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Source link: http://archive.mises.org/9232/falling-prices-are-the-antidote-to-deflation/

Falling Prices Are the Antidote to Deflation

January 14, 2009 by

A disastrous economic confusion, one that is shared almost universally, both by laymen and by professional economists alike, is the belief that falling prices constitute deflation and thus must be feared and, if possible, prevented. Contrary to The Times and so many others, deflation is not falling prices but a decrease in the quantity of money and/or volume of spending in the economic system. To say the same thing in different words, deflation is a general fall in demand. Falling prices are a consequence of deflation, not the phenomenon itself. FULL ARTICLE

{ 37 comments }

Deefburger January 14, 2009 at 9:43 am

Full Article is a broken link….

Deefburger January 14, 2009 at 9:46 am

Its the trailing “/”….The link works if it is “http://mises.org/daily/3296″ not “….3296/”.

Jimmy January 14, 2009 at 9:54 am

Excellent article!

Of course the strong resistance to deflation isn’t merely cultural or ideological. Many people make their money precisely by way of inflation… not least of which are the banking sector (crying out most loudly against deflation) and the government (which could never have funded all of the operations that it’s overseen in the last hundred years without a central bank to buy its bonds, and the central bank can only buy bonds by inflating the money supply).

So we can’t really expect deflationary policy from government and the central bank – that policy will stop only when they don’t have any choice… which will no doubt be when it’s far too late.

StatusQuoJoe January 14, 2009 at 10:33 am

Great article, I think I am a good example of the author’s “target” audience since I really don’t know much about economics. I was able to digest a considerable portion of the article at my usual internet article reading speed. This is necessary, to reach out to the average person and argue economic policy from the Austrian School perspective, sort of a “grass roots effort” since the political and monetary power structure are so ingrained in Keynesian dogma they cannot or will not change without complete collapse (IMO).

The final discussion on housing was especially enlightening, I purchased my home in around 2002 and was very surprised and pleased to see its value appreciate in a couple of years so I took out a home equity loan to make improvements/repairs to my home thinking that the maintenance would add to the appreciating value. To my horror when the bubble popped I saw that the “equity” I had spent was imaginary and the cost of the improvements was really a liability not an asset. So much for ignorance. I think that another factor is that since America has left its roots as a “producing” economy from manufacturing and industry, it changed into a financial planning economy (predominantly) in which it needed the real estate bubble to have some kind of collateral for all the inflationary economic “growth”. As a base it allowed for all the manifold derivatives and financial instruments that were created by the financial industry. Now I think we are seeing the errors of our ways, i.e. that basing our entire economy on financial planning for a depreciating asset has severe consequences.

Thanks for the article and for anyone who read my consciousness stream :>)

hardway January 14, 2009 at 11:00 am

Outstanding article, concise and understandable to people who don’t study this stuff. I’m forwarding it to a bunch of friends and family who give me the thousand yard stare every time I bring these issues up.
Americans are so attached to the idea of their home as an appreciating investment that they REALLY don’t want to hear that it’s not. The government will be doing whatever it can to keep the inflation going, and wrapping it in the veil of, “Saving your home’s value”.

David Ch January 14, 2009 at 11:16 am

Nice sensible article thank you.

The spectre of deflation as the ultimate bogeyman in the minds of keynesian ( and monetarist) economists baffles me. When monetarists discovered the empirical correlation between inflation and employment in the form of the famous phillips curve in the sixties, it was seized upon the world over as a policy instrument, despite the lack of any theoretical understanding of the causalities involved – ( the monetarist transmission mechanism was always a bit of a black box after all). But then the relationship vanished on subsequent data, not surprisingly (EMH or Rational expectations kicking in? mere fluke coincidence in original data? whatever), thus discrediting the phillips curve as a definitive relationship.

