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Source link: http://archive.mises.org/9098/deflation-and-liberty/

Deflation and Liberty

December 12, 2008 by

In the present crisis, the citizens of the United States have to make an important choice. They can support a policy designed to perpetuate our current fiat-money system and the sorry state of banking and of financial markets that it logically entails. Or they can support a policy designed to reintroduce a free market in money and finance. This latter policy requires the government to keep its hands off. It should not produce money, nor should it appoint a special agency to produce money. It should not force the citizens to use fiat money by imposing legal-tender laws. It should not regulate banking and should not regulate the financial markets. It should not try to fix the interest rate, the prices of financial titles, or commodity prices.

Clearly, these measures are radical by present-day standards, and they are not likely to find sufficient support. But they lack support out of ignorance and fear. FULL ARTICLE

{ 50 comments }

Gil December 12, 2008 at 9:08 pm

“But they lack support out of ignorance and fear.”

What a bland bald assertion! How about ‘most people don’t want live in the modern world giving up the speed and convenience of electronic and paper money for bars & coins of metal’.

People whine on about the ’90% loss in value of the U.S. dollar’ but ignore the huge increase for the standard of living for the last hundred years. Maybe when peoples’ standard of living fall 90% then gold & silver might come into fashion.

GH December 12, 2008 at 9:32 pm

hmm..

well for most of that 100 years there was certainly not electronic banking. and for more than half of that 100 years there was still a gold standard.

also, there is no reason that the market would not make electronic gold-backed banking popular.

newson December 12, 2008 at 10:49 pm

“…champions of inflation conceded the insight of the classical economists that the wealth of a nation did not depend on its money supply, but they argued that this was true only in the long run. In the short run, the printing press could work wonders.”

and yet the long-term is only a succession of short-terms! but then again, commonsense was never a big part of keynesianism.

“The Japanese governments of the 1990s sought to fix the economic crisis through increasingly heavy doses of inflation. But the only result of this policy was to give a zombie life to the hopelessly bureaucratic and bankrupt conglomerates that control Japanese industry, banking, and politics.”

agreed, but let’s not forget that the massive inflationary policies set in train by the japanese pumped up bubbles in international markets (yen carry-trade), so the distortions weren’t confined to the domestic economy.

another fine work by one of the brightest stars in the austrian galaxy. “the ethics of money production” is the perfect companion to rothbard’s “mystery of banking”. a great read, and concise, too.

i found philpp bagus’ paper, comparing attitudes on deflation held by rothbard, mises, sennholz and reisman, very useful.
here’s the link – http://mises.org/journals/qjae/pdf/qjae6_4_3.pdf

one question: jacob viner’s work “international aspects of the gold standard” – any idea whether this is available free via the internet?

newson December 12, 2008 at 11:15 pm

to gil:
my uncle died in an accident in his nineties. he was a healthy life-long smoker.
conclusion: smoking is harmless

Gil December 13, 2008 at 12:52 am

Or better yet:

“David Hume, Adam Smith, and Étienne de Condillac observed that money is neither a consumers’ good nor a producers’ good and that, therefore, its quantity is irrelevant for the wealth of a nation.”

Then what’s there to complain about then if ‘quantity doesn’t matter’? :)

newson December 13, 2008 at 4:16 am

to gil:
the article makes it abundantly clear, the absolute quantity of money is irrelevant. it’s the redistributional effect of changing the supply of money which is the real question being discussed.

gene berman December 13, 2008 at 8:43 am

Gil:

There’s nothing wrong with your observation. It’s your analysis—and certain conclusions drawn therefrom—that’s faulty. Those who’ve responded to you haven’t explained matters satisfactorily nor would it even have been possible in this format of comment and response.

Neither has Mr. Hulsman addressed your point in what would (from your point of view) explain the matter. He glosses past the relevant analysis (and, again, I’d impute it to constraints of time, length, and specific germanity to the subject) with the words: ” “whatever benefits might result from inflation are largely the accidental result of inflation hitting a particularly favorable set of circumstances.”

The past 100 years have been characterized by almost constant inflation with episodic correction in stagnation, recession, and depression. Those same years have also been characterized by enormous (stupendous, actually!) advances in `most areas of material welfare including many which have greatly enhanced the productivity of human labor.

Neither of these processes is caused by the other.
But the plain fact is that, the lower the level of economic welfare, the less “extra” or “juice” is available to be parasitized. At a lower economic level, not only would there be less to be milked off to the benefit of groups identified by Mr. Hulsman, but the effect on the mass of the population in most sectors of the economy would be more visible (and immediately perceived).

