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Source link: http://archive.mises.org/8925/time-to-panic-about-deflation/

Time to panic about deflation

November 10, 2008 by

If you’re a Keynesian.

Robert Samuelson is still whining about the supposed evils of deflation.

His economics is terrible, but his journalism is beyond ridiculous, describing deflations as “terrifying” and “menacing.” Do they still teach such melodrama in J-school?

I’m sure you’ve been sitting up nights worrying about how much worse off you are now that gas is only 2 dollars per gallon instead of 4 dollars per gallon. Clearly, the government should act immediately to make gas 6 dollars per gallon ASAP. It’s for the good of the economy.

The bubble-burst has brought down the price of many things to where they should be, but Samuelson still thinks that cheap food is what caused the Great Depression, so…inflate.

He’s right about one thing. Deflation is bad for debtors and good for creditors. What he forgets is that everyone who saves and invests is a creditor, so is it so awful for those people to catch a break once in their little lives? Must debtors always be the only ones rewarded by our fiscal and monetary policies?

UPDATE: Here are two resources on the non-evil that is deflation:

An article by Philipp Bagus from the Quarterly Journal of Austrian Economics

Hulsmann on “Deflation and Liberty”

{ 36 comments }

Bruce Koerber November 10, 2008 at 9:45 pm

Cherish it (price deflation for some goods and services) while it lasts because inflation is about to destroy the dwindling purchasing power so much and so universally that only the best entrepreneurs (ones who can anticipate the impact of specific acts of intervention) will be able to perceive relative deflation in a hyperinflation environment.

The reason? Because the identities of the economic terrorists in charge of the unConstitutional coup are still not well known.

Our job? To find out who they are and get that information out. Paulson is one of them.

Stanley Pinchak November 10, 2008 at 10:01 pm

Ryan McMaken,
please report to reeducation in room 101 immediately. Seriously, I really can’t believe that Keynesian Economics has any proponents who don’t have a conflict of interest in maintaining the state. Keynesian Economics says that saving is bad, and make work programs generate prosperity. Since saving is bad, it shouldn’t occur. We, as a policy, should not encourage saving with high interest rates and increasing purchasing power of money. Since indebtedness allows for increased consumption, it should be encouraged. We, as a policy, should encourage low interest rates, and a destruction of the purchasing power of money. This will have the effect of maximizing consumption. Pay no attention to the consumption of capital and the cannibalism of the future. All that matters is the here and now.

Does Keynesian Economics purport to be value free as Austrian and Classical Economics could? I see no way that it can claim this de facto. It’s value is most certainly the maximization of time preference in general. Its capability of achieving this is certain (until the bust). Its capacity for punishing those who would maintain low time preferences is its most vulgar aspect. Keynesian Economics is the destroyer of all traditions that served humankind since time immemorial. No longer is it worth teaching the young values of thrift and hard work. Just hold out your hand. Unfortunately its spoils are rotten and the manacles are strong, forged by our own labor and reinforced by our subservience to the state and our aversion to liberty.

Oil Shock November 10, 2008 at 10:07 pm

Ryan,

All creditors don’t win in a deflation. Infact, most of them end up losing as their borrowers default or file for bankruptcy.

In a deflation, both the creditors and debtors both lose.

Stanley Pinchak November 10, 2008 at 10:38 pm

Oil Shock,
Are you ignoring the entire 19th century (excluding war years)? A slight and steady increase in the purchasing power of money did not prevent the making and fulfillment loans then, and nothing logically would prevent them under such conditions now.

Ryan M November 10, 2008 at 10:52 pm

Oil shock,

In a market system, deflation rewards those who should be rewarded most. Those who saved and invested in sound investments now have cash (which is now more dear) to buy up cheaper assets and employ them in a more efficient manner.

Those who have cash due to more sounds savings and investment are the exact ones who should be buying up the assets, and it is they who will use those assets more efficiently than the big spenders who frittered all their wealth away.

Inflation works in the opposite direction, punishing savers and rewarding spenders who make foolish investments.

maera November 10, 2008 at 10:58 pm

“In a deflation, both the creditors and debtors both lose.”

Explain.

According to my limited reading of Austrian economists:

Debtors lose but since prices are lower for things they buy they may still be able to make ends meet while paying off their debt. (It’s mostly relative I guess; they don’t have cash saved that was earned at the higher inflationary rate). And those without debt are able to save more money because prices are lower.

