Finflation

Finflation describes the effects of an increase of financial assets, i.e. monetary vehicles (monetized base) over real production. This concept was created and coined in 1992 by Professor Nazar, by joining the terms financial-inflation (Fin-flation or "finflación" in Spanish).
Monetized supply/base
Inflation is the consequence of an excess supply rate of monetary values over the rate of “real world” growth. Economists usually use different definitions of money supply to estimate future inflation but forget to include other monetary vehicles which add up to several times the monetary base.
Monetized base is a related concept and term coined by Prof. Nazar in 1992, which includes all "papers" or vehicles reflecting value: stocks, bonds, derivatives, corporate debt, mortgages, warrants, uncashed checks, credit card coupons, etc.
Virtual Economy Monetized markets ==
Real economy is the material economy. It’s the “real deal”: what we actually purchase/consume, including human hours in services we receive, what we touch, we eat, we build, we live on, etc.
Virtual economy is the market involving transactions with values (monetized supply and demand); this includes "papers" indicating the theoretical price/value we give to real things through vehicles such as money, securities, derivatives, etc.: monetized support.
Findeflation
Fin-deflation (financial deflation or "findeflación" in Spanish), also created and coined by Prof. Nazar is the nominal reduction of the monetized base.
Usually Government debt represents a large part of the monetized base.
With the exception of small states such as the Vatican or others ruled as personal assets (Monaco in certain periods), in the long run, governments tend to increase debt in nominal terms. This is why findeflation is a rare short term case, usually related to debt defaults (private or public) or bankruptcy: both processes are a way to deal orderly with the inherent crisis model of an uncontrolled monetized system.
Governments promote finflation
Securities’ markets are bound to have recurrent crisis due to the inherent gap between real economy and virtual economy.
There is constant increase in papers supposedly having value but this increase is not matched by real production. Sooner or later this creates a tension, which usually resolves in a crash. The crisis usually affects what the market believes is the weaker paper (the perceived risk) even if the origin is in another vehicle (e.g. government debt).
Year after year governments issue more debt than the real economy is able to supply for. Sooner or later this creates a crisis, which may start in other value vehicles such as the US mortgage market in 2008.
Valuation gaps promoted by finflation
Supply and demand pressures on the real markets constantly create differences between the established monetized value and the real value (the value we should actually be paying if the market had adjusted the pricing on the monetized vehicles).
An example: up to 2004, analysts did not pay enough attention to real oil reserves. Suddenly they realize the overestimation. Oil prices have gone up by over 400% in less than 4 years. It is obvious the oil shock was created by the information gap: supply and demand didn’t change much.
Information gaps can always be reduced through several measures (including risk management) but there will always be differences between the real and the monetized world, not only because of inefficient or unfair information flow but also because of recurrent speculative bubbles which seem to be part of human nature.
Analogy: it’s like a sea (of financial assets), where water level (virtual economy) is much higher than the seabed level (real economy), blown by the wind (expectations), which creates waves (bulls and bear trends), some of which break on the shore (crisis when collision against reality). The more water (uncontrolled monetized base), the higher the probability of a crisis.
Impact of finflation on foreign exchange rates
Corollary: a country’s currency (e.g. the US dollar) should be worth much less in terms of other currencies if we consider the total debt (including all vehicles, all monetized supply) over current real production. The more a government issues debt, the less should the currency be worth in the long run.
This is a more intuitive way to understand the forces behind the "twin deficits"
Simplified example
Considering, ceteris paribus, that an economy has in year one:
- a stock of $100 billion in real assets (not only the assets produced in a certain year but also the accumulated stock of real assets, including real estate) and services
- a stock of $500 billion in monetized base
If the government increases the monetized base in $100 billion through an expensive government health plan, increasing the base to $600, wouldn't you expect a devaluation of the currency?
The monetized base is what the market accrues on the real economy, but if the real economy hasn't been able to increase throughput, then there are more guests to eat the same pie, so the only way to make things match is to reduce the real value of the "papers" through a financial crisis which would take the monetized stock to $500 billion (e.g. reducing stocks and bonds values or through bond haircuts and bancruptcies) and/or to increasing the value of the real assets to $600 (inflation). Usually both forces may act simultaneously and meet in the way.
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