One of the keys to understanding is that the goal of the inflation (to reduce interest rates to the level sufficient to induce continued entrepreneurial borrowing) cannot proceed at a steady rate; what “did the trick” yesterday cannot suffice today without an increase of at least the same size as the rate of inflation applied to the former rate of inflation without bringing onset of deflation. So, the general trend is multiplicative, despite the awareness of everyone that such process must lead to complete breakdown of the entire system.

An office worker of today (and here I’m just making a “stab” at an unknown ratio) is capable of the productivity of 10, maybe more, of the past. Email provides (other than the cost of the labor-time in composition) nearly instantaneous communication
virtually across the globe; other automated data-processing enables such reliable control of material movements (again, worldwide) that “just-in-time” industrial processing (with concomitant lowering of costs of construction and personnel for storage and reduction on the interest cost of storage time) is now an everyday reality (instead of the “pipe dream” of visionary types less than 30 years ago).

Millions of more good hands have joined our efforts to create the decent, prosperous world—many formerly somewhat poorer, many more formerly in abject squalor.

Every kind of electronic gadgetry is not only better but much, much, cheaper. Telecommunications are dirt cheap. For years, right through the ’90s, my phone bills ran from $250 to $$550 monthly (self-employed from home). I get the same level of service now for $55 (though I use it less due to reduced activity); the comparisons are staggering, to say the least.

Are you willing to maintain that the flowering in arts, sciences, and general human creativity and productivity are a RESULT of inflation? I didn’t think so. So, ask yourself where so much of it went that we should see so much of the financial sector in such turmoil and such looming disaster that government is imminently moving in on such huge portions of the economic life of the nation (with similar occurences worldwide)?

The answer is that it’s steadily been diverted to unproductive sectors and largely, by them, has been wasted. And, though, to a certain extent, part of it is still embodied in real, existing things, their existence is, by and large, unprofitable waste.

It is a mistake to confuse the matter of whether or not people prefer the convenience of paper and electronic money to the inconvenience of coin and bullion. Of course they prefer convenience–but that’s no reason for the institution of a process through which many of those same people must eventually be reduced to poverty–and worse. More to the point, it’s a reason for those who know better the inescapable result of such policies to refrain from such behavior.

Mr. Hulsman sees clearly the “handwriting on the wall”–the scenario to which I, myself, have alluded briefly several times in the last few years. And, like me, he has chosen to devote as few words as possible to such contemplation of the most likely outcome of all present proposals.

gene berman December 13, 2008 at 9:19 am

Gil:

One more point.

Theoretically, it would be entirely possible to have entirely “sound” money of the convenient sort desired by most people. Some maintain that we had such “sound” money in the past when the paper was convertible.

What is overlooked is that the maintenance of money’s soundness comes at a cost to people in general (the storage, printing, and convertibility
costs themselves); these are significat but neither
very large nor intolerable. What IS intolerable, at least to government for any length of time, is to be constrained in its spending desires by a lack of funds which cannot be remedied by an appeal to the voters for more (tax increases).

The “convenient” forms of money are favored by the government(s) NOT because people desire their utility but because they are manipulable by themselves in just such ways as have been observed now and in the past.

I don’t know whether you’ve ever read Mises. But, even if you haven’t, I’d recommend that you seek out and read (in HUMAN ACTION) “Observations on the Cause of Decline of Ancient Civilization” and reflect that, in its day, Rome was in a far better position for the survival of its population than are we (and much of the rest of the modern world).

It’s barely two pages. But, once you’ve read and understood it, you’ll understand more about what’s at stake than virtually anyone in any governemnt anywhere.

Gurrie December 13, 2008 at 2:09 pm

Mr. Hulsman should have stopped when he had given a thorough dissertation on the evils of inflation. Instead he went on to praise deflation as, more or less, a good thing.

The reasons that Mr. Hulsman, and the monetarists, are wrong is that they fail to understand the role that money supply and interest rates play in entrepreneurial planning. Any modern economy has to be based on contractual relationships, and virtually all contracts are denominated in money. When you make abrupt changes in the quantity of money, either up or down, or when you constantly manipulate interest rates up and down, you are destroying the value of the entrepreneurial planning and calculation that went into the formulation of those contracts.

Hulsman says that the real wealth hasn’t changed when you decrease the money supply. He apparently takes the view that a carpenter’s hammer has an intrinsic value whether or not it is being used creatively or is laying unused in the toolbox. That is not the real world. Any capital goods have to be used in order to be considered part of the economy and part of the total wealth. Tools that are not used because of economic miscalculation (more often than not caused by governmental manipulation of interest rates and the money supply) are no more a part of wealth than are crops that have gone rotten in the field because of agricultural price manipulation.

