Dear Friends,
It seems to me, when economists worry about deflation it is like a doctor worrying about a runny nose, they both are concentrating on a symptom, not the underlying disease. The consensus among economists is that deflation is so bad a little inflation is needed to insure no deflation occurs. The possibility of deflation is why most economists agree we cannot go back to the gold standard, and why all the proven dangers of fiat money must be tolerated, else we would get the dreaded deflation. But, as we all know putting leaches on a patient because he has high blood pressure is not a viable solution, persistent inflation is as bad and probably worse than a little deflation. The safety of your IRA account and job security depend on this question.
The economy of a country is like the body of a person. The corpus economic is a complex system that reacts to stimulus as is the human body. If we give a person lead oxide, (as they did in the Roman times) it may have a temporary palliative effect but the long term effects will be profoundly negative. The state of modern economics is about where the Romans were in medicine. Our very limited knowledge gives our economists the hubris to prescribe lead oxide when penicillin is what the patient needs.
The argument against deflation is this; if a person knows his money will be more valuable in the future, a rational maximizer will not spend money and instead save it. Using the aggregate supply aggregate demand model as described by John Maynard Keynes, this incentive to save instead of spend, lowers aggregate demand below aggregate supply and this results in economic recession. This logic depends on the aggregate supply, aggregate demand model being an effective analog of how an economy works, it also presumes the incentives will outweigh the needs of individuals.
So, what he is saying is that we wont spend our money, if we know it will be more valuable later. Let’s look into this presumption. If I have a dollar in my pocket, and I know that next year it will be worth one dollar and one cent, is that sufficient incentive against my rumbling stomach? Further, if my washing machine breaks down today, is it logical that for the gain of a penny or two in a year, I will put off buying a new one, and instead wash my clothes in a creek with a washboard? Moreover, if we take the opportunity cost into consideration, in other words the good I could have today weighed against the good I could have tomorrow, it only makes sense to buy the things I need today.
Deflation does provide a greater incentive to save just as inflation does a disincentive to save. If we consider the effects of a greater savings rate in a country, say, the US, we can see a lot of good that can come of it. The balance of trade is effected by the savings rate in a country. Balance of trade is both in goods and money. If the demand for money, capital, exceeds the savings rate money will flow into that country. This importation of money is counted in the balance of trade. If the savings rate exceeds the demand for capital then money will flow out, again effecting the balance of trade, but for the good.
Another effect of a greater savings rate is that more capital would be available for entrepreneurs to invest in ideas, small businessmen to invest in equipment or start businesses and more money available to build homes, cars and washing machines. A greater availability of capital means lower capital costs. But this doesn’t come at cost to savers because the money they have put away is growing both by compounded interest and deflation. There is no need for government to use lead oxide to gin up the savings rate against the disincentives inflation creates.
Economists will scoff at he idea pointing to the Great Depression as historic proof that deflation is a bad thing. In doing so they will confuse the fact that deflation was a symptom not the cause. The cause was government’s tampering in the economy. Price controls, regulations about what farmers could plant, how much any given product could be made, what could be made and making it nearly impossible to start a business. The result was the lowering of the demand for labor, this caused high unemployment and lower wages, lowering demand below aggregate supply. The government poisoned the patient and economists blamed the symptoms not the cause.
Some of the times where growth was highest was in times of deflation. During the 1800’s there were times where the Dollar was deflating… but the economy was growing. This further undermines the historical argument that the consensus of economists use. Economists use this spurious argument against deflation while ignoring the pernicious effects of inflation, negative incentive to save, negative balance of trade that the low saving rate creates, perpetual lowering of wages through the devaluing of the wages that are paid, allowing government to run up huge deficits, all the negative effects of fiat currency… among many others.
Inflation is simply a modern form of seigniorage. Seigniorage is where kings would collect all the money, shave a bit from them all and reissue the coins a little smaller. Inflation allows Governments to rack up huge deficits and have confidence that those deficits will evaporate due to inflation. History shows us that where deficits were too big and money printing got out of control the effect has always been runaway inflation, or in other words, hyper inflation. This is far more destructive of the wealth of a nation than anything proposed by economists about deflation.
So, when you hear that government must do this or that, to defend against deflation, (like monetizing the debt), you will know they are engaging in group think. Today economists are giving the corpus economic lead oxide and leaches when what the economy really needs is the penicillin of deregulation and the nutrition of lower taxes. This doesn’t serve the interests of the elite however, who want more control, not less. So we will continue to be bled, suffer heavy metal poisoning and all the while our leaders will claim it has to be done. To the destruction of the wealth of our nations… and by extension, us.
Sincerely,
John Pepin
