Inflation and deflation 3: Obama stimulus plan | Finance & Capital Markets | Khan Academy

I finished the last video
touching on the stimulus plan and whether it’s going
to be big enough and what its intent was. But I was a little handwavy
about things like savings and GDP and I thought it would
actually be good to get a little bit more particular. This isn’t just me
making up things. So a good place to start
is just to think about disposable income. And people talk about it without
ever giving you a good definition. It’s important to understand
what disposable income is. So this box right here is GDP,
so it’s all the goods and services, essentially all the
income, that we produce. The disposable income is
essentially the amount that ends up in the hands
of people. So the U.S. GDP, I don’t know
what the exact number is, it’s on the order of I think
$15 trillion. And so some of that money
goes to taxes. I don’t know. Let’s say $3 trillion
ends up in taxes. And these are round numbers,
but it gives you a sense of the make-up. Then maybe about another
$1 trillion is saved by businesses. So let’s say that I’m Microsoft
and I make a billion dollars a share. Microsoft makes a lot more
than that, but I make a billion dollars. And I just keep it in a bank
account owned by Microsoft. I don’t give it to
my employees. I don’t dividend it out
to the shareholders. I just keep that. So corporate savings,
let’s say, is another trillion dollars. These are roundabout numbers. And then everything
left over is, essentially, disposable income. I’m making some simplifications
there, but everything left over is
disposable income. And the idea is, what is in the
hands of households after paying their taxes:
disposable income. That check that you get after
your taxes and everything else that is taken out of your
paycheck, that money, that is disposable income to you. So the interesting thing is
where this disposable income has been going over the
last many, many years. So this right here, this
chart, is a plot of the percentage of disposable income
saved since 1960. I got this off the Bloomberg
terminal again. And just so you get a good
reference point, let me draw the line for 10%. Because I kind of view that
as a reference point. That’s 10% personal savings. Actually, you could go back even
further than this, and you can see from the 1960s all
the way until the early `80s, the go-go `80s, people were
saving about 10% of their disposable income. Of what they got on that
paycheck after paying taxes, they were keeping about 10% of
it, putting it in the bank. And, of course, that would later
be used for investment and things like that. But then starting in the early
`80s, right around, let’s see, about 1984, you see that people
started saving less and less money. All the way to the extreme
circumstance, to 2007, where, on average, people didn’t
save money. Where maybe I saved $5, but
someone else borrowed $5. So on average, we didn’t
save money. Actually we went slightly
negative. And all of this, and this is
kind of my claim– and it can be borne out if you look at
other charts in terms of the amount of credit we took on– is
because we took on credit. I guess there’s two things
you could talk about. We took on credit and we started
having what I call perceived savings, right? If I buy a share of IBM a lot
of people say, oh, I saved I saved my money, I’m invested
in the stock market. But when I bought a share of
IBM, unless that dollar I paid for the share goes to IBM to
build new factories– And that’s very seldom time. Most of the time, that dollar I
gave to buy that IBM share, just goes to a guy who
sold an IBM share. So there’s no net investment. It’s only investment, it’s only
savings, when that dollar actually goes to invest in some
way, build a new factory or build a new product
or something. So I think you had more and more
people thinking that they were saving when they weren’t. Maybe thinking that they were
saving, as their home equity in their house grew, or
as their stock market portfolio went up. But there wasn’t actual
aggregate savings going on. In fact, if anything, they were
borrowing against those things, especially
home equity. And the average savings rate
went down and down and down. So now we’re here in 2007, and
maybe you could say 2008, where this is the capacity. We should probably talk about
world capacity, because so much of what we consume really
does come from overseas, but this is the capacity serving the