Aloïs Everhard December 13, 2008 at 3:41 pm

As I have pointed out before, I strongly disagree with the patent nonsense put forward in this monograph.

Peter van Haaren December 13, 2008 at 3:43 pm

I strongly disagree with the patent nonsense put forward in this monograph.

Edmond Bachelard December 14, 2008 at 2:24 am

The ignorance is definitely on Hülsmann´s side!

newson December 14, 2008 at 4:19 am

for the “patent nonsense” trio – can you elaborate, or must you be taken on authority?

Edmond Bachelard December 14, 2008 at 7:01 am

To summarize, it would seem that Guido confuses the theoretical case for a particular monetary arrangement, such as a 100 percent reserve regime – and which may be entirely sound – with the economics of transition, which requires separate and careful consideration.

fundamentalist December 14, 2008 at 8:13 am

Gurrie: “The reasons that Mr. Hulsman, and the monetarists, are wrong is that they fail to understand the role that money supply and interest rates play in entrepreneurial planning.”

Take a look at Hayek’s “Profits, Interest and Investment.” It’s a restatement of “Prices and Production” but from a different perspective. He wanted to show how little effect interest rates have on entrepreneurial planning and therefore the business cycle. If interest rates were held constant but below the natural rate, changing relative profits would initiate the business cycle. Profits effect entrepreneurial planning to a far greater degree than does interest rates. The essay is not online anywhere that I know of. You’ll have to find it at the library.

Gurrie: “When you make abrupt changes in the quantity of money, either up or down, or when you constantly manipulate interest rates up and down, you are destroying the value of the entrepreneurial planning and calculation that went into the formulation of those contracts.”

I think Hulsmann’s would agree with you. It’s the manipulation of the money supply that causes the abrupt changes. A gold standard with 100% reserves would almost eliminate manipulation and fluctuations in both.

Gurrie: “Hulsman says that the real wealth hasn’t changed when you decrease the money supply. He apparently takes the view that a carpenter’s hammer has an intrinsic value whether or not it is being used creatively or is laying unused in the toolbox.”

Actually, he takes the opposite view. Like Bastiat, he sees wealth consisting of goods and services, not money. A hammer is wealth because it is a good. Money is nothing but the measure of wealth just as a ruler is the measure length. The distance between Tulsa and New York remains the same whether I use inches, miles or kilometers. My measuring device doesn’t change that distance. Now what if standards organizations changed the length of a mile to half what it is today. Suddenly, the distance to New York from Tulsa would be twice as many miles, but the actual distance would not have changed. That’s what happens when the feds monkey with the money supply; they change the standard of measurement. If the money supply doubles, the price of the hammer might change from $5 to $10, but it’s still the same hammer. The value of the hammer hasn’t changed at all. All that has happened is that someone screwed up our measuring device. Gold is a better measure of wealth than any other instrument because the quantity of it changes very little. Dollars, Pounds, Euro and Yen are very inexact measuring devices because they change so much.

Edmond Bachelard: “To summarize, it would seem that Guido confuses the theoretical case for a particular monetary arrangement, such as a 100 percent reserve regime – and which may be entirely sound – with the economics of transition, which requires separate and careful consideration.”

Actually, just the opposite is true. A static economy needs no money at all. People hold money only because they don’t know the future. In a static economy, no uncertainty exists by definition. Only economies in transition need money because transition causes uncertainty about the future. The future provides enough uncertainty as it is. Increasing that uncertainty by manipulating the money supply and re-arranging relative prices makes planning almost impossible.

Gil: “People whine on about the ’90% loss in value of the U.S. dollar’ but ignore the huge increase for the standard of living for the last hundred years.”

How do you know there is a cause and effect relationship there? It could be that our standard of living has grown in spite of the damage caused by inflation. The only way you can know is if you understand sound economic theory.

Dick Fox December 14, 2008 at 11:50 am

Once again we find an article on the Mises.org site that spits in the face of Ludwig von Mises on deflation.

It is true that without further government intervention there would be a deflationary spiral.

Here we find Hülsmann confusing prices with deflation, something Mises totally rejected. Lack of government intervention would allow technology to improve products and production techniques such that prices would fall and quality would improve. The value of the money would not change.

It is not true that this spiral would be bottomless and wipe out the economy. It would not be a mortal threat to the lives and the welfare of the general population.

True because it is not deflation.

