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Nick,

I seem to remember Rogoff making the point that the problem was faster growing asian economies adopting inappropriately loose monetary policy because they were pegging to the dollar. US monetary policy was loose but appropriate for the US, asia's monetary policy was inflationary and not appropriate for their economies. The excess liquidity ended up flowing to the western world. I agree with Rogoff.

Adam: That's an interesting new (to me) twist. China did have inflation, IIRC, and was probably not alone. So the inflation was trying to make their currencies appreciate in real terms against the US dollar, because the nominal exchange rate couldn't, being fixed. Which makes sense.

So it wasn't loose US monetary policy that caused loose world monetary policy, except indirectly, via its effect on asian monetary policy.

Hmm. That does make sense.

There are some Toronto real estate market statistics here, at least in graph form:
http://www.randi-emmott.com/market.htm

Adam and Nick, The Balassa-Samuelson effect is a very big deal in Asia. So the Asian countries need to understand that if they want to peg to the dollar, they will have high inflation. That inflation is not caused by US monetary policy, it is caused by their decision to peg to the dollar. (By the same token we should stop bashing China about its exchange rate, because their real exchange rate is set by the market.)

Beginning in 2005 the Chinese got tired of high inflation and started appreciating their currency. By 2008 the yuan was up from 8.2 to 6.8 to the dollar--that's quite a jump. When the international recession hit last year the Chinese wisely put the currency on a temporary dollar peg. Because of the Balassa-Samuelson effect, this has been equivalent to a gradual devaluation, in terms of its impact on the Chinese price level. My pet theory is that Asia is bouncing back first from this recession because of the Balassa-Samuelson effect, combined with fixed exchange rates, or even devaluations in some cases like Korea. The "green shoots" in America after March of this year correlate closely to the recovery in Asia. Sorry I got so off topic, this doesn't relate to your post so much as your two comments.

Nick, I agree that we are moving into a low real interest rate world. I expect massive Asian saving in the next few decades, dwarfing anything we have seen so far. I hesitate to predict markets, but another "bubble" at some point wouldn't shock me. (I put "bubble" in quotation marks, as I simply mean price run-up.)

Scott: Yes, I find myself mentally putting "bubble" in quotation marks too.
But why do you expect massive Asian saving? As a percentage of income? Or just because their income will grow? It's US saving I would expect to be higher over the next 10 years than over the last 10 years.

Scott:
According to a piece in the economist around December last year, the export industry is less than ten-percent of the Chinese economy. Its hard to believe that the Balassa-Samuelson effect explains Chinese inflation.

An alternative explanation is that the inflation arises from yuan monetization of dollars. This represents a massive infusion of high-powered money that then gets multiplied. This reads quite plain from the Chinese CB balance sheet. 92% of the assets backing the Yuan are dollars and treasuries.

So as you say: "That inflation is not caused by US monetary policy, it is caused by their decision to peg to the dollar."

"(By the same token we should stop bashing China about its exchange rate, because their real exchange rate is set by the market.)"
I disagree the inflationary pressures reflect a process of adjustment that will lead in the long run to their real exchange rate being set by the market. However, in the meantime we can say that their beg is low. Its a small export sector bolted onto a huge economy. So the imbalance is a bit like jumping on the earth. Yes, the Earth moves too but you move much more.

"So the Asian countries need to understand that if they want to peg to the dollar, they will have high inflation."

"By the same token we should stop bashing China about its exchange rate, because their real exchange rate is set by the market."

Are you sure about that? There is a fairly large body of research aimed at explaining the observed weakness of the Balassa-Samuelson effect in China.

The Balassa-Samuelson Relationship and the Renminbi - Jeffrey Frankel
http://ksghome.harvard.edu/~jfrankel/BalassaSamuelson&ChinaRMB.pdf

Non-economist question: How does being the reserve currency constrain/complicate US monetary policy? Sure, it's great having all your debts denominated in your own currency and buying oil in your own currency is nice too, but the Fed also has to think about providing dollar liquidity to the whole world. Seems an impossible task to manage monetary policy when there are huge piles of your currency sitting in foreign banks, just waiting to slosh around and make your life miserable. On balance, is being the reserve currency really such a great thing?

Is the global "savings glut" nothing more than wealth/income inequality on a global scale?