U.S. And let’s say, going into 2007, this was demand. Supply and demand was, let’s
say, pretty evenly matched. If you go to that top up here,
you see that we were at 80% utilization, which
isn’t crazy. So if anything, you could say
that demand was maybe right around here. But that’s a good level. You want to be at around
80% utilization. That’s the rate at which you
don’t have hyperinflation, but you’re utilizing things
quite well. Now all of a sudden, the credit
crisis hit and all this credit disappears. And I’d make the argument that
the only thing that enabled us to not save this money,
is more and more access to cheap credit. Every time we went through a
recession, from the mid `80s, onwards, the government
solution was to make financing easier. The Fed would lower
interest rates. We would pump more and
more money into Fannie and Freddie Mac. We would lower standards
on what it took to get a mortgage. We would create incentives
for securitization. We would look the other way when
Bear Stearns is creating collateralized debt obligations,
or AIG is writing credit default swaps. And all of that enabled
financing. Until we get to this point right
here, where everything starts blowing up. So you essentially have
forced savings. When people can’t borrow
anymore, the savings rate has to go to 10% because most of
this is just from people taking on more credit. There were a group of people
who were probably already always saving at 10% of their
disposable income. But there’s another group of
people who were more than offsetting that by
taking credit. Now that the credit crisis hits,
you’re going to see the savings rate– and you already
see it with this blip right there– the savings rate is
going to go back up to 10% of disposable income. Now if the savings rate goes
back to 10% of disposable income, that amount of money,
that 10% of disposable income, this gap, is 10% of disposable
income that cannot be used for consumption. And let’s think about how large
of an amount that is. Right now, the U.S. disposable
income, if I were to draw disposable income– this number
right here, I just looked it up– it’s around $10.7
trillion, let’s say $11 trillion for roundabout. So this 10% of disposable income
that we’re talking about, this gap between the
normal environment, the environment that was enabled
from super-easy credit, that’s 10% of disposable income. 10% of $11 trillion is $1.1
trillion per year of demand that will go away. That’s per year. So all of a sudden, you’re going
to have a gap where this was the demand before
and now the demand’s going to drop to here. And all of this $1.1 trillion
of demand is going to disappear, because credit
is now not available. And then you do get a situation
where you might hit a low capacity utilization. Unfortunately, the capacity
utilization numbers don’t go back to the Great Depression,
and we could probably get a sense of, at what point
does a deflationary spiral really get triggered. But because that $1.1 trillion
in demand disappears, you’re going to see this orange line
just drop lower and lower in terms of capacity utilization. And that’s going to
drive prices down. And what Obama and the Fed and
everyone else is trying to do, is to try to make up this gap. Now, everyone else can’t
borrow money. Companies can’t borrow money. Homeowners can’t borrow money. But the government can borrow
money, because people are willing to finance it. At the bare minimum, the Fed’s
willing to finance the government. And so the government wants to
come in and take up the slack with this demand and
spend the money themselves with the stimulus. Now we just talked about, what’s
the magnitude of this demand shock? It’s $1.1 trillion per year. While the stimulus plan
is on the order of a trillion dollars. And that trillion dollars isn’t
per year, although I have a vague feeling that we
will see more of them coming down the pipeline. This stimulus plan that just
passed is expected to be spent over the next few years. So in terms of demand created
over the next few years, it’s going to be several hundred
billion per year. So it’s not going to be anywhere
near large enough to make up for this demand shock. So we’re still going to have
low capacity utilization. So the people who argue that
these stimulus plans are going to create hyperinflation, I
disagree with that, at least in the near term, because in
the near term it’s nowhere near large enough to really
soak up all of the extra capacity we have
in the system. And if anything, it’s going to