It destroys essentially those companies and industries that live a parasitical existence at the expense of the rest of the economy, and which owe their existence to our present fiat-money system.

Schadenfreude always irritates me.

Even in the short run, therefore, deflation reduces our real incomes only within rather narrow limits. And it will clear the ground for very substantial growth rates in the medium and long run.

This is just totally false. Deflation is the appreciation of the monetary unit and is always destructive. I have gone into detail on this in the past so I will only give it a quick analysis. Deflation favors lenders over borrowers and so any person or business buying on time is harmed. Deflation is destructive to plant and equipment and profits as it increases the value of future money relative to current money. If promotes hoarding of money today to be used in the future at a higher value.

We should not be afraid of deflation. We should love it as much as our liberties.

This is simply sick and needs no comment to someone who thinks beyond the end of his nose.

Gurrie December 14, 2008 at 11:51 am

fundamentalist

I believe that interest rates play a bigger role in planning than you think. Being in the real estate development field, I am perhaps more affected by them and therefore more conscious of them. A typical real estate development has financing of 75% or more. It takes anywhere from 2 to 5 years before you begin to see results (i.e., were your calculations of profit potential right or wrong?). The cost of your borrowed money, under the Fed, can go up and down many times during that period. Economists still talk in such terms as when rates go from 4% to 5%, it is a 1% change. It is not, it is a 25% change in the cost of borrowed money and it is very real.

Real estate (including manufacturing plants, shopping centers and office buildings that non-real estate people occupy) also highlights another basic flaw in the monetarist approach. The Fed speaks of “loan demand” and usually measures it by looking at the dollars of loans outstanding. After a typical construction loan is negotiated and approved by the bank, it is usually 12 to 24 months before the loan is fully paid out. In other words, it doesn’t even show up in the numbers until a year or two after it was “demanded”.

My point about hammers was perhaps too cryptic. I wasn’t talking about hammers versus money as real wealth. I was talking about hammers that are being used versus those that are not being used, or are being used less effectively than they could be if they were part of a well-planned operation. A plant that is operating at 100% of capacity is a greater piece of “wealth” than an equally large plant that is operating at 50% of capacity. A railroad line to the Hudson Bay is wealth only to the extent that it can be made to function well and profitably. Oil did not become wealth until the many uses for it were developed. Goods and services are not wealth in any intrinsic sense.

Finally, I have never understood conversations about 100% reserve banking versus fractional reserve banking. All banking, by definition, is a process of aggregating capital by providing a service or a return on investment to the depositors of the capital. The only reason anyone would want to do that as a business is that they want to lend the money out at a higher rate of return than what they have to pay out to the depositors. There is no way they can do this if they are holding 100% of the money in their vault. Fractional reserve banking is necessary and potentially a positive force if they don’t keep changing the reserve requirements. Gold is a reasonably good standard only because government cannot easily manipulate the supply of it, and for no other reason. Fiat money would work just as well if the government turned the job over to the Bureau of Standards and said “hold this to a reliable and transparent standard” such as dollars per capita.

Dick Fox December 14, 2008 at 11:58 am

fundamentalist wrote:

A static economy needs no money at all. People hold money only because they don’t know the future. In a static economy, no uncertainty exists by definition. Only economies in transition need money because transition causes uncertainty about the future. The future provides enough uncertainty as it is. Increasing that uncertainty by manipulating the money supply and re-arranging relative prices makes planning almost impossible.

fundamentalist,

You overstate your case. Money exists because it enhances exchange not whether the economy is static or dynamic. Money allows the subdivision of goods that direct exchange does not allow. It also allows a time element that direct exchange does not allow. Money is an important good in the economy.

Eric December 14, 2008 at 5:45 pm

Dick,

It depends on what is meant by a static economy. In the absolute extreme, where every transaction in the future is completely known today, there would be no need for money, since one would be able to construct a set of transactions along with a set of timetables and thus know exactly what to produce when so that barter would be 100% efficient.

Of course, this is an academic situation and the argument is also completely academic.

But if we look at a range, from little certainty to a lot of certainty, we should be able to see that in the case of more certainty, there would be less need to hold cash reserves. This is Rothbard’s point.