Walt D. November 11, 2008 at 12:38 am

Since the Keynesian solution is to spend our way out of the recession (depression if you use GNP instead of GDP), the Fed and the Treasury can, and will, pump out fiat money quicker than goods and services. It is hard to see how deflation can occur. Since the Fed suffers from compulsive repetition, when pumping out more money doesn’t work, their solution will be to pump out more -G3 on steroids!”

Oil Shock November 11, 2008 at 1:13 am

Stanley,

I was refering to contraction in money supply due to debt defaults. I wasn’t implying any price movements.

Ryan,

I agree. In deflation, cash will be king. I was just refering to the following sentence from your post: “Deflation is bad for debtors and good for creditors.”

Maera,

Yes, assuming people don’t lose their job, they will be able to save more money provided their earnings don’t fall along with all the other prices.

anon November 11, 2008 at 1:14 am

Krugman on Franklin Delano Obama:

http://www.iht.com/articles/2008/11/10/news/edkrugman.php

Hope someone on Mises provides a full fledged rebuttal!

Artisan November 11, 2008 at 6:20 am

@Ryan M. Very well put.
Many people of good will accept the factuality of the inflationary system because of the propaganda that curbs any realistic depiction of a deflationary system.

The population refuses to force back a deflationary system (gold) because they seem to consider the advantage of inflation is overwhelming in its psychological aspect. It lets a majority of poor people believe that they earn more over time (esp. so in countries with minimum wages and large State servant industry)… even though their real purchasing power sinks.

Gil November 11, 2008 at 6:21 am

What on earth is the fascinating with per se lower prices? Such as “back in 1900 the U.S. dollar was a lot of money!” or “look at the price of a loaf of bread!” But how many fat-arse Americans lived in 1900? Prices in 1900 are a lot lower in 2000 but wages were considerably too!! Judged by the relative standard of living of people in 1900 the real price of food was higher as people didn’t seem to be able to afford much.

Alternatively why necessarily care if the price of things in the future are going to cost more if people will be paid more in kind? The rich are going to win either way: rich people are in the best position to receive the fresh cash during inflation or are going to have the most idle cash during a deflation. The poor are going be at the end of the queue during inflation and generally can’t stockpile much cash during deflation to get a mystical boost in spending (except hyperdeflation maybe) and are the first to be expected to get pay cuts with deflation.

What is ‘a dollar is worth’ isn’t as much as the standard of living increase. And I’d say the standard for the average schmoe increased a helluva lot during 1900 and 2000 than 1800 and 1900.

Renaud Fillieule November 11, 2008 at 6:43 am

Paul Krugman on the Great Depression: “What saved the economy, and the New Deal, was the enormous public works project known as World War II, which finally provided a fiscal stimulus adequate to the economy’s needs.”
http://www.iht.com/articles/2008/11/10/news/edkrugman.php
(Thanks Anon for this link)

Now it’s really time to panic…

scineram November 11, 2008 at 6:44 am

With lower prices I can buy more. Which is fascinating.

Eric November 11, 2008 at 6:45 am

Gil,

I think a majority of what you see is an increase of productivity since the 1900s not an increase in the value of the dollar.

Dick Fox November 11, 2008 at 7:39 am

Why do so many here persist in opposing Mises?!!!

Inflation is bad! Deflation is bad! Don’t you understand. Get off of your soap box promoting deflation.

Ryan, when I read a passage like, “What he forgets is that everyone who saves and invests is a creditor, so is it so awful for those people to catch a break once in their little lives? Must debtors always be the only ones rewarded by our fiscal and monetary policies?” I am appalled! What arrogance! What gives you the right to choose who will be hurt in the economy? What gives you the right to extract revenge against some simply because the government was stupid?

Deflation is an evil that too many do not understand. Deflation creates a condition where it is difficult for businesses to maintain their capital. As prices fall their profits are squeezed and they must cut real costs of doing business to accomodate the deflation. A dollar lost today in profits means that the business cut to make up that dollar tomorrow will be more than a dollar. How can I shout it loud enough!

Oil is the best example. Prior to Nixon taking us off of the gold standard we never had oil and gas problems. The moment we left the gold standard inflation made oil and gas explode in price. This inflation lasted until the Reagan revolution, but Volker’s monetarism pushed us into deflation and in the late 1980s there was a depression in the oil industry. Had the policies advocated by Mises been employed, neither inflation nor deflation, this would have never happened.

When the dollar finally returned to a more balanced exchange value (around $350/oz of gold) under Greenspan oil slowly recovered and the oil recession ended. In the early 1990s oil was nearly ignored as its price was niether too high nor too low.