soak up different capacity. So the stimulus plan might
create inflationary-like conditions in certain markets
where the stimulus plan is really focused. But in other areas, where you
used to have demand, but the stimulus plan doesn’t touch,
like $50 spatulas from Williams Sonoma or granite
countertops, that area is going to continue to
see deflation. And I would say net-net, since
this thing this is actually so small, even though we’re talking
about trillion dollars relative to the amount of demand
destroyed per year, we’ll probably still
have deflation. And, for anyone who’s paying
close attention to it, and I am because I care about these
things, the best thing to keep a lookout for, to know when to
start running to gold maybe or being super-worried about
inflation, is if you see this utilization number creeping back
up into the 80% range. At least over the last 40 years,
that’s been the best leading indicator to
say when are we going to have inflation. And for all those goldbugs out
there, who insist that all of the hyperinflation or the
potential hyperinflation is caused by our not being on the
gold standard, I just want to point out that you can very
easily have– we went off of Bretton Woods and completely
went to a fiat currency in ’73, that right around here. But our worst inflation bouts
were actually while we were on the gold standard. And that’s because we had very
high capacity utilization. This is the war period. What happens during a war? You run your factories
all-out. You run your farms all-out
to feed the troops. The factories, instead of
building cars, build planes. Everyone was working. Wages go up. Everything goes up and
you have inflation. A lot of people say, oh, the
war was the solution to the Great Depression. And it is true in that it got
us out of that negative deflationary spiral
that I talked about in the last video. And it did it by creating an unbelievable amount of inflation. And then after the war, you
could argue what allowed– I don’t have GDP here, but the
U.S. GDP really did do well in the postwar period– it wasn’t
the war per se, although the war kind of did take us out of
the deflationary spiral. So after the war, you had
all of this capacity, after World War II. So you had all this capacity
that was being used up by the war, and then, all of the
sudden, the war ends. And you’re like, well, we don’t
have to build planes anymore, we don’t have to feed
the troops anymore, and now we have all these unemployed troops
who come back home. What are we going
to do with them? You’d say maybe, capacity
utilization would come back down there. But what a lot of people don’t
talk about is, the rest of the industrial world’s capacity
was blown to smithereens. At that point in time, the U.S.
was a smaller part of GDP and the other major players
were Germany, Western Europe and Japan. In the U.S., we didn’t have
any factories bombed. The entire war took place
in these areas. And whenever people go on
bombing raids, the ideal thing that they want to bomb
is factories. So what you had in the postwar
period, is you had all of these countries that had their
capacity blown to smithereens. The U.S. was essentially the
only person left with any capacity, and so all the demand
from the rest of the world picked up the slack
in the U.S. capacity. And that’s why, even though
there was a demand shock in the U.S. after that, you also
had a supply shock from the war where you had all of this
capacity that was blown to smithereens. In this situation that we
are in now, we have a major demand shock. Financing just disappears and
the savings rate’s going to skyrocket because people
can’t borrow anymore. But there’s no counteracting
supply shock. Supply of factories making
widgets and all the rest is staying the same. So the Obama administration is
trying to create a stimulus to sop some of this up, but it’s
not going to be enough. And my only fear is, with all
the printing money and all that goes, once we do get
back to the 80% capacity utilization, once we do go back
here, how quickly they can unwind all of this printing
press money and all of the stimulus plan. Because that’s going
to be the key. Because, if we do get to 80%
capacity utilization or we start pushing up there, and we
continue to run the printing press– because that’s what,
essentially, government’s incentive is to do, because they
always feel better when we’re flush with money– then,
and only then, you might see a hyperinflation scenario. But I don’t see that at least
for the next few years.