I wish all writers on inflation and deflation would be more precise in their terminology, otherwise one is often confused with whether the terms mean money inflation/deflation or price inflation/deflation. These are 2 different things that are often blurred together, and this makes things difficult to debate.

newson December 14, 2008 at 5:50 pm

dick fox says:
“Deflation is the appreciation of the monetary unit…”

if the value of the monetary unit increases, the aggregate price level must fall. no confusion on hulsmann’s part.

you’ve asserted in previous posts that deflation occurred in the nineties when the oil price collapsed, without explaining why this indicates deflation.

finally, this is not a cult. mises made errors, and changed his mind (“human action” refined and corrected certain errors in “theory of money and credit”).

from “mises suggested research topics 1950-1968″ :
May 9, 1962
• A history of deflations. There has been a great deal written on inflation, but
deflation has received much less attention.

those who decry deflation as the necessary purge to inflation, must necessarily favour reflation. bravo hulsmann for raising the subject.

newson December 14, 2008 at 6:43 pm

to gurrie:
100% reserve banking doesn’t preclude intermediation between savers and borrowers. merely that current account depositors’ monies are not lent out as well.

apart from upholding security over title, 100% reserved free banking eliminates the boom/bust business cycle (if you are a believer in the abct), and systemic banking collapse.

there would be less lending than today and the finance sector would be smaller, granted, but i don’t see that as all bad.

fundamentalist December 14, 2008 at 9:34 pm

Gurrie: “Being in the real estate development field, I am perhaps more affected by them and therefore more conscious of them.”

Real estate is more sensitive than other industries because of the high degree of leverage involved. No other business, other than banks, operate with such a high degree of leverage so the interest rate is not so important.

Gurrie: “There is no way they can do this if they are holding 100% of the money in their vault.”

Well, 100% reserve is short-hand for reserves for demand deposits, such as checking and savings accounts. Banks could loan out money on time deposits where a customer deposits money for say a year and will not withdraw it for a year. But you’re right that banking is much more profitable under fractional reserves, which is why they fight for the privilege so hard. It’s very lucrative. Fractional banking is like the real estate market would be if getting 75% financing, you got 99% financing with just 1% equity. It’s a very dangerous business.

Dick Fox: “Money exists because it enhances exchange not whether the economy is static or dynamic… ”

As Eric wrote, the static economy is a theoretical construct in which no change occurs. It’s used to analyze what happens when change does occur. I’m not sure that’s what Edmond Bachelard meant by a static economy, but since he didn’t explain I took the liberty of assuming that’s what he meant.

Dick Fox: “Deflation favors lenders over borrowers and so any person or business buying on time is harmed.”

That’s only true for loans made during a period of inflation. Loans made during deflation would take into account the rising value of money.

Dick: “Deflation is destructive to plant and equipment and profits as it increases the value of future money relative to current money. If promotes hoarding of money today to be used in the future at a higher value.”

People will not hoard money when investments are available which will provide a greater return than the mere increase in money’s value. Long periods of monetary deflation in the past have proven this. The idea that deflation will cause hoarding and therefore hurt profits and reduce employment is pure Keynes. Austrians disagree. Under mild monetary deflation, interest rates will be very low because people will save more as saving will not be punished by inflation. Low interest rates will spur investment and innovation because because 1) depreciation will actually work to provide funds to replace worn out equipment, something inflation prevents, and 2) corps won’t pay taxes on inflated dollars so real profits will be higher. The main difference will be that banking will no longer be as lucrative as it is under inflation. Businesses and individuals will rely more on savings to finance purchases whereas under inflation they depend more on loans.

Christopher Richard Wade Dettling December 15, 2008 at 12:33 am

J.G. Hulsmann is on to something folks.
This essay is the basis of a three volume work on Political Economy. What a job!

Gurrie December 15, 2008 at 1:25 am

newson and fundamentalist

If there were a neat distinction between demand deposits and time deposits, fractional reserve versus 100% reserve might be a more meaningful discussion, but such a distinction hasn’t really existed for decades. Most banks will cash in time deposits or Certificates of Deposit any time you need them; the time element is just to either preserve or penalize the interest paid. There are so many hybrid forms of deposit accounts these days that demand vs. time cannot even be adequately measured. It also changes seasonally, and it changes as economic conditions improve or grow worse. In the end, it would not make any difference because the multiplier effect operates with time deposits as well. It is the changes in reserve ratios that operate to make banking less stable. The Fed not only controls this, but it allows banks to push the envelope via the discount window. When Greenspan, and now Bernanke, pushed the discount rate to 1% or lower, they were saying “get the money out the door”.

Because of the extreme gyrations of interest rates in the last 30 years, banks have become mainly generators of loans, rather than holders of loans. Sometimes they continue to service them, sometimes not, but the effect is always to make the banks less concerned about the long term soundness of the loan and the relationship with the borrower. In the standard models of the multiplier effect, the reserve ratio and the multiplier were tied together in an inverse relationship. With the banks as loan generators, the multiplier effect is much more difficult to measure and predict, and certainly Bernanke and Paulson have not yet figured it out.

fundamentalist, you are right that banks are more hiighly leveraged than real estate, but you are way off on the ratios. Sound banks run 10% or higher in equity. Even the not so sound ones are more like 5 to 6% equity.