I also agree on the "bubble" thing, setting aside the idiots buying houses they couldn't afford and the further idiots who lent them the money, the house price run up was going on for years without the heop of that.

Moreover, the low private savings rate in the US was really a pretty rational response to the crazy high prices/low expected returns of assets.

There is something wrong with this analysis. A country as a whole cannot increase its savings rate unless someone else decreases theirs. Either that or there needs to be much more investment.

I think the prognostication is wrong. We will still MUCH more public investment in the future.

oops ... we will see....

By the way I personally don't believe that the propensity to save is very interest rate elastic, I think savings is driven more by the rate of change of real income.

So China, rapidly rising real income => high savings rate, US stagnant or falling real income => low savings rate.

Jon: but if a country has an overly loose monetary policy, while trying to keep the nominal exchange rate fixed (or even appreciate), that would normally cause an increase in net imports, and a loss of forex reserves. This sounds very much like the UK of my childhood (1950's/60's), but not much like China over the last 10 years.

Patrick: One clear advantage of having the reserve currency is that you have a ready source of profit from low or zero interest loans. There's a large and growing demand from other countries to give you real stuff in exchange for little bits of paper. Plus it's easier to borrow abroad in your own currency, which is much safer since you can always print more if there's a sudden run on your debt (like a bank run). But I expect it does create an additional source of instability in the demand for your money, but that could presumably be countered by adjusting money supply in response.

Too much Fed: No, I don't see any obvious relation between total savings and income or wealth inequality. Perhaps paradoxically, it was the richer countries that seemed on average to be saving less.

reason: "There is something wrong with this analysis. A country as a whole cannot increase its savings rate unless someone else decreases theirs. Either that or there needs to be much more investment."

That is true for a closed economy, (for the world as a whole). An individual country can increase its saving, holding investment constant, by increasing net exports.

But at the world level, if DESIRED savings increases, interest rates fall to re-establish equality between desired savings and desired investment.

"So China, rapidly rising real income => high savings rate, US stagnant or falling real income => low savings rate."

But paradoxically, it ought to be the other way around. If the point of saving is to smooth consumption across time (7 good years, 7 lean years, etc.) it's the people who expect their income to be higher in the future who should be borrowing (dissaving) against that future income. And the people who expect their income to be lower in the future who should be saving against the future bad times.

Nick: "Perhaps paradoxically, it was the richer countries that seemed on average to be saving less."

no paradox here, asset prices where bid up/expected returns bid downby all the emergin market saving enough to discourage rich country saving. Low real rates are supposed to mean a consumption boom.

Jon and Jeff, Having been to China many times I can tell you that their cost of living is almost absurdly low. The Balassa-Samuelson effect merely says that when countries go from being poor to rich their cost of living begins to approach that of other rich countries. I've had $1.50 haircuts in China in elegant hair salons. In 30 years those haircuts will be at least $15. And the process is already underway. It was happening before China agree to appreciate the yuan, and it has happened since.

The percentage of GDP in exports in China may be low at PPP, but if you buy the PPP estimates then that pretty much makes a real yuan appreciation a certainty over a period of a few decades. Balassa-Samuelson doesn't require that exports be a large share of GDP. The mechanism may be the PBOC's monetization of CA surpluses, but I think people focus too much on the mechanism, and not enough on the underlying forces causing real yuan appreciation over time. The Chinese yuan is likely to eventually reach 3 to the dollar. I don't dispute economists who argue that Balassa-Samuelson doesn't predict short run changes, but it certainly does predict long run changes.

Reason raises a good point. A high saving propensity only leads to high actual saving if there is high investment. My prediction isn't so much high saving and investment, but rather low real interest rates caused by a high propensity to save, plus rapidly rising Asian incomes as a share of world GDP (to answer Nick's question.)

BTW, if saving exceeds investment, you don't need public investment, you need an inflation target high enough to avoid liquidity traps.

Adam: I sort of agree. But there is a viewpoint out there that says: "The rich can afford to save, but the poor need to spend all their income and more, so when the distribution of income gets more unequal we should see more saving by the rich and more borrowing by the poor, and therefore inequality is the cause of rising debt."

So the "paradox" is that the facts don't seem to conform to that viewpoint.

I don't agree with that viewpoint, either theoretically, or empirically. (Though it does have an element of theoretical truth if the income inequality is due to fluctuations in transitory income, because transitory income should be saved.)

