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Title: The Deflation Bogey [Paging Nebuchadnezzar: LEARNING Opportunity For You!]
Source:
marketoracle.com
URL Source: http://www.marketoracle.co.uk/Article21777.html
Published: Aug 10, 2010
Author: William_Anderson
Post Date: 2010-08-10 18:28:17 by Capitalist Eric
Keywords: None
Views: 18195
Comments: 40
The Paul Reveres of the economics profession are riding their horses, warning Americans, "Deflation is coming! Deflation is coming!" From Paul Krugman to Joseph Gagnon to the various mainstream news publications, the message is the same — the government needs to induce inflation now, or else the economy will sink further into the Slew of Despond and unemployment will increase.
A recent U.S. News article declared,
When the price of cars or sweaters or iPods declines, it's a break for consumers and a welcome sign that economic productivity is improving. That helps drive up living standards. But when the price of everything drops, it's an alarming development that portends stagnation.
The consumer price index, which measures inflation, declines every now and then, usually when there's a big drop in the price of volatile goods like energy or food. But there hasn't been sustained deflation in America since the early 1930s. Now, we may be on the verge of yet another unnerving economic adventure. Inflation over the last 12 months has been a scant 1.1 percent, which is below the level most economists deem optimal. And so far this year, inflation on a monthly basis has been negative as often as it's been positive. The odds are growing that low inflation could become deflation — with some economists worried that it has already started to happen.
The article continues,
Falling prices cut into revenue at firms that build things and provide services, so they need to cut costs to remain profitable. That usually leads to layoffs and pay cuts. When people bring home less money, they invariably feel worse off and buy less. So demand for products falls further, forcing even deeper price cuts to entice consumers. Breaking the cycle becomes a destructive game of chicken between companies and consumers, with neither willing to take the first step.
But it is not just the journalists who are sounding the alarm. Gagnon writes,
it is now apparent that deflation is a more serious risk for the US economy than inflation. The latest data show overall declines in consumer and producer prices. Even after excluding the volatile food and energy components, core inflation has trended well below the 2-percent level that central banks view as optimal for economic growth and that the Fed has adopted as its goal.
Unfortunately, all of these warnings fail to note what Frédéric Bastiat once wrote about what is seen, and what is not seen. All of the antideflation/pro-inflation writings (and that includes everything Paul Krugman currently is putting out) operate solely upon the initial effects both of inflation and deflation. We know that in the early stages of inflation, economic activity picks up, as the boom begins. Later, as Austrian economists have noted time and again, the boom is unsustainable. The earlier economic gains are seen to be illusory as the crisis begins, and ultimately the economy sinks into recession.
The pro-inflation writings of the current class of economic "experts" demonstrate a great misunderstanding of the role of money in the economy. In its most crude form, this view is based upon the belief that an addition of money to an economy is an addition of wealth itself, although I doubt seriously that either Gagnon or Krugman would admit such a thing.
There are some education issues here, the most important being an explanation of what really happens during a period of deflation — the entire period — as opposed to how most economists (especially Keynesians) and journalists, not to mention nearly everyone else, explains it.
The important thing that most people do not understand is that inflation and deflation have a profound effect upon the factors of production. Furthermore, people don't understand that during the course of either an inflationary period or deflationary period, the adjustments of the factors is continuous, not static, and the early stages of either situation are not permanent.
When we think of rising or falling prices, generally we are referring to consumer prices, and certainly they are affected by inflation and deflation. However, that is only part of the equation. Because so much mainstream economic analysis is done either with factor prices as a "given" or done with the assumption that factors are homogeneous, the most important effects of inflation and deflation often are not recognized by "professional" economists or the general public.
Rothbard's Analysis
One economist who did not make the error of overlooking the effects of monetary changes on factors was Murray N. Rothbard, and his classic Man, Economy, and State deals with these issues in great detail. Obviously, a short article like this cannot give justice to all of Rothbard's explanations, so I strongly recommend that you sit down with this book and read it in its entirety.