Gil December 15, 2008 at 2:21 am

Meh. If mild inflation is inherently bad because hyperinflation definitely is then if mild deflation is good then bartering is best.

newson December 15, 2008 at 2:25 am

to gurrie:
i agree with your view of the confused situation today, but that’s not what is being discussed. the discussion is over the way back to monetary health.

as fundamentalist says, the abnormal profits to the banking sector under frb, and the government’s interest in inflation as covert taxation, means the chances of 100% reserve banking are slight. but who knows what will emerge out of the dark tunnel we’re entering?

Peter van Haaren December 15, 2008 at 4:03 am

Hülsmann is on to what? This paper is certainly still far away from a respectable three volume work on political economy… It illustrates all the reasons why I would never send my son to the University of Angers to get a PhD in economics: lack of rigor, pamphleteer style, naîve prejudices against any contributions of members of other schools of thought etc… You guys all the time confuse quality with quantity; it´s not because one writes thick books, one is on to something…

newson December 15, 2008 at 8:20 am

to peter van haaren:
“…naîve prejudices against any contributions of members of other schools of thought etc…”

to which schools are you referring?

newson December 15, 2008 at 8:28 am

gurrie:
“It is the changes in reserve ratios that operate to make banking less stable. The Fed not only controls this…”

sweeps mean the fed’s control is minimal over reserve ratios. refer to hatch’s paper – http://mises.org/journals/scholar/hatch.pdf

Peter van Haaren December 15, 2008 at 10:00 am

To Newton:
The Austrian School itself, and Mises in particular, to start with…

fundamentalist December 15, 2008 at 10:22 am

Peter van Haaren: “… naîve prejudices against any contributions of members of other schools of thought etc…”

If you really learn Keynesian, monetarist and Austrian economics (Roger Garrison’s book compares and contrasts them) you’ll find that the Austrian school is so different from the other two that integration is virtually impossible. You have to accept one or the other; you can’t integrate them. That’s why Keynesians never tried to integrate Austrian econ into their system; it’s impossible. The disagreements over fundamental issues are not even close to each other. For example, capital is the heart and soul of Austrian economics. Keynesians and monetarists absolutely refuse under any circumstances to consider capital as anything but a homogenous glob. How can you integrate those?

Dick Fox December 15, 2008 at 10:28 am

fundamentalist wrote:

Dick Fox: “Deflation favors lenders over borrowers and so any person or business buying on time is harmed.”

That’s only true for loans made during a period of inflation. Loans made during deflation would take into account the rising value of money.

This is a dangerous assumption. I have heard the same justification concerning inflation. Any distortion in the monetary value is destructive.

Dick: “Deflation is destructive to plant and equipment and profits as it increases the value of future money relative to current money. If promotes hoarding of money today to be used in the future at a higher value.”

People will not hoard money when investments are available which will provide a greater return than the mere increase in money’s value. Long periods of monetary deflation in the past have proven this. The idea that deflation will cause hoarding and therefore hurt profits and reduce employment is pure Keynes. Austrians disagree. Under mild monetary deflation, interest rates will be very low because people will save more as saving will not be punished by inflation. Low interest rates will spur investment and innovation because because 1) depreciation will actually work to provide funds to replace worn out equipment, something inflation prevents, and 2) corps won’t pay taxes on inflated dollars so real profits will be higher. The main difference will be that banking will no longer be as lucrative as it is under inflation. Businesses and individuals will rely more on savings to finance purchases whereas under inflation they depend more on loans.

You are wrong about the problems with deflation being Keynesian. The problems I mention with deflation came directly from Mises in The Theory of Money and Credit.

Both inflation and deflation distort market signals so any assumptions you make concerning interest rates and deflation are suspect.

You still don’t seem to understand that deflation causes businesses to delay capital improvements. You buy machinery that will produce a product for $50 unit cost and you plan to mark this up to sell it for $100. After overhead and fixed costs you may make 5%. But due to deflation, monetary appreciation, the market is only willing to now pay $90 for your product. Even though the $90 is now actually worth $100 you have actually lost money on the transaction. You would have been better off putting the $95 unit cost under your matress.

You make too many assumptions about deflation. You could just as easily make assumptions based on the same logic concerning inflation, but both would be very risky.