59 thoughts on “Inflation and deflation 3: Obama stimulus plan | Finance & Capital Markets | Khan Academy

  1. i have not even seen this video….but i can already say….keep up the explanations.

    p.s great job at explaining what the toxic asset buy out will do.

  2. maybe we had the worse inflation when we were on the gold standard, but remember that the President took all the gold from the american people, so infaltion was not measured with gold even though we had the gold standard.

    If the US people had their gold, inflation would have not been a problem.

  3. Why don't you work for CNBC and teach America how to fix itself? We crave satisfactory explanations of what is going on! WE CRAVE IT I SAY!!!!

  4. One factor should be considered is the reserve currency role of US dollar. Right now the debate on this has become more popular. What if most other countries lost confidence on US$? I do believe that the whole world has to be considered when discussing inflation since it is the world currency.

  5. This really just goes to show that Wall Street is the problem. If the money people "invest" actually went to the company they "think" they are investing in the company would have more capital to invest and pay bills and they wouldn't need loans from bailout banks.

  6. The stock market bubbles and the savings decline coincide with the advent of 401K plans. 401K plans began Jan. 1 1980. 401K plans tend to be blind shotgun approach to investing, worst yet it's difficult to take your money out. The next bubble is just beginning. Most people haven't a clue what the P/E ratios, Market Cap, or market share of the stocks they are buying. They just see a statement every 3-6 months. and call that savings.

  7. Mouljran, the money supply changes aren't the only cause of inflation. You have to look at velocity of money also, as well as many other factors. For example if guys like you hoard gold, the price of it will rise (inflate) regardless of money supply. For a very good document examining the various theories of inflation do a google search for Causes of Inflation in Turkey: A Literature Survey with Special Reference to Theories of Inflation

  8. Khan, You need to understand that when the dollar is dumped from reserve banks around the world, and the debt obligations of the US become exponetially increasing, that hyperinflation will set in. its not about whether people save or not, or nomial prices of goods – the world banks will set their USD into the market – hyperinflation… that happens when no-one wants USD – this isn't a normal economical cycle… thats the problem with these vids your doing.. its based on a normal contraction

  9. that's the next stage of the crisis, not what is happening presently. They can raise taxes, increase the reserve requirements, or even increase interest rates to combat this. The exchange rates and capital flows however are something of another story.

  10. People are saving more/buying less these days pressuring companies to lower their prices in order to sell. Secondly, the amount of credit money flowing in dramatically decreased, and so far the fed hasn't printed enough money to cause hyperinflation at current lending levels. Theoretically the fed could cause hyperinflation should they choose pay for gov spending with printed money, or freak people out that they will do that people will buy fearing inflation comes instead of save prices rise

  11. YES! The natural thing for people to do is save! That will increase the value of the dollar and is nessecary since the 80's. Bringing back the savings rate to 10% would be GREAT, however, the government KEEPS spending! How will that effect the dollar? Negatively! The government is devaluing the dollar with all this spending! Sure, we won't have hyperinflation now, but we will as soon as people start dumping the dollar because they'll see americans never pay back or save the money we've borrowed.

  12. > hat will increase the value of the dollar and is nessecary since the 80's.

    Now I understand better Hugh Hendry's point. He forsee deflation with a dollar rally, and he's bear on all other assets. I didn't get precisely his reasoning till now.

  13. Good Video. The bigger potential currency event that is coming is when we have to continually increasing demands to bailout the derivatives market and Foreign countries stop buying our debt at which time we monetize, which has already began. That could be much greater than the stimulus and is the real threat those concerned with hyper infla are concerned about

  14. Inflation is one thing, but what about creating yet another credit bubble and lengthening the recession?

    And what about Bernanke printing trillions of dollars? Isn't that significant?

  15. Big: Keynes' theories were rationalizations for the fascist anti-free market economies we have now. This video is an example of the fixation that Obama's govt has with domestic manufacturing capacity. 3/4 of goods consumed here are made overseas. As China and other creditors stop buying our T bonds long interest rates will go sky high. This will bring on an even weaker economy and more bailouts. The USD will fade until our factories are competitive ( 52 on the DX). Oil =$100, Gold = $2-3K

  16. No savings? What about the people that maxed out their 401k's every paycheck? Is that not considered "saving"?

  17. So, you said capacity utilization is at 80% and demand drops. The US will then print more dollars to increase demand to keep us our capacity utilization up. But didn't you say it was the worlds capacity utilization. Wouldn't it present a problem is the US is the only one printing money. Wouldn't it be better if the whole world printed money together so we won't have to be the only ones going into debt? Does this make sense?

  18. This is so much Keynesian BS

    Learn some capital structure theory – you are treating GDP and capital as some big homogenous blob.