"if saving exceeds investment, you don't need public investment, you need an inflation target high enough to avoid liquidity traps."

the man is finally making some sense :)

Personally, I'm wondering about "If only half the world increases its supply of savings, the world rate of interest falls by (roughly) half the amount it would if the whole world increased its supply of savings." It seems to imply a linear relationship, but even assuming that data point is correct (0.5 World Savings Increase = 0.5 Interest Rate Decrease), on a gut instinct level it would seem wrong to assume that 0.75 World Savings Increase = 0.75 Interest Rate Decrease.... I'm thinking about Econ 101 week 1 supply and demand curves, and I'm wondering if 0.75 World Savings might mean 0.9 Interest Rate Decrease.

Because of human longevity and the belief we all have that we need to save to ensure our own old age is comfortable, these reduced returns on savings could then result in an even greater increase in savings, eventually driving real interest rates to near zero, especially as more and more people plug the lower returns they are acheiving into simple retirement calculators.

Considering all the factors involved, my gut is saying a "worldwide savings glut" is coming down the road too.

What I was getting at is that the issue with China is not the pegging of the nominal exchange rate, but rather China's ability to effectively peg the real exchange rate and avoid the Balassa-Samuelson effect.

Steve Waldman had a good post a while back on the subject:

Pegging Real Exchange Rates: A Synthetic Tariff?
http://www.interfluidity.com/posts/1159223072.shtml

"In theory, central banks ought to be able to cap nominal exchange rates, but real exchange rates should be market-determined, "endogenous" in the lingo. If a currency "ought" to rise according to "market fundamentals", a central bank's cap should force it to print more currency, increasing domestic inflation, and causing the real exchange rate to rise. In practice, central banks have been successful at manipulating real exchange rates via a combination of nominal exchange rate pegs, capital flow controls, capital market regulation and interventions, and sterilization.

And when central banks succeed in pegging real exchange rates, they are manipulating trade flows as surely as they might with explicit tariffs and subsidies."

"If China were simply pegging its currency without sterilizing, it would stimulate demand for nonimported goods and services, but it might also stimulate inflation, permitting real exchange rate adjustment. But, by adjusting the degree of sterilization, it can seek a sweet spot that grows unsterilized money at a level chosen to maximize real GDP without provoking inflation, preventing real adjustment. The net effect is a synthetic tariff, raising the price of foreign goods while stimulating the domestic economy and providing revenue to the state. It's no wonder that China's trade partners object."

Steve: the relationship would only be exactly linear under very special assumptions (all supply and demand curves are linear, and have the same slope in all countries). I was just trying to give a flavour of the results. It would be more exact to say that the fall in the world rate of interest will be greater the greater the proportion of the world that increases its savings.

A fall in interest rates has a negative income effect on lenders, and a positive income effect on borrowers. Roughly, we expect these two effects to cancel out, leaving only the substitution effect of interest rates on savings.

Jeff: On my reading, it's exactly as if the central bank's forex market interventions were a form of public saving, and so increase national savings.

"On my reading, it's exactly as if the central bank's forex market interventions were a form of public saving, and so increase national savings"

CB FX intervention doesn't actually create public saving; rather it forces private saving by preventing the current account from clearing via trade. That's what increases national saving.

Nick: That sounds about right to me

anon: huh? I don't follow

Jon: but if a country has an overly loose monetary policy, while trying to keep the nominal exchange rate fixed (or even appreciate), that would normally cause an increase in net imports, and a loss of forex reserves. This sounds very much like the UK of my childhood (1950's/60's), but not much like China over the last 10 years.

But Jeff is right that CB issues bonds to reabsorb enough Yuan to regulate the inflationary effect. They don't completely null the inflation--actually they tolerate a very high-inflation, just not one as high as might be.

"Where can I find what happened to the trade-weighted US dollar real exchange rate?"

Nick,

The FED publishes nominal and real trade weighted indexes for the USD under report H.10. The methodology used can be found here. Alternatively you can try the IMF International Financial Statistics database, which uses a slightly different methodology.

Several commenters were comparing a low exchange rate policy with a tariff. They are completely different. Tariffs reduce exports, low exchange rates do not. And low exchange rates do not cause countries to grow faster. It is true that a falling exchange rate can provide a short term cyclical boost, but that has nothing to do with the 10% growth China has averaged over 30 years.