Dick Fox December 15, 2008 at 10:39 am

Newson wrote:

dick fox says:
“Deflation is the appreciation of the monetary unit…”

if the value of the monetary unit increases, the aggregate price level must fall. no confusion on hulsmann’s part.

Newson,

This is not necessarily true. There is both supply and demand in the value of the monetary unit. Prices can decrease even in inflation. Look at our current situation. It is hard to say that we are suddenly in a deflation and I would actually say the monetary unit is still losing value relative to all goods and services but demand has fallen through the floor. Prices are a poor indicator of inflation or deflation.

You need to read The Theory of Money and Credit. If you have read it you need to go back and read it again with this in mind.

fundamentalist December 15, 2008 at 11:18 am

Dick Fox: “You still don’t seem to understand that deflation causes businesses to delay capital improvements. You buy machinery that will produce a product for $50 unit cost and you plan to mark this up to sell it for $100. After overhead and fixed costs you may make 5%. But due to deflation, monetary appreciation, the market is only willing to now pay $90 for your product. Even though the $90 is now actually worth $100 you have actually lost money on the transaction.”

If you look at one transaction and one transaction only, and allow nothing else to enter the discussion, then you’re right. Keep in mind, however, that you’re talking about price deflation and not monetary deflation because price deflation will happen if the money supply remains fixed. With a fixed money supply, prices will naturally fall as production increases. We have witnessed that to some degree over the past year as the US money supply has remained relatively stable, causing prices to fall rapidly.

History is against your fear of price deflation. Several times in US history price deflation has lasted for years with great results. The reason is that the prices of inputs, and therefore costs, fall along with the fall in the price of outputs.

Monetary deflation is another thing. It can happen under a gold standard if gold leaves a nation due to imports, but as history demonstrates the adjustment isn’t too painful. The worst monetary deflations happen under central banking. The US has never experienced the deflation of the 1930′s any other time. But trying to stop these sudden, sharp declines in the supply of money will cause worse problems than the deflation will cause.

Dick Fox December 15, 2008 at 4:20 pm

fundamentalist,

Money supply measurements are a monetarist myth. No one knows how to measure the money supply, but there is a way to know the intersection of supply and demand and that is the price of gold.

What is price deflation? I know what it means for prices to either rise or fall, but what does it mean when they deflate? Are you talking about contraction?

One of the problems we have today is the FED confuses contraction/deflation and expansion/inflation. That means that they may slow money supply during an expansion when demand signals an increase is actually needed in the money supply. Likewise they may pump in more money during a contraction when the money supply is actually okay. Their inability to make this distinction compounds their errors.

Pat December 15, 2008 at 8:46 pm

Correct me if I am wrong, but aren’t inflation and deflation related to the comparison between the growth rate of the money supply and the growth rate of the production of goods and services? Dick Fox, I get your point that deflation, just like inflation, has its downside, also how the Feds get confused between contraction of the money supply/deflation and the expansion of the money supply/inflation.

newson December 16, 2008 at 1:28 am

dick fox says:
“This is not necessarily true. There is both supply and demand in the value of the monetary unit. Prices can decrease even in inflation.”

you’re not reading or understanding what i actually said. “aggregate prices” is the term i used. of course some prices can go down in inflation (think computer hardware), but these declines are outweighed by the price rises in other sectors. prices of services, goods (financial and otherwise).

if you’re only looking at some prices, you’re going to fall into the same trap as steve forbes, who was always squealing deflation during greenspan reign. he was looking exclusively at the gold price decline that extended to the end of the century.

newson December 16, 2008 at 1:36 am

definitions of money supply vary from exponent to exponent, even the austrians have disputes about what aggregate best represents money supply. that said, i know of no austrian who would disregard all of the aggregates on the pretext that they’re not perfect.

the monetarists advised targeting money supply growth, which obviously is not an austrian approach.

Peter van Haaren December 16, 2008 at 8:18 am

Fundamentalist:

I know all these things of course. Now if you yourself have read Garrison, you should know that he distinguishes, and correctly, between a theory of the unsustainable boom and a theory of depression. As regards the latter, Austrians can learn something from monetary disequilibrium theorists, monetarists etc. The work of Yeager and followers is recommended too. It is indeed a naïve prejudice – besides very pretentious – to believe that THERE NEVER CAN BE ANYTHING OF VALUE in all the others´ work, even if one agrees that the Austrian approach is in some respects superior. On those issues where other approaches have anything to add, they are complementary to, rather than exclusive of, Austrian ideas.