Nobody anymore, even in the mainstream, seriously believes that you can generate high employment by ramping up inflation willy nilly. And yet the inverse, the belief that DEflation generates rising UNemployment , persists, but imho it’s no more than an unfounded superstition. But in the mainstream media, even the financial press who should know better, nobody even questions it!

AJM January 14, 2009 at 12:33 pm

Thank you, Prof. Reisman, for sharing your knowledge.

Your article is a sobering commentary on the arrogance of the central planners. Is it merely a stubborn refusal to accept alternative solutions that seek to reduce or eliminate the State’s role in the economy that is perpetuating this experiment in futility? As Jimmy mentioned, the economics of recovery seems to be rooted in inflation. However, as you succinctly stated, this policy will give rise to an even greater crisis. It’s the “pass the buck” mentality where the entrenched political class is looking for an escape hatch out of the mess they perpetuate and pretend to wipe their hands clean. We should all be wary of the ‘positive’ economic news that is spun from the DC propaganda machine. Also, we should closely observe where all this ‘bailout’ money (poor or non-existent accounting aside) ends up.

billwald January 14, 2009 at 12:40 pm

I have a defined benefits pension and a free and clear. Deflation is just fine with me because I will get more for my money. I am in as good a position as the billionaires who couldn’t spend 1% of their assets if they tried.

But the half of all credit card owners who owe an average of $8,000, they will not owe less. Neither will the third of all new car buyers in the last several years who are upside down. Their debt will not decrease even when their pay does.

As a Libertarian I should be pleased that I might come out 20% ahead while half my neighbors are eating beans and rice, no meat? Ayn Rand would say so. P. T. Barnum, “Sucker born every minute.” H. L. Mencken, “No one ever lost money underestimating the intelligence of the American public. Are all Libertarians free and clear and ready to clean up in the coming crash? We will see.

Robert A. Meyer January 14, 2009 at 12:41 pm

I love George Reisman’s book “Capitalism”—a masterful defense of capitalism, reason and honesty. And, of course his article is excellent.

I guess that knowledge trickles down from the originator of ideas, to their students, down to the intelligent layman and maybe it reaches the masses. Although I believe the propagators of illusion and delusion sway the masses.

I have one suggestion. The article would be more readable if it was broken into three parts. For most people, 3300 plus words are too heavy of a dose of reason and logic for one sitting. Also some of us also read Bill Bonner, Robert Ringer, Michael Masterson, Joe Vitale, etc. We have a heavy reading load. Plus we’re also attempting to earn money by adding value to the marketplace. Our time is limited.

One question: Is the intelligent layman 1 out of 100 people—1 out of a 1000 people or maybe 1 out of 5000 people? Until we get through to the masses our chances of success are limited.

Joel January 14, 2009 at 1:07 pm

The private sector has shown itself to be morally befouled, with a level of corruption matched only by its collective incompetence. Before Reagan, we were the biggest creditor-nation in the world and our economy was manufacturing-based, which at least generated wealth directly. Now, we are the biggest debtor-nation in the world, and our economy is 70% based on Americans buying stuff, usually with money they don’t have. That change is a direct result of the private sector’s mania with short-term profit and its refusal to look at the good of this country as a whole.

Private sector better using resources? Don’t make me laugh.

Eric January 14, 2009 at 1:09 pm

I too wish to thank Professor Reisman for an excellent article.

It used to be a puzzle for me why housing prices would go up, when logic tells me that something that is wearing out over time should be dropping in value.

I also want to thank the professor for his 1999 article, “When Will the Bubble Burst?” which woke me up as it began,

“Clearly, something is wrong. It simply cannot be that we can have a society in which everybody lives by day trading in the stock market. ”

http://mises.org/daily/284

This story cured my stock market gambling and saved my pension funds. It’s worth going back and reading.