In this article, however, I will point out why Rothbard's explanations of inflation and deflation are more complete and more accurate than what we see in the mainstream today. First, Rothbard takes on inflation and its effects on the economy. He writes,
Credit expansion has, of course, the same effect as any sort of inflation: prices tend to rise as the money supply increases. Like any inflation, it is a process of redistribution, whereby the inflators, and the part of the economy selling to them, gain at the expense of those who come last in line in the spending process. This is the charm of inflation — for the beneficiaries — and the reason why it has been so popular, particularly since modern banking processes have camouflaged its significance for those losers who are far removed from banking operations. The gains to the inflators are visible and dramatic; the losses to others hidden and unseen, but just as effective for all that. Just as half the economy are taxpayers and half tax-consumers, so half the economy are inflation-payers and the rest inflation-consumers.
Most of these gains and losses will be "short-run" or "one-shot"; they will occur during the process of inflation, but will cease after the new monetary equilibrium is reached. The inflators make their gains, but after the new money supply has been diffused throughout the economy, the inflationary gains and losses are ended.
Indeed, that is precisely why so many people who have benefitted from inflation are likely to call for another round. As the political and monetary authorities continue to inflate, Rothbard notes that the following things happen, things that seemingly are invisible to economists not trained to see inflation's effects upon the factors:
Inflation also changes the market's consumption/investment ratio. Superficially, it seems that credit expansion greatly increases capital, for the new money enters the market as equivalent to new savings for lending. Since the new "bank money" is apparently added to the supply of savings on the credit market, businesses can now borrow at a lower rate of interest; hence inflationary credit expansion seems to offer the ideal escape from time preference, as well as an inexhaustible fount of added capital.
Likewise, this economic activity will seem profitable at first, drawing more firms into an industry. Rothbard continues,
Conversely, there will be a deficiency of investment elsewhere. Thus, the error distorts the market's system of allocating resources and reduces its effectiveness in satisfying the consumer. The error will also be greatest in those firms with a greater proportion of capital equipment to product, and similar distorting effects will take place through excessive investment in heavily "capitalized" industries, offset by underinvestment elsewhere.
At this point, the crisis is inevitable and only can be stopped when the malinvestments themselves are stopped. Unfortunately, as we have seen, people in these industries (especially if they are politically well-connected, as we saw in the General Motors/Chrysler and Wall Street debacles and bailouts) are often able to convince authorities to continue to prop up these malinvestments by taking the resources away from the relatively healthy firms and individuals. In other words, they often are successful in continuing the transfer, not by inflation per se, but by more overt means of direct expropriation of property.
That is where we are today, and we can see the results. However, there really is a cure, even if people like Gagnon and Krugman cannot see it — deflation. Once again, Rothbard's clearheaded analysis leads the way.
First, Rothbard points out that deflation is a secondary development; that is, it comes after the initial malinvestments crises and is an effect, not a cause, of the downturn. He writes,
After the crisis arrives and the depression begins, various secondary developments often occur. In particular, for reasons that will be discussed further below, the crisis is often marked not only by a halt to credit expansion, but by an actual deflation — a contraction in the supply of money. The deflation causes a further decline in prices. Any increase in the demand for money will speed up adjustment to the lower prices. Furthermore, when deflation takes place first on the loan market, i.e., as credit contraction by the banks — and this is almost always the case — this will have the beneficial effect of speeding up the depression-adjustment process.
Most people, including the majority of economists, make their error in the failure to see that the initial effects are not permanent, provided the government and the monetary authorities permit these adjustments to occur. Just as inflation has a very real and harmful effect upon the relative values of factors of production, deflation also has an effect on the factors, but the effect over time is to return those factors to their proper proportional values, according to consumer preferences.
To put it another way, the economy right now needs deflation, yet all of the public voices are shouting that what we really need is for the economy to take another "hair of the dog." Rothbard explains,
Just as inflation is generally popular for its narcotic effect, deflation is always highly unpopular for the opposite reason. The contraction of money is visible; the benefits to those whose buying prices fall first and who lose money last remain hidden. And the illusory accounting losses of deflation make businesses believe that their losses are greater, or profits smaller, than they actually are, and this will aggravate business pessimism.
It is true that deflation takes from one group and gives to another, as does inflation. Yet not only does credit contraction speed recovery and counteract the distortions of the boom, but it also, in a broad sense, takes away from the original coercive gainers and benefits the original coerced losers. While this will certainly not be true in every case, in the broad sense much the same groups will benefit and lose, but in reverse order from that of the redistributive effects of credit expansion. Fixed-income groups, widows and orphans, will gain, and businesses and owners of original factors previously reaping gains from inflation will lose. The longer the inflation has continued, of course, the less the same individuals will be compensated.