  19. No. The value in the dollar is based off how much it can buy which is based off CPI. The point this guy is making is that if you print 1000 trillion dollars it won't effect anything as long as the money is locked in safe or someones mattress where it is not circulating. The added currency will not effect anything until people start using it. The % of capacity used increasing will indicate people are starting to spent their dollar, and would lead to inflation which he is worried about.

  20. I love the silly Libertarian comments which simply say,

    "you're a keynesian idiot!!!"

    without trying to form any constructive argument.

  21. government deficits = private sector surpluses. As in the great depression, people's balance sheets were repaired, they were able to save without decreasing GDP (paradox of thrift), and so after the war, americans found themselves in a much better position to spend. It wasn't only an export lead recovery, it was strong domestic demand also.

  22. I really enjoy all of Kahn's down-to-earth educational videos, both for learning new things as well as brushing up on things I've …we'll, majored in…I would like to add that in my opinion, any stimulus should be directed to the middle and lower classes that have a lower propensity to save, but contribute to a huge velocity in money. This added demand will enrich all, factory owners and workers, say, and with less borrowing, create the means for saving. Okay, okay, I'll run your country!.

  23. hmm it looks like that for the US and Europe to be saved, North Korea (3rd largest army of the world) must go to war with China (world's largest economy), blow up their factories then get beaten up by coalitions of nations, and another nuclear bomb. The rebuilding Chinese infrastructure would satisfy the demand shock. 😛

  24. i very much enjoy these videos. a question: if investment instruments have swollen the annual liquidity reserves used for speculation to over 8 times the annual global gdp, and most of the losses left to occur have to hit that sector, does that have any effect on where the stimulus is actually going.

  25. @30percentplusreturns Yes, that is correct. But bear in mind that private credit is also money creation. As matter of fact there are 800 trillions of dollars around in CDSs.
    The capacity of government to create money, compared to the private banking is minimal.

  26. Hyper-inflation concept for me is when currency looses its transaction capacity, when people start to trade real goods instead. That can be avoided by indexation, or inflation hedging upon daily indexes

  27. Khanacademy, what do you think would happen if the current bubble the FED is creating has to be burst by a shof of interests a la Paul Vocker? 20 somethint percentage year on short-term debt? To the real economy, taking into consideration the debased industrial base of US, the debt addiction and net interest costs in budget?
    Do you think a sovereign default is possible in the next 10 years?

  28. @30percentplusreturns That is because you do not understand economics. That's why you don't buy it. Keep learning from Sal.

  29. I have a few questions (not specifically for Khan but also the YT community), but first of all: I am not of the opinion that creating deflation is good for the economy.

    What is your viewpoint on 'natural deflation'? (where natural deflation is a declining CPI due to innovation & research)

    Sometimes I hear a stable inflation of 2-3% and some say even 8% is good.
    Does a stable inflation rate of 2-3% really benefit the people and not just the first receivers of the money?

  30. This guy's powerpoint style is totally nuts. Fortunately he is very well spoken. If I just saw the picture I'd think this was the work of an utter loon.

  31. people aren't saving because our dollar doesn't hold value. 1985 — PLAZA ACCORD! Forced dollar devaluation.

  32. QE 1,,,QE II …OH then why did the price of oil go from $32.50 to $100?….with no demand?…plus when oil goes up that much you destroy demand? this is not a normal market or normal economics….but you do a great job….oh and nixon got us off the gold standard 1971…

  33. The one thing the stimulus package has not done is stimulate the economy.
    Prior to the bailout money to the banks, the banks were lending more money than they were afterwards, the speed at which money circulated in the economy fell to the lowest level in 50 years and investment in businesses fell by over 25% AFTER the stimulus.

  34. yeah. alright. penny stocks trading needs good patience and advice from experienced professionals. dont think its funny, These professionals are being with us always to guide us to choose and trade in proper way. have a try now here =>

  35. Now that we are very nearly back to 80% capacity utilization, I would really like to see an updated economic analysis. Thanks for the clear and concise explanations.

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