The Chinese do not peg their real exchange rate, it was appreciating before they let the yuan float, and it appreciated even faster after the yuan began to float. Instead of worrying about how much the Asian countries save, the US should save a lot more.

hishamh: Thanks! Good find.

Now real exchange rate data is very important in this case. It lets us distinguish between two competing theories of the low US interest rates:

The savings glut theory says that an increase in savings outside the US should reduce the US natural rate of interest, and cause a real appreciation of the US dollar exchange rate.

The "US monetary policy was too loose" theory says that the Fed lowered interest rates below the natural rate, which should lead to a real depreciation of the US dollar exchange rate.

My eyeball test of that data says that the US real exchange rate appreciated as the US lowered interest rates. I think it tends to confirm the savings glut theory, and contradict the "loose monetary policy" theory. (I think I'm reading the numbers the right way round; an increase means appreciation?) Here's the data I'm looking at: http://www.federalreserve.gov/releases/H10/Summary/indexbc_m.txt

Do readers' eyeballs come to the same conclusion as mine?

I wish I knew how to draw and post graphs, like Stephen.


Scott: Normally a low exchange rate policy is very different from an import tariff, I agree. But I don't think China controls its exchange rate in a normal way. I don't understand this very well, but I think there are multiple exchange rates, and exchange controls. If you have one exchange rate for imports, and a different one for exports, I think it comes to the same as a tariff.

Nick: The St. Louis Fed has a nifty web site that will draw the graph for you:

Exchange rates are here:
http://research.stlouisfed.org/fred2/categories/15

The home page is here:
http://research.stlouisfed.org/fred2/

"It takes two to tango. An increase in borrowing and lending requires an increased willingness to borrow as well as an increased willingness to lend. That's true. So why say the increased savings caused it?

Because real interest rates fell, that's why. If the quantity of apples consumed increased it might be due to a shift in the demand curve or a shift in the supply curve. But if quantity rises and price falls, we figure it was an increase in supply (or, at least, that supply increased more than demand)."

The problem here is that while you can't simply print apples, you *can* print money, and the countries with housing bubbles have been creating a lot of money.

For example, say I get up tomorrow morning and decide I want to spend 8 times my annual income to buy an asset that generates a roughly 1% rate of return at 20-1 leverage (i.e. I am transformed into a typical Vancouverite first time buyer). So I go down to the bank and they say no problem and they push a button and 8 times my annual income appears in my bank account. Nobody in Asia had to save that money, the bank simply creates it.

Historically, the bank may have needed to have at least some of the money on hand due to reserve requirements but we don't have those in Canada any more. We do have capital requirements, but since my 20-1 leveraged loan is insured by the Federal government, the amount of capital required was 0 (for the time period in question, nowadays they might need a sliver of capital) meaning the banking system had the ability to effectively print an infinite amount of money via CMHC insured mortgages, constrained only by the capacity and willingness of people to borrow (and people wonder why there was a housing bubble!)

So back to your example, my demand for apples goes up, so I go to the bank and they say a few magic words and conjure, say, half a million apples out of the air. Some of those apples will end up in the hands of whoever is most willing to hold these ever more abundant and hence worthless apples (sucks to be you, Asia!), but that is an effect, not a cause. The fact that apples are cheap under this scenario (go figure) does not prove that someone somewhere has been planting a lot of apple trees.

"constrained only by the capacity and willingness of people to borrow (and people wonder why there was a housing bubble!)"

Well, also constrained by that newly created money not affecting inflation as measured by cpi, of course, but it doesn't seem like that was an issue, likely since the money was created as debt.

Patrick: Thanks for that link. This weekend I will try to gather up the courage to open it, because it could help me prove what I am about to argue to:

Declan: it is true that looser monetary policy could lower interest rates below the natural rate in the short run (though not in the long run, where super-neutrality kicks in, and the faster printing of money creates faster inflation and a growing demand for (nominal) money that matches the growing supply and pushes real interest rates back up again, and nominal interest rates even higher.)

But in the short run we have two theories of low US interest rates:

1. Savings glut.
2. Printing money.

How do we teat these two theories?

