Mark Levey, senior managing director at Lotsoff Capital Management in Chicago, has a piece on FDR’s New Deal today on the Wall Street Journal’s opinion page that starts out well, but then crashes and burns because (surprise, surprise) Levey misunderstands deflation (and misunderstands money, as well). Once again, we see someone who realizes that the New Deal was a failure, but then says that Roosevelt and his advisers did not recognize the problem of deflation.
Fat chance of that. Much of the New Deal was aimed at keeping up prices, with the government trying to support prices through edict and subsidies, and printing lots and lots of money (after taking the country off what was left of the gold standard). Levey writes:
The problem was that neither Roosevelt nor President Herbert Hoover before him grasped the essential nature of the crisis, which was not the stock-market crash, but global deflation. At the end of the roaring ’20s, an overhang of intergovernmental war debt from World War I, coupled with falling commodity prices and a currency crisis, had started the decline. Weak credit structures and European banks hurt by wartime inflation worsened it. When the Austrian Creditanstalt Bank failed, it ignited a global banking crisis that slashed across the international financial system cutting down everything in its path. Deflation went into full howl.
Indeed, this is a real howler. Not only do bankers and policymakers not understand deflation, few economists do, either. (The late Paul Heyne in his wonderful text, The Economic Way of Thinking, wrote that deflation was as bad as inflation.)
However, as Murray Rothbard has explained, deflation is actually a time when the fundamentals of the economy are put back into order and the distortions are eliminated. Furthermore, money itself becomes more valuable and also facilitates trade instead of distorting it.
Obviously, many people don’t like deflation, as prices fall. Workers don’t like pay cuts, and owners of other factors of production don’t like seeing the prices of their goods fall, yet such a time is necessary if we are to bottom out of the recession and to have a good recovery. However, the inflationist cranks, from the bankers to