.

If business A was at 40% capacity and business B had demand that could fill 120% of capacity, and you raise demand temporarily by some kind of stimulus, then you'll have 60% capacity for business A and 140% capacity for business B (I realize that the math is off, but it doesn't really matter for the example). The result is that consumers will be overserved in one area and underserved in one area. Allow company A to shrink so that company B will grow; that will allow for the greatest increase in consumer satisfaction.
Business growth is not a zero sum game, especially across industry lines. If A and B are within the same industry, then competition will necessarily shrink the least competitive firm. Firms shrinking/failing due to cyclical pressures is entirely different than the result of competition.
 

phattonez

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I know you don't do economics, but this is just embarrassing. Firms liquidate (short run) based on revenue/variable cost = or < 1. :shrug:
Do you want me to state that a company that is running at 40% capacity is probably losing money? You couldn't have just guessed that I was getting at that? If they were profitable at 40% capacity then why not increase production? You're just looking for problems because you have some kind of vendetta against me, it wasn't hard to see what I was getting at.

What is the user cost of capital in a recession relative to an expansion? If interest rates and prices remain stable or heaven forbid decline, that signals that there is not a vast competition for credit/resources/labor.
If savings are increasing as they would naturally do during a downturn, well, I'll let the person that does economics figure out this brain buster.

Business growth is not a zero sum game, especially across industry lines. If A and B are within the same industry, then competition will necessarily shrink the least competitive firm. Firms shrinking/failing due to cyclical pressures is entirely different than the result of competition.
And cyclical pressures aren't a part of changing demands? Changing demands is in no way related to the business cycle?
 

Kushinator

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Do you want me to state that a company that is running at 40% capacity is probably losing money? You couldn't have just guessed that I was getting at that? If they were profitable at 40% capacity then why not increase production? You're just looking for problems because you have some kind of vendetta against me, it wasn't hard to see what I was getting at.
Basic micro dude. In the short run, if your revenue equals or exceeds variable cost, then a firm does not need to close. Firms do not close based on lack of profitability, but on a marginal revenue/marginal cost basis. I have nothing against you, however i will continue to press you to actually learn the subject you so deeply desire to discuss/debate. You were getting nowhere.

If savings are increasing as they would naturally do during a downturn, well, I'll let the person that does economics figure out this brain buster.
Then why make comments about expansion and over capacity?

And cyclical pressures aren't a part of changing demands? Changing demands is in no way related to the business cycle?
Cyclical pressure explodes onto the scene when income expectations go sour. This seems very straight forward as income is the primary driver for consumer demand.
 

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You're basically arguing an economy with no profit possibilities. That's utterly unforeseeable except in a philosophical construction.
An economy in which households are so indebted that they have little to no discretionary income? Small businesses that can't get loans? Stagnant incomes? These aren't philosophical constructions. They're reality.
 

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I can't speak for him, but I think there is validity to Irving Fisher's work on depressions and deflation. (Debt-Deflation Theory of Great Depressions) I hear people like Peter Schiff talking on CNBC about all of this money the Fed is "printing" and that hyperinflation is lurking around the corner. What money? The monetary base is not money:





I read through your link and the I've got issues with a few things. For example:




Ultimately, what matters for business is customers--demand for goods and services. If I'm a businessman and I'm running at 60% of capacity and I see my customers losing their jobs and struggling to repay debts and people with money sitting on the sidelines with their T-bills, why would I hire any additional workers? :confused: What if I am in hock up to my eyeballs and the faster I repay my loans the more I owe because overall demand is dropping faster than the debts can be repaid because everyone else is in hock, too? Will I be in a hiring mood? :confused: Or what if I still want to borrow money to hire workers but I can't get any additional credit for because my "partner"--the bank--doesn't want lend me any more money? :confused:
When the Fed took in paper that banks had on their books for less than par, then in fact the Fed was attempting to increase money supply. That is banks can make loans ( create money) as a ratio of their captial. Taking bad paper allowed the banks to be more profitable, thus able to " print" money. Alas you are correct that companies do not have the appetite to take on additional debt, consumers are reducing debt and banks are leery of making bad loans.

Thus people are rightfully ( I think) worrying about a huge credit contraction in the U.S. By huge people talk in the range of 13-15 trillion. This is the fear of the Fed as this type of pullback would have a deflationary impact. The Fed worries that deflation lowers economic activity as people will be in no rush to buy something today that they can buy tommorrow for less.

The real crunch for the U.S. would be to have deflationary prices and have interest rates on their debt rise. This could happen if people find an alternative to the U.S. dollar. Then people could ask for more interest even if there is no inflation.

As with all economic prognosis we hear about no one really knows what is certain to happen.
 

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The real crunch for the U.S. would be to have deflationary prices and have interest rates on their debt rise. This could happen if people find an alternative to the U.S. dollar. Then people could ask for more interest even if there is no inflation.

As with all economic prognosis we hear about no one really knows what is certain to happen.
I suppose it could happen, but is it likely? I don't think so. Once again, the model is Japan, whose currency represents 11% of the value of IMF Special Drawing Rights. So while the yen is a reserve currency, there are viable alternatives--like the dollar--that are used more extensively to settle international trade. As we've seen deflation flow more than ebb in Japan over the years, there has been a corresponding unwinding of the Carry Trade in which investors borrowed heavily in (low interest) yen. As deflation took hold, these borrowers were forced to repurchase yen and settle their debt accounts (since the real interest rate was rising). This demand for yen caused the value of the currency to rise against other currencies and put additional pressure on the borrowers to purchase the Japanese currency. In that sense, an international borrower is no different from a domestic one: In a deflation, the moron is the guy who owes money, while the genius is the lender. Demand for borrowing is low, and interest rates stay muted.
 
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