1. predicts the US real exchange rate will appreciate, and the US will run an increased current account deficit.
2. predicts the US real exchange rate will depreciate, and the US will run an increased current account deficit.

To my eyeballs, the data fit 1 much better than 2.

Damn! Typo. Let me try that last bit again:

1. predicts the US real exchange rate will appreciate, and the US will run an increased current account surplus.
2. predicts the US real exchange rate will depreciate, and the US will run an increased current account deficit.

Double damn! It's too early.

1. predicts the US real exchange rate will appreciate, and the US will run an increased current account deficit.
2. predicts the US real exchange rate will depreciate, and the US will run an increased current account surplus.

3. Number 2 will happen--did happen against the Euro--but did not happen against the Asian countries because of subsidies to their export industry.

I think in the face of the complicating factors your test may be faulty.

Well, the U.S. dollar did weaken a lot from 2001-2008, and has been trending down for decades, but I wouldn't take that as definitive - like Jon says, I think there is too much going on in terms of various interventions around the world by central banks to assess the situation on a single metric (the Americans aren't the only ones printing money!). Plus, the U.S. current account deficit increased
at the same time the U.S. dollar was depreciating suggesting something is amiss with your suggested framework.

See here for U.S. current account deficit and U.S. dollar on the same chart. Note the divergence between the two metrics that appears in 2001.


Also, is there any evidence that super-neutrality kicks in in the long run, or is that just a theory? I would imagine that the dynamics are quite different depending on whether the additional money is literally printed (an unlimited, self-reinforcing process) or created as debt (an inherently self-limiting process).

Nick, a couple of comments.

First, you state the following:

The "US monetary policy was too loose" theory says that the Fed lowered interest rates below the natural rate, which should lead to a real depreciation of the US dollar exchange rate.

My eyeball test of that data says that the US real exchange rate appreciated as the US lowered interest rates. I think it tends to confirm the savings glut theory, and contradict the "loose monetary policy" theory.

How can you apply this test when all of the dollar block countries over the last 8 years or so have purposefully aimed to prevent a real exchange rate appreciation in the U.S.? (Yes, they are pegging nominal exchange rates but since inflation differentials are not that large, they effectively are preventing a real appreciation.) Moreover, the fact that there has not been an appreciation means that U.S. monetary policy is being exported abroad to those countries defending their explicit/implicit peg against the dollar. It also means that imports to the dollar block countries are more expensive and thus domestic consumption in these countries is less then it would otherwise be; saving, therefore, increases in these dollar-block countries and then is recycled back to the U.S. Hence, some--not all--of the saving glut is a response of monetary authorities in the U.S. and in the dollar block countries. In other words, some of saving glut may simply be an endogenous response to loose U.S. monetary policy.

Second--and this gets to your comment you left at my blog on global capital markets--a key assumption the saving glut theory and you make is that the total or global amount of desired savings increased over the past 8 years. Maybe the numbers bear this assumption out, but all I know is that desired saving in Asia went up while it went down in the United States. If these two areas roughly offset each other then the global amount of desired savings should not be higher and there should be no effect on interest rates. Again, I probably am way off here, but just wondering. And yes, if true would not support my story laid out above.

Nick, Are you sure China has two exchange rates? I know one is 6.8, but I have never heard of the other. What is the rate? Also, doesn't China have an export subsidy? Export subsidies actually encourage imports.

They certainly have exchange controls, I agree with you there.

The chart Declan links to supports the savings glut theory up to 2002, because the US Current account deficit increased and the US$ appreciated. But it contradicts both theories thereafter, because the CA deficit continued to increase (which contradicts the loose monetary policy theory), and yet the US$ depreciated (which contradicts the savings glut theory).

I think that chart shows the nominal exchange rate, rather than the real exchange rate, but I don't know if that would make a lot of difference.

Puzzling.

Super-neutrality is just a theory. It is a very precise theory, and so is almost certainly false, like all precise theories. Theories of particular non-super-neutralities are less precise, and so more likely to be true a priori. But the only particular non-superneutrality I know that has emprical support is the one that does match theory: real money balances will be smaller at high inflation rates. Inflation is a tax on holding (non-interest bearing) money.

David:
Your first point: Is 8 years long enough to count as the long run? I would have thought it's getting close. And is Canada for example part of the dollar block? One would have thought so, but this did not keep the Bank of Canada keeping Canadian inflation on target. And if your hypothesis is correct, we ought to see the "dollar block" running a current account suprplus and depreciating real exchange rate against the non-dollar block countries. Is that what happened?