Then came the Greenspan deflation of the late 1990s driving the price of gold down to around $250 per barrel. Oil prices crashed to $10 per barrel, almost below the cost of production. Once again oil producers cut back on maintenance, exploration, and production declined.

But then Greenspan rushed into a massive increase in the money supply planning to retire with the economy in a huge boom and his popularity high. The massive US inflation hit the entire world and suddenly the demand for oil went through the roof. The only problem is that the deflation of the late 1990s devastated oil production and suddenly there was a much greater demand than production could support. Oil prices again soared as they did in the 1970s.

I do not believe we have reached deflationary levels yet, because we are still working off the Greenspan inflation following the year 2000 but we are getting close. If oil falls to the low $50 per barrel level or lower we could once again return to an oil recession that will simply set the stage for the next oil crisis when the next inflation hits.

DO NOT PRAISE DEFLATION! It is as evil as inflation only it is more subtle in its destruction.

Artisan November 11, 2008 at 8:17 am

@Ryan M. Very well put.
Many people of good will accept the factuality of the inflationary system because of the propaganda that curbs any realistic depiction of a deflationary system.

The population refuses to force back a deflationary system (gold) because they seem to consider the advantage of inflation is overwhelming in its psychological aspect. It lets a majority of poor people believe that they earn more over time (esp. so in countries with minimum wages and large State servant industry)… even though their real purchasing power sinks.

Matthew November 11, 2008 at 9:17 am

I suggest you all figure out what you mean by inflation and deflation before you go blue in the face arguing about which is good and which is bad, completely missing each others’ points the whole time.

I’ve forgotten the various definitions and stances Mises took, but in AGD, Rothbard described inflation as the creation of money not backed by the real economic production of underlying commodity money. As such, deflation could be occurring as fractional reserve banks cut back their lending while the Fed could be adding to the monetary base, which is inflation. Rothbard would argue that such inflation, even if used to offset deflation occurring elsewhere, would be unjust and bad for the economy. Rothbard didn’t address whether the Fed should intentionally precipitate deflation (determining the justice of such an act would be complicated and difficult), but insofar as the deflation occurred naturally as a result of a bubble popping, I am quite certain that we would be in favor of allowing it to occur.

Dick Fox November 11, 2008 at 10:05 am

Matthew wrote:

…insofar as the deflation occurred naturally as a result of a bubble popping, I am quite certain that we would be in favor of allowing it to occur.

Matthew,

I think you are right about many would favor deflation, even Rothbard. Rothbard ignores demand in his definition of inflation and he has led many away from the truth that Mises states about supply and demand for money. Inflation is not an in crease in the money supply. Inflation is an excess of the supply of money over the demand for money.

If you have forgotten Mises I challenge you to go back and meet him again.

Curt Howland November 11, 2008 at 10:32 am

“Debt defaults” don’t cause a contraction of the money supply, except in a fractional reserve system where the money is vaporware anyway.

And good riddance!

Oil shock, you’re not paying attention.

Curt Howland November 11, 2008 at 10:40 am

Indeed, a correction in terminology is important here.

Even the original author has made the mistake of equating “deflation” with a decrease in prices.

Mises.org articles have been very careful to isolate “inflation of the money supply” from the perceived increases in prices. We need to do the same for “deflation”.

What the 19th Century saw was a steady decrease in prices due to ever increasing efficiencies. The decrease in prices was a reflection of a very real decrease in costs, not a decrease in the supply of money.

There were ripples in this line, times of inflation and deflation caused by the usual suspects, central banks, fractional reserve ponzi schemes and fiat currency frauds.

But once the (extremely mild in comparison to the 20th Century) recessions had run their courses, out the other end was a continuation of the general downward slope of prices.

So everybody, let’s watch that terminology! Don’t confuse the poor Keynsians!

Stanley Pinchak November 11, 2008 at 10:43 am

“DO NOT PRAISE DEFLATION! It is as evil as inflation only it is more subtle in its destruction.”

Dick Fox,
I encourage you to try to read Hulsmann’s Deflation and Liberty (again). You will discover that it is inflation that is more subtle in its destruction. The winners and losers in deflation are clear for anyone to see, not hidden in a veil of secrecy. I understand that you are a self described proponent of neither inflation or deflation, but how can you hope to achieve a balance between supply and demand for money either under a fiat or commodity standard (are you suggesting that we target an interest rate, for clearly this is flawed)? I think that the best situation we can hope for is a slow physical increase coupled with a steady increase in the purchasing power of money under a gold standard, leading to a gentle fall in prices.