Some may object that deflation "causes" unemployment. However, as we have seen above, deflation can lead to continuing unemployment only if the government or the unions keep wage rates above the discounted marginal value products of labor. If wage rates are allowed to fall freely, no continuing unemployment will occur.
However, today's Keynesians (and other so-called free-market mainstream economists) claim that this supposed downward spiral goes on forever, until the economy is mired in long-term depression. Not so, argues Rothbard.
Finally, deflationary credit contraction is, necessarily, severely limited. Whereas credit can expand … virtually to infinity, circulating credit can contract only as far down as the total amount of specie in circulation. In short, its maximum possible limit is the eradication of all previous credit expansion.
In other words, contra the current set of "experts," this economy really needs a strong bout of deflation to eradicate the rest of the malinvestments and to permit the economy to have a real recovery. Unfortunately, we have seen the authorities run the other way, trying to inflate (calling it a "stimulus") and then watching the rates of unemployment increase and confidence decrease.
Right now, the Austrians seem to be the economic version of Cassandra, predicting the future and giving sound advice, only to be rejected by most academic economists and certainly the politicians. Krugman last year demanded that the government "stop the pain" via inflation and dramatic increases in government spending.
Unfortunately, more doses of inflation will not stop the pain, at least any longer, and the more the government inflates and recklessly spends, the worse the pain will be. The very "cure" of inflation will be what makes the economy sicker. However, if we would be willing to experience the real economic pain just a little longer, a real recovery would be around the corner. In fact, had the authorities more than two years ago agreed to stop the foolishness of promoting inflation and malinvestments, we would be in recovery now.
Unfortunately, there is going to be no recovery, at least for a long time. Deflation is the answer, but few are listening. Rothbard understood this fact intimately. Those who reject his wise counsel will live to regret it.
William Anderson, an adjunct scholar of the Mises Institute, teaches economics at Frostburg State University. Send him mail. See William L. Anderson's article archives. Comment on the blog.
© 2010 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors. (2 images)
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Begin Trace Mode for Comment # 27.
The Paul Reveres of the economics profession are riding their horses, warning Americans, "Deflation is coming! Deflation is coming!"
Deflation is already here...
#16. To: war (#15)
Deflation is already here...
It's no use talking to him. He's a Ron Paul Gold-bug.
#17. To: Nebuchadnezzar (#16)
Read How Deflation Creates Hyper-inflation, and then get back to me.
Get educated, boy... Then maybe you'll be able to talk with the adults.
#18. To: Capitalist Eric (#17)
Here is from YOUR link:
Deflation CAN create Hyperinflation
Note the emphsis on the work "CAN". The Fed has been trying it's best to creat inflation, but has failed in a breathtaking fashion.
Please note, I'm ruling out the possibility of hyper-inflation in about 4 or 5 years, I just don't see it happening as:
A. People right now aren't spending money. Demand is way down. They are paying off debts. This is deflationary.
B. You need a mechanism to get all those dollars into the system and if people are not working (U-6) or afraid of losing their jobs they just won't buy homes, cars, etc.
And drop the attitude, okay?
#19. To: Nebuchadnezzar (#18)
Note the emphsis on the work "CAN". The Fed has been trying it's best to creat inflation, but has failed in a breathtaking fashion.
LOL.
Not surprised, that you would look for a single sentence, to cherry-pick out of the article, and then twisted to match your ignorance. I have a lot of engineers do that, and they always end up looking the fool, with such petty tactics.
So, once again, important information is handed to you on a silver platter... And you failed to READ it.
From the article:
Deflation Vs HyperinflationYes, there is debt deflation, and the overall money supply is shrinking as a result. However, those calling for "multi-year bull market" for the US dollar are insane. These individuals need to review basic monetary theory. The money supply is only one of three factors that determine whether prices rise or fall. The other two are the changes in the velocity of money and the real output of the economy. The danger of hyperinflation lies in a dramatic increase in the velocity of money due to a loss of confidence, not in changes in the money supply.
It is no accident that many of the worst periods of hyperinflation are preceded by deflation. In fiat currencies with high levels of government debt, severe cases of deflation cause a loss of confidence in the nation's currency by shrinking the economy and making the government's debt appear increasingly unsustainable. The loss of confidence then causes the flow of money to speed up as individuals become desperate to exchange cash for real goods as fast as possible, producing hyperinflation.