fundamentalist December 16, 2008 at 9:31 am

Peter Van Haaren: “It is indeed a naïve prejudice – besides very pretentious – to believe that THERE NEVER CAN BE ANYTHING OF VALUE in all the others´ work…”

I agree. I earned a masters degree in mainstream economics long before I learned Austrian econ. I’m fairly familiar with what the other schools have to offer. So far I have found no ideas from other schools that Austrians didn’t anticipate and deal with long ago. It amazes me that many of the “new” ideas that people came out with recently I find that Mises or Hayek dealt with those ideas back in the 1930′s. But that’s what happened when people ditched an entire school of economics to go after Keynes’s “new economics,” which of course was not new and anyone who understood economics knew it wasn’t new. Keynes merely dusted off popular mercantilism and gave it respectability.

Peter van Haaren December 16, 2008 at 9:48 am

I disagree. Neither Mises nor Hayek have a satisfactory theory of depression. It´s doubrful they really understood what was going on during the Great Depression. And mainstream economics comprises much more than Keynes…

fundamentalist December 16, 2008 at 10:56 am

Peter, If you have some specific criticisms of Hayek or Mises that you want to discuss, or mainstream ideas that you think those two missed out on, that might be interesting. Otherwise, I take the opposite view. I don’t think anyone other than Austrian economists have a clue as to what happened in the Great D or what is going on in the economy today.

newson December 17, 2008 at 12:04 am

to peter van haaren:
and rothbard’s “america’s great depression”?

newson December 17, 2008 at 9:03 pm

mises on credit contraction:
“contraction produces neither malinvestment nor overconsumption… No protracted scars are left”

human action, scholar’s edition 1998, p565)

Gil December 18, 2008 at 5:41 am

‘Tis good to see the Skeptical Optimist has tackled just ‘the depreciating dollar means we’re doomed myth’.

http://www.optimist123.com/optimist/2008/12/purchasing-power-propaganda.html#comments

PR December 18, 2008 at 8:24 am

That Skeptical Optimist article is terrible. The effect of inflation on savings or fixed incomes doesn’t even get a passing mention. And not a word about the redistribution of wealth to early receivers of new money from everyone else? The article’s heavy reliance on averages specifically avoids the issue.

Then the article points to rising standards of living as the sole evidence that inflation isn’t even harmful. Yes, standard of living has improved, so what? Post hoc ergo propter hoc. Do we have rising real incomes because of inflation or in spite of it? The article doesn’t even try to make a case.

Gil December 19, 2008 at 5:18 am

Were you being dim PR? His article did make a passing mention on inflation – “If deflation is avoided and inflation is kept low and predictable . . .”.

Interesting are ‘those on a fixed income’. Who are those? Public servants? Old age pensioners? Chances are those who are receiving a fixed income are getting stolen tax income from the guvmint. Private operators are more likely to get paid on what they produce, no?

If inflation steals from some to others than so does deflation. Both can wreck the economy when in hyper- mode. Likewise you’d have to have a huge amount of new money to get a big time buzz from inflation (excluding hyperinflation) and likewise you’d need a huge amount of idle cash to get a big time buzz from deflation, neither of which the poor is likely to have.

PR December 19, 2008 at 9:25 am

Gil, the rest of the sentence you quoted has nothing that addresses inflation as a tax on savings. The article might as well be saying, “See! Hydrogen cyanide isn’t really bad for you if you take it in small enough doses. And if you improve your diet and exercise more, your health might even improve! Don’t listen to those naive anti-poisonists. Look at my fancy aggregate numbers. Numbers never lie!”

Maybe I’m just being “dim,” but surely the best way to avoid (hyper-)deflation is to not artificially inflate in the first place. Historically, episodes of sharp monetary deflation didn’t just happen on their own. They were simply the reversal of some previous period of inflation. I bet there were “Skeptical Optimists” cheering on the inflation back then too.

Stephen Grossman December 25, 2008 at 3:43 pm

Thanks to Prof. Hulsmann for a clarifying, intellectually refreshing defense of deflation. The only problem is that it makes consumptionist economics, bleated out by mainstream public even more surrealstic and intolerable. Peter Schiff is one of the few voices, available to the average person, who is identifying our inflationary crisis. See his YouTube videos.

Stephen Grossman December 26, 2008 at 10:47 am

People like Bernanke and Krugman should not be regarded as scientists but, instead, as technicians. Perhaps as Inflation Technicians. “Voters rebelling against higher taxes? Call EconoBloat now. Voters will get more govt and never know they’re paying for it. Until it’s too late and you’re out of office. Call 1-800-FED.”

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