Subtly advocating inflation as you did in parts of this post is counterproductive to your argument in that inflation punishes capital formation far greater than slow deflation (as defined by increase in purchasing power) did during the 19th century. I would suggest that you read Reisman on how pernicious inflation and taxes on capital are to the creation and particularly the maintenance of capital. Compare the increasing cost over time to maintain capital under inflation with the fall in prices of capital goods under deflation. You will see that your argument on the capital side is flawed. In fact taxes on capital are less pernicious under deflation as reported profits are lower than real profits. This is the exact opposite of the problem which has contributed to the destruction of the manufacturing base in the United States.

Alex November 11, 2008 at 10:56 am

Dick wrote:
Inflation is an excess of the supply of money over the demand for money.

This is correct. However, it often is the case that the gov’t deficit spending (without private borrowing), borrows instead from the Fed, thereby increasing the money supply. This monetary increase is done without an increased real demand for the additional supply. Which, by the way, leads to an excess of the supply of money over its demand.

Inflation/deflation, neither is good. Which is why, if the Fed’s control and gov’t control of the money supply was ended in favor of decentralized private banking, the money supply would be regulated by supply and demand similar to any other commodity. I’m fairly sure that the money supply (like any other commodity) would expand and contract. It would do this inresponse to offset any actual inflation/deflation through corrections in the money supply. This effect would be to mitigate any actual inflation/deflation. And, by the way, we would no longer experience the large wholesale disruptions caused by central meddling. A free efficient market would arise in its place.

Oil Shock November 11, 2008 at 12:35 pm

Curt wrote…

“Debt defaults” don’t cause a contraction of the money supply, except in a fractional reserve system where the money is vaporware anyway.

Agreed. But we do have fractional reserve system. I didn’t make any statement to the effect that deflation is bad or for that matter deflation is good.

I was just saying in a deflation many creditors and all debtors lose.

Curt Howland November 11, 2008 at 1:23 pm

“But we do have fractional reserve system.”

Then put the blame squarely where it rests: “With a fractional reserve system, many creditors and all debtors lose when the system collapses.”

Dick Fox November 11, 2008 at 1:46 pm

Curt,

Good post. Thank you for recognizing that price decreases are not necessarily deflation.

Stanley, you will never find me advocating any amount of inflation, but neither will you find me advocating any amount of deflation. I have refuted Hulsmann’s pro-deflation views. You seem to hold a view that if you choose the lesser of two evils you are virtuous. Why not just hold that both inflation and defaltion are bad and then promote a system that will be as neutral as possible. I personally would prefer a gold standard but I would also support a currency board standard with a gold anchor. These two systems are virtually the same only with a gold standard money is defined in terms of a weight of gold and with a currency board standard money would be defined at a parity free market price of gold.

Alex, I am in favor of free banking but not coerced banking, buy that I mean if people wish to bank with a bank that engages in fractional reserve banking then they should have the choice.

Layperson November 11, 2008 at 1:46 pm

Can anyone point to an article that explains for the layperson why Keynesians believe that deflation is bad? If not, perhaps Mr. McMaken or another qualified Mises contributor will consider writing one, because I’d love to read it.

Dennis November 11, 2008 at 1:56 pm

Layperson,

Here is the link to an excellent article regarding deflation by Professor Joseph Salerno that appeared in the Winter 2003 issue of the Quarterly Journal of Austrian Economics. I hope it helps.

http://mises.org/journals/qjae/pdf/qjae6_4_8.pdf

Christopher Lewis November 11, 2008 at 2:05 pm

“Krugman on Franklin Delano Obama:

http://www.iht.com/articles/2008/11/10/news/edkrugman.php

This guy actually won a Nobel Economics prize???

About this blog though. I read this article, and the supplementing comments, with a hayekian sense of equilibrium in mind. I did not think that anyone here was specifically lobbying for deflation, right? I mean, yeah, great, deflation is absolutely necessary to bring us back to some sort of equilibrium, but, it is still just another symptom of Fed/gov’t intervention in the market system.
I thought the whole premise of the business cycle was that it exists because there is truly no such thing, in our lifetime atleast, as a completely free economy. We should be clamoring for neither inflation nor deflation. We should be trying to spread the noble ideas freedom and liberty, both economically and physically.

Please, correct me if I’m wrong.