Scott: I'm not sure of anything about China. But if it has exchange controls, it effectively does have two exchange rates: the official one, and the shadow one.

Sorry I haven't been posting and replying to comments much. I have been hauled back into university administration this last 10 days.

your second point: my friend and Carleton graduate Michael Francis emailed me to say that the numbers show not so much a savings glut as an investment dearth (though it comes to the same thing in many respects). He has a paper with Brigitte Desroches, published in Applied Economics (I can't find a link), cited by Alan Greenspan http://opinionjournal.com/editorial/feature.html?id=110010981 .

"Is the global "savings glut" nothing more than wealth/income inequality on a global scale?"

"Too much Fed: No, I don't see any obvious relation between total savings and income or wealth inequality. Perhaps paradoxically, it was the richer countries that seemed on average to be saving less."

You need to break down each country into three groups, the spoiled and rich, the gov't, and the lower and middle class.

Is there wealth/income inequality in the USA because of lower and middle class debt leading to excess corporate profits?

Is there wealth/income inequality in china because of cheap labor leading to excess corporate profits?

Is there wealth/income inequality in the middle east dollar pegers because of oil leading to excess corporate profits?

If so, is lower and middle class consumer debt in the high wage countries transferring wealth to the few in china and the few in the middle east pegers. We send them debt, they print the currency, and the few keep it only investing in financial assets (indirect investment) in most of the high wage countries.

Here is an example and from:

http://www.theatlantic.com/doc/200801/fallows-chinese-dollars/3

The voyage of a dollar

"But the Chinese manufacturer can’t use the dollars directly. It needs RMB—to pay the workers their 1,200-RMB ($160) monthly salary, to buy supplies from other factories in China, to pay its taxes."

And, "At no point did an ordinary Chinese person decide to send so much money to America. In fact, at no point was most of this money at his or her disposal at all. These are in effect enforced savings, which are the result of the two huge and fundamental choices made by the central government.

One is to dictate the RMB’s value relative to other currencies, rather than allow it to be set by forces of supply and demand, as are the values of the dollar, euro, pound, etc. The obvious reason for doing this is to keep Chinese-made products cheap, so Chinese factories will stay busy. This is what Americans have in mind when they complain that the Chinese government is rigging the world currency markets. And there are numerous less obvious reasons. The very act of managing a currency’s value may be a more important distorting factor than the exact rate at which it is set. As for the rate—the subject of much U.S. lecturing—given the huge difference in living standards between China and the United States, even a big rise in the RMB’s value would leave China with a price advantage over manufacturers elsewhere. (If the RMB doubled against the dollar, a factory worker might go from earning $160 per month to $320—not enough to send many jobs back to America, though enough to hurt China’s export economy.) Once a government decides to thwart the market-driven exchange rate of its currency, it must control countless other aspects of its financial system, through instruments like surrender requirements and the equally ominous-sounding “sterilization bonds” (a way of keeping foreign-currency swaps from creating inflation, as they otherwise could).

These and similar tools are the way China’s government imposes an unbelievably high savings rate on its people. The result, while very complicated, is to keep the buying power earned through China’s exports out of the hands of Chinese consumers as a whole. Individual Chinese people have certainly gotten their hands on a lot of buying power, notably the billionaire entrepreneurs who have attracted the world’s attention (see “Mr. Zhang Builds His Dream Town,” March 2007). But when it comes to amassing international reserves, what matters is that China as a whole spends so little of what it earns, even as some Chinese people spend a lot."

Let's go back to the global savings glut and wealth/income inequality. If the few have most of the savings, do they only want to invest "indirectly" in financial assets (debt, stocks, real estate) in the high wage countries? They do NOT want to invest directly in the high wage countries to produce more goods because that might lead to price deflation and/or higher wages helping workers to achieve some positive real earnings growth. Then, the workers could pay down some debt or accumulate some financial assets themselves. That probably means the investors would get a negative real investment return and then go crying to the fed and congress we aren't getting any richer.

The whole key to this is exploitation of cheap labor because of a globally oversupplied labor market and a "fungible" money supply that is skewed towards too much debt to prevent price deflation.

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