Meanwhile the human narrative must put the spotlight on a aspect of the crisis and unravel the relationships, the best I can do in "for dummies" is to use examples that everyone can grasp instead of throwing out 3 letter acronyms that scare little girls away. But do not lose sight of the fact that it is only when all these variables are at play at the same time, that the real story unfolds.
There are however variables and agents that play more important roles than others, they are central to the drama. Today I focus on "money", or rather credit money, monetary levels and their impact on price levels. Inflation and Deflation.
It came as a surprise to me when I was 38 years old and my brother told me "you realize credit money is money and increases the monetary mass". Assume there is a house on the market the ask is 500k. Assume there are 2 buyers you and them, A and B. Assume now that the amount of CASH that you hold doubles both for A and B. That Cash is CREDIT and you have access to it. If you start with 50K and can borrow up to 700k what is the price going to be? 750k. Because credit created CASH IN THE SYSTEM, the price level goes up. This is MONETARY ASSET INFLATION.
Assume the reverse for credit. Credit is tight. You have 50K cash assets and you can borrow only 300k. The price of the house will be 350k. THIS IS MONETARY ASSET DEFLATION.
The amount of CREDIT-MONEY in the system (monetary levels) directly affects price level. This is one of the tenets of modern economics:
Inflation and Deflation are always and everywhere monetary phenomenons
What about CPI?
You may ask "but wait, the government CPI index has shown very benign inflation for the past 20 years, while the credit has expanded, what gives?"
Be careful that CPI, the index of consumption prices that governments use does not take into account asset prices. Housing and stocks for example may inflate in a monetary bubble, it will not be captured as "inflation" by the CPI index but rather be touted as "growth". It is mostly monetary growth. So while official statistics were showing low CPI due to the Chinese influence, a more comprehensive CPI measure would include the cost of housing in full, the cost of stock assets, and would have shown a HUGE BUBBLE. ASSET PRICES are subject to monetary inflation and deflation.
Inflation in bad, Deflation is worse
Inflation is bad, at least a lot of it is bad. We all know that from recent memory and history. But Deflation is worse, why? because if nominal prices are going down then you are better off holding onto cash and spending later. That house you want to buy will be cheaper in a year, so wait! The problem with this is that economic activity slows down dramatically and the "velocity of money" goes down. Worse still the burden of debt increases. See it this way: you took a loan on that 750k house. Your income may go down or disappear. The net worth of your assets may go down (your house is now worth 350k in the market), but the nominal value of you debt is still 750k. In a deflationary environment your cash inflow follows deflation but your cash out-flow is set.
Ponzi type II bubbles
Monetary bubbles kick off ponzi type II mechanisms. Expand credit, you will expand prices, so you will expand returns, so you will expand demand for credit to invest in those very assets and you will further expand prices and return and so on and so forth. Keep this in mind, the original inflationary euphoria in monetary led bubbles is really hard to resist. It talks and walks and looks like growth! The problem with this dynamic is that is kicks IN REVERSE when the prices go down. This is the "negative feedback loops" everyone talks about.
Price Stability: the FED charter, shock and awe
Central banks have as a stated goal to insure "price stability". This has resulted in practice in "a little inflation is optimal, too much is bad and deflation is worse". One can understand the current FED shock and awe program (QE and MTM suspension) as a desperate effort to derail the negative feedback loops. It is done by artificially raising monetary levels (printing presses are on: Quantitative Easing (QE)) and suspending mark to market so that at least on paper earnings stop going down with the market. Do not be fooled.