Dick Fox November 11, 2008 at 2:39 pm

Layperson,

Be careful to read Salerno with a skeptical eye. He is a deflation advocate. Much of what he writes is educational but beware when he moves to promoting deflation. At that point he move away from Mises.

Generally Keynes believed if prices decline the liabilities of debtors and assets of creditors increase in real terms. He believed that debtors have a higher marginal propensity to consume relative to creditors, consequently, there is a reallocation of real wealth from debtors to creditors and thus the aggregate marginal propensity to consume declines. For Keynes consumption is god.

Keynes also believed that reduction in money wages and prices leads to the expectation further wage reductions. Then the marginal efficiency of capital will fall and will lead to the postponement both of investment and of consumption.

Finally he believed that deflation and the consequent rise in the debt burden depresses the “animal spirits.”

But Keynes was a nut and so it will be better to spend your time with the ABCT and other Austrian (Misean) teaching.

Stanley Pinchak November 11, 2008 at 5:11 pm

Dick Fox,
I do not advocate an interventionist policy of inflation nor deflation, but I abhor interventionist attempts to prevent increases in the purchasing power of money (sometimes a definition of deflation). Decreases in the real cost of goods provides all of the benefits I mentioned above and is not dependent on supply side intervention. Increases in the real costs of goods have the negative effects on capital formation that Reisman eloquently points out ad nauseum. A supply side neutral monetary standard will have a decreasing real cost of goods over time as long as the time preferences of the economy as a whole allow for increases in the capital stock and advancements in technical knowledge. An increasing purchasing power of money is self reinforcing, encouraging saving and thrift, the foundation of capital formation.

Aaron Melear November 11, 2008 at 6:53 pm

I think that the term “inflation” and “deflation” have been used in many different ways on this thread.

In an asset backed money that is created by the people (not by the government), inflation and deflation are both good. They are adjustments in the supply and demand of the asset backed money. Natural money self regulates and is treated like any other good in the economy. As “natural money” loses value, production (or mining) of the natural money will become more profitable and will expand. As natural money becomes less valuable, production (or mining) will slow.

In the uS economy, we are so far away from natural money, it makes little sense to argue whether or not inflation or deflation is better. In fact, it is the inability for a central entity to plan the money supply that is the problem. As with planning for production of any other good, the market determines the appropriate supply MUCH more accurately than a central planner. Throw in the fact that the central planners are also trying to control the price of money (interest rates), we are bound to fail. In our case, we are inflating far more than the market would have it. This does not mean that inflation or deflation is inherently bad. Instead, centrally planned inflation or deflation is always going to misrepresent the market for new money.

Richard November 11, 2008 at 7:01 pm

Can somebody please explain why an increase in the gold supply doesn’t set off the business cycle while an increase in fiat money does? I know Rothbard covers it in AGD but the explanation isn’t very clear.

Stanley Pinchak November 11, 2008 at 8:14 pm

Richard,
it basically comes down to intervention. If true free market demand leads to an increase in the supply of money under a specie standard there is no disinformation spread to achieve particular governmental aims, so a large cluster of entrepreneurs do not fall prey to errors in calculation. For a more in depth examination of business cycles as a subset of error cycles see Hulsmann’s article, “Toward a General Theory of Error Cycles.”

Ryan M November 11, 2008 at 8:40 pm

I updated the main blog post with links to 2 excellent articles on the non-problem of deflation.

Dick Fox November 12, 2008 at 9:46 am

Stanley Pinchak wrote:

A supply side neutral monetary standard will have a decreasing real cost of goods over time as long as the time preferences of the economy as a whole allow for increases in the capital stock and advancements in technical knowledge. An increasing purchasing power of money is self reinforcing, encouraging saving and thrift, the foundation of capital formation.

Stanley,

It appears that you and I actually agree. Perhaps it is language that gets in the way. I do not define what you describe as deflation. The money doesn’t change but the quality and quantity of goods may. In a way if the quantity of goods increases and prices fall you might say there is a change in demand, but it is the change in the goods that creates the change in demand not preference.

It is this kind of change that causes the monetarists a problem. A fixed or slightly growing supply of money does not satisfy this change in demand. That is why we need some kind of system with a gold anchor. That allows the money supply to adjust to changes in the quality and quantity of goods without changing the exchange value of the money.

Henry November 21, 2008 at 2:40 pm

I am a new comer to the Austrian school of economics and I am in awe of how much knowledge all of you possess. I will continue to devote much needed time and energy to this understanding of economics. Long live Freedom and Liberty!

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