How deflation creates hyperinflation1) Deflation slows the speed of money to crawl due to fears about the deteriorating economy. The public hoards cash, or, in the case of the US, short term treasuries.
2) The slowing speed of money and debt destruction force the government to create huge quantities of cash to prevent prices and the economy from collapsing. However, because the public is hoarding cash (or short term treasuries), most of the money doesn't reach the real economy, which leads the central bank to print even more money. In essence, cash hoarding acts as a dam, preventing the enormous quantities of printed money from affecting prices.
3) Deflation weakens economy until it leads to a loss of confidence. With doubts about the government's solvency growing, the velocity of money quickly picks up speed, and a flood of hoarded cash comes out of hiding, entering the marketplace all at once and creating hyperinflation.
#20. To: Capitalist Eric (#19)
Not surprised, that you would look for a single sentence, to cherry-pick out of the article, and then twisted to match your ignorance. I have a lot of engineers do that, and they always end up looking the fool, with such petty tactics.
Okay, tell me, when does the hyper-inflation hit?
#21. To: Nebuchadnezzar (#20)
He won't answer...in his usually circular fashion he'll tell you to read the article and then you'll know. But when you actually read the article and point out how it's long on bullshit and short on anything remotely empirical, he'll claim that you didn't read it and declare victory.
#23. To: war (#21)
He won't answer...in his usually circular fashion he'll tell you to read the article and then you'll know. But when you actually read the article and point out how it's long on bullshit and short on anything remotely empirical, he'll claim that you didn't read it and declare victory.
Agreed. You and I disagree on about 90% of the issues, but at least you give a fair and interesting fight.
Kudos to you evil War.
#25. To: Nebuchadnezzar (#23)
Agreed. You and I disagree on about 90% of the issues, but at least you give a fair and interesting fight.
That you disagree with war 90% of the time, indicates you have some scintilla of intellect.
Unfortunately, that last 10% is where you can't discern that he's still bullshitting you.
Nobody can predict exactly when hyper-inflation will hit. Trying to predict that, has as much reliability as weather predictions. The further out you get, the harder it is to make any meaningful guess.
And frankly, once it starts, you'll need a prediction of the exact time, as much as you'll need a weatherman, to tell you it's raining (when you can look out your front window). --Nod to Bob Dylan--
Like yukko the flaccid little clown, war spouts off about what other people do, when he is in fact guilty of the sophmoric attempts to evade and dodge, that he accuses other of. The bit about the "circular argument" is a classic tactic of war.
war bullshits people, because that's his purpose. Any argument that stands for American values (outside D.C.), advocates upholding the law and punishing the sick bastards that run our country, war will be there, spouting shit, lying his ass off, and generally attempting to be the biggest turd in the toilet. He gets off on mind-fucking people like you.
He's a useless little shit.
If you don't get that yet, then that last 10% is going to be painful for you to learn.
#26. To: Capitalist Eric (#25)
That you disagree with war 90% of the time, indicates you have some scintilla of intellect.Unfortunately, that last 10% is where you can't discern that he's still bullshitting you.
Nobody can predict exactly when hyper-inflation will hit. Trying to predict that, has as much reliability as weather predictions. The further out you get, the harder it is to make any meaningful guess.
And frankly, once it starts, you'll need a prediction of the exact time, as much as you'll need a weatherman, to tell you it's raining (when you can look out your front window). --Nod to Bob Dylan--
Like yukko the flaccid little clown, war spouts off about what other people do, when he is in fact guilty of the sophmoric attempts to evade and dodge, that he accuses other of. The bit about the "circular argument" is a classic tactic of war.
war bullshits people, because that's his purpose. Any argument that stands for American values (outside D.C.), advocates upholding the law and punishing the sick bastards that run our country, war will be there, spouting shit, lying his ass off, and generally attempting to be the biggest turd in the toilet. He gets off on mind-fucking people like you.
He's a useless little shit.
If you don't get that yet, then that last 10% is going to be painful for you to learn.
At least War can answer a direct question.
#27. To: Nebuchadnezzar (#26) (Edited)
Notice he responded exactly as I predicted and he didn't even have the balls to PING me.
Replies to Comment # 27.
Notice he responded exactly as I predicted and he didn't even have the balls to PING me.
Yes, he's very immature, and I suspect has some mental issues.
I'm through with him. If he can't answer a direct question I won't waste any more time with him.
End Trace Mode for Comment # 27.
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