Stanley Pinchak January 14, 2009 at 1:29 pm

Joel,
An inflationary playing field corrupts the traditional methods of gainful employment and has the effect of demoralizing traditional moral principles. It encourages risky behavior and an increase in time preference. You, apparently, only see the immediate effects of a transititon from a manufacturing based society to a service based society without understanding the unseen forces which proved the incentive behind this transition. It is precisely the political/state actions with regards to deficit spending and inflationary monetary policy which paved the road for the ongoing destruction of wealth in the United States.

The solution is to move the production of money back to the market where it belongs. This has the effect of limiting the damage caused by reckless state spending, reining in rampant inflation and allowing the market to adjust the price level through the interplay of market controlled supply and demand. The first step is elimination of legal tender law. Sound money rewards the prudent and punishes the reckless, inflationary money stifles the penny pincher and encourages the profligate.

Robert A. Meyer January 14, 2009 at 3:00 pm

Joel, here’s a challenge for you. Show us one single instance where the public sector utilized resources more efficiently than the private sector.

I don’t believe you can. Profit making concerns are without exception more efficient than government bureaucracies are.

Michael A. Clem January 14, 2009 at 3:07 pm

As a Libertarian I should be pleased that I might come out 20% ahead while half my neighbors are eating beans and rice, no meat?
No, Bill, that’s not a reason to be pleased. But trying to artificially maintain high prices isn’t going to actually help them, either. The economic damage was already done with the boom cycle. Deflating is merely the correction after the fact. You can’t fix a lie with another lie.

Gabriel January 14, 2009 at 4:00 pm


Bill used to go shopping once a week in his local supermarket. When he went there, he could afford to spend $10 for bottled water. At the prevailing price of $1 per bottle, he was able to buy 10 bottles. Now, in the midst of the downturn, when Bill visits the supermarket, he can afford to spend only $5 for bottled water. Here’s the question: At what price per bottle of water would Bill be able to buy for $5 the 10 bottles of water he used to buy for $10? Answer: 50¢.

But, there is a follow-up question that bothers me now. The supermarket owner bought those bottles of water at $0.90, and we suggest that he sell them at $0.50. So, what about his losses? If he had borrowed from his bank to finance his business, he will default, and will go out of business. How do we find an example that works its way through and completes the circle?

Rebel Ally January 14, 2009 at 4:06 pm

This article gives a great in depth explanation of why Say’s law of markets work to cure deflation. Good to know.

And does not this article show that falling prices are a better “economic stimulus” package than any tax rebate that Obama is planning? (although I still welcome the rebate, just as when a robber returns to give back 5% of the money he stole, better than nothing!)

Dick Fox January 14, 2009 at 4:23 pm

I’m sorry but the article is very confused. For example in the Sixth Grade question Reisman uses teaches the Quantity Theory of Money. This was dealt with by Austrians a long time ago. If he is teaching this to his students he is teaching error. But then later he uses another example that directly contradicts his Sixth Grade example when he has a consumer’s preference change even with a change in money. Reisman really must work to get a consistent understanding of inflation and deflation and then he must work to learn how to clearly communicate it.

I think that maybe he understands Mises but you wouldn’t know it from this article.

Rebel Ally January 14, 2009 at 4:27 pm

Gabriel said,

“The supermarket owner bought those bottles of water at $0.90, and we suggest that he sell them at $0.50. So, what about his losses? If he had borrowed from his bank to finance his business, he will default, and will go out of business. How do we find an example that works its way through and completes the circle?”

He might go out of business, but he could keep adjusting his production and speculation on prices until he makes a profit again (he won’t buy any more bottled waters for over $0.45 each). On the other hand, there is a sort of “default market” as well. If the bank starts to see a cluster of businesses that are not completely paying up each month due to business losses, then the banker has two alternatives: either enforce bankruptcy on the businesses that didn’t pay up, and lose all future revenues coming from those defaulted loans, or negotiate with at least some of the business that while they cannot pay this month or next month, the bank will charge higher interest rates until the weak businesses start making a profit again and return to paying their respective loans, and the bank will have more of its money again along with some future revenues secure.

Whatever alternative is decided upon, it is the correct decision from the markets point of view if it is correctly turned out to be profitable, and this is true of the defaulted businesses as well (they can’t be expected to keep going on month after month with losses, they need to go out of business and find more profitable work).

Either way, the correct course of action(s) can be determined only the by market’s actors, and not the government. Long story short, tell the Keynesians “Do what Say says!”

Kitty Antonik Wakfer January 14, 2009 at 6:06 pm

The majority of this article is very clear in explaining what “deflation” is and is not and how lowered prices are its cure. However the postscript’s second point, home prices, is missing something.

“Only decades of inflation and credit expansion could make it possible for people to think of the houses they occupy as an investment. In reality, a house is a consumers’ good, just like an automobile or a refrigerator. The only difference is that it depreciates more slowly than they do…..If not for inflation, the price of new houses would not rise. They would probably even fall from year to year. In addition, the price of a house that was 5, 10, or 20 years old would be significantly less than the price of a new house.”

Houses are not “just like an automobile or a refrigerator”. I was disappointed that Prof Reisman made no mention of the land on which all houses (and condominiums, as well as rental dwellings) are built. This is a significant factor and not to include it in the discussion of house prices is to me a weakness. I hope that he will cover this aspect in the near future.

**Kitty Antonik Wakfer

MoreLife for the rational – http://morelife.org
Reality based tools for more life in quantity and quality
Self-Sovereign Individual Project – http://selfsip.org
Self-sovereignty, rational pursuit of optimal lifetime happiness,
individual responsibility, social preferencing & social contracting

Inquisitor January 14, 2009 at 6:18 pm

Spot the obvious troll!

Stanley Pinchak January 14, 2009 at 6:29 pm

Kitty Antonik Wakfer,
I believe that land was ignored in the example due to the fact that under non inflationary conditions and with the demographic projections currently expected, the value of land will not appreciably increase on the average. it is true that specific land may drastically increase in value due to proposed capital improvements of entrepreneurs, but the vast majority of American home owners can not expect to be bought out for the creation of a factory, condominium, or other capital improvement which would drastically increase the rent from the land that their depreciating home now occupies. More likely, their home will be replaced at the end of its useful life with a structure capable of earning a similar real rent as their present home.

If there is a major change in demographics, large population migrations, or other large change in the demand for housing, then you can expect to see a rise in land prices in the areas experiencing this growth. Extreme urban areas may expect to see a rise in land rent in the future as a result of higher productivity in business tenants, but it appears as though great suburbia will not experience a comparable increase in rent.

StatusQuoJoe January 14, 2009 at 8:39 pm

Wow, Kitty Antonik Wakfer I was sort of thinking the same thing. But we have to remember that nearly all land titles in the United States are non-Alloidal meaning that the government or jurisdiction owns the land and thus can claim taxes on the land. The only thing that a “property owner” in this situation owns is the structure above ground which depreciates in value.

Then there are the other factors which Stanley mentioned above being related to appraisal values of the land. Obviously the value of the land in a non-Alloidal title are dominated by location, available infrastructure, quality of neighborhood, etc.

Eric January 14, 2009 at 9:59 pm

StatusQuojoe, that’s an interesting thought.

So, when one sells their home, and the land it sits on, the portion they get for the land is sorta like buying and later selling a taxi medallion, while you got it, you have an exclusive right to rent the land at the rent they choose.

newson January 14, 2009 at 10:24 pm

to dick fox:
it’s about time you put up. name one episode of deflation, and how you came to identify this deflation. please no more quotes from tmc, just cite one example.

Mantas January 15, 2009 at 6:05 am

Great Article!
Prof. Reisman explained what influence deflation has for recovering economy. And this article plays very important role to understand what is going on in nowadays global economy.

Goodie2Shoes January 15, 2009 at 10:58 am
Gabriel January 15, 2009 at 3:22 pm

Rebel Ally, thanks for your comments. Yes, I agree with the scenario and the solution (and I did think it through), but what makes me uneasy is how to make the supermarket owner survive while eating all the losses. Deep down, I am in agreement with how the ripple effect should cure the problem all the way back to the source of production, but it’s the semantics of how to institute the solution without having a huge turmoil (bread and soup lines). I completely agree that Keynesian solution is not even a solution, it’s just another layer of problem slapped onto the onion.

Per-Olof Samuelsson January 15, 2009 at 4:09 pm

Inquisitor: “Spot the obvious troll!”

Do you mean Mr. Fox?

Inquisitor January 15, 2009 at 7:53 pm

No, I mean Joel.

Dick Fox January 16, 2009 at 7:12 am

newson,

I have given examples on this site before and discussed their consequences. The easiest is the period after the US Civil War when we returned to the old parity.

A more current deflation is perhaps more instructive. Greenspan had held the value of the dollar very constant during the late 1980s and early 1990s holding a value indicated by the gold price of between $350/oz and $400/oz. This, along with good fiscal policy adopted by the Republican congress and signed by Clinton, gave us the Clinton prosperity. Then about 1996 Greenspan began to force the value of the dollar up until in 1999 it had appreciated almost 40% (gold near $250/oz.) This was deflation and the consequences compounded the problems of the Greenspan/Bernanke inflation of the 2000s (most obvious a neglect of investment in oil production).

We must understand Mises. To deal with inflation we first stop the presses. But most modern Austrians fail to continue to follow Mises after this point. Mises continues saying that we must then find the new equilibrium; the value of the currency has changed. Once we find that new equilibrium we define the currency at a new parity as near the new equilibrium as possible. Failure to define at this new parity will lead to deflation and you will have the bad consequences of both inflation and deflation to deal with as we have seen in the inflation following Y2K.

Per-Olof Samuelsson January 16, 2009 at 10:03 am

Inquisitor: Sorry. I missed that comment.

michael January 16, 2009 at 12:43 pm

Let’s put this in even plainer English: deflation is an erosion of the money supply. In the current instance its cause is a failure of confidence in the credit markets.. which, in our debt-based economy means just about ALL markets.

The net effect is that people and industries who are reliant on loans to tide them over are rapidly running out of money.

This has a direct effect on those of us who work for wages. Because as their wages have eroded or stayed the same over the past 35 years their standard of living has only been supported by an abundance of cheap, generally available credit. So once that credit gets removed, their real spendable income drops.

Is this a good thing? In terms of the economy as seen by a disinterested observer, perhaps. It untangles horrible snarls in our web of who is owed what by whom.. and makes the big picture more elegant looking and easier to understand.

In terms of the little people, though, the toll is horrendous. The snowball continues gathering speed, each year sees more foreclosures than the one before and the hemorrhage of jobs continues to accelerate. Operating funds freeze solid for large corps and little families alike.

Finally, when we find ourselves back in a primitive barter economy, we have to reinvent tokens in order to facilitate the trade of Jill’s home grown vegetables for Jack’s shoe repair. And in order to prevent easy counterfeit of those tokens, we can make them of some metal only avaiable in limited quantity.

Simple and elegant, all right. We’re back in the Dark Ages, before the Italians invented banking and credit. Then the author adds this:

“Indeed, under a full-bodied, 100-percent-reserve gold standard, falling prices, caused by increased production, are likely to be accompanied by a modest elevation of the rate of profit and a somewhat greater ease of repaying debt, both owing to the increase in the production and supply of gold and thus in the spending of gold.”

So the idea is to limit expansion of the money supply by going to a gold standard. Yet this will be okay, because we’ll just increase the amount of gold in circulation. Say what?

To me, if we fail because the credit market implodes and everyone runs out of operating funds, it’s going to be hard for most of us to get our hands on any of that gold. Only the richest, most fortunate among us will be able to weather the drought. And that’s not good economic policy for the country.

Per-Olof Samuelsson January 17, 2009 at 1:40 am

Maybe I should explain why I object to in the comments by Dick Fox.

In his first comment he criticizes Reisman for teaching the quantity theory of money. He sure does. But if one thinks this is some kind of wild departure from what Mises taught, one cannot have read “The Theory of Money and Credit” with any care. Because Mises only attacks certain versions of this theory, e.g. what he calls the “mechanical version” of it. If you are interested, there are some scattered remarks on the subject in chapter 8 of the book.

As to the second comment, the subject of how to implement the gold standard (once the presses are stopped) is addressed in detail in Reisman’s own book, p. 959ff. There is also a lecture, available on this site, that deals with this matter.

And thirdly: in all fairness, Reisman’s treatise “Capitalism” is comparable only to classics like “Human Action” and a few others. If one wants to criticize it (or improve on it), it should be based on something more than a mere scattering of knowledge of Austrian economics.

Jesse Giangioppi January 17, 2009 at 7:54 am

Thanks for the enlightening article on deflation which I fully agree with.

In a completely different order of idea, I am at a complete loss as to how it is that not a single editorialist in your venerable institute has made reference on what is probably the greatest misnomer used by lending institutions the world over ie the word credt.

We all know that any goods or services sold on the promise to pay in the future means that a debt has been contracted and does not imply any credit. If you fail to make good on the term of repayment, you are in breach of contract and singularily resposible for the consequences.

Knowing that any reference to indebtedness would present a major stumbling block to lending, banks easily circumvented the problem by selling ‘credit’ rather than debt. To foolish borrowers this of course meant they could now rest their conscience since the goods and services that had bought were sold to them on the strength of their ‘credit’.

I believe that as long as this fraud remains undenounced by serious institutes,foolish borrowers and greedy bankers will continue with the charade at the expence of honest taxpayers.

Jesse Giangioppi January 17, 2009 at 7:56 am

Thanks for the enlightening article on deflation which I fully agree with.

In a completely different order of idea, I am at a complete loss as to how it is that not a single editorialist in your venerable institute has made reference on what is probably the greatest misnomer used by lending institutions the world over ie the word credt.

We all know that any goods or services sold on the promise to pay in the future means that a debt has been contracted and does not imply any credit. If you fail to make good on the term of repayment, you are in breach of contract and singularily resposible for the consequences.

Knowing that any reference to indebtedness would present a major stumbling block to lending, banks easily circumvented the problem by selling ‘credit’ rather than debt. To foolish borrowers this of course meant they could now rest their conscience since the goods and services that had bought were sold to them on the strength of their ‘credit’.

I believe that as long as this fraud remains undenounced by serious institutes,foolish borrowers and greedy bankers will continue with the charade at the expence of honest taxpayers.

Per-Olof Samuelsson January 19, 2009 at 9:31 am

Correction: The word “scattering” in the last line of my last comment should be “smattering”.

Jaycephus April 1, 2009 at 6:59 pm

Gabriel, re: hyper-deflation

I see two assumptions that are exaggerating the case you originally made. You have a bottle of water dropping from $1 to $0.50 in less time than it takes a store owner to sell his stock. That would be my definition of ‘hyper-deflation’. I don’t think that is remotely realistic at all across all stock that a store-owner carries. Secondly, a store owner ‘may’ not ever be required to sell any product for less than he paid throughout the entire period of prevailing deflation. As gas prices recently fell more than 50% in a relatively short period of time (a couple of months?), gas stations would purchase an order of gas at lower prices, but keep selling their current stock at the old price until the new delivery arrived, at which point they would lower their price. This could be observed as first one station received a new delivery of gasoline and took the low-price lead, followed a few days later by a different station lowering their price significantly when they got their new delivery of cheaper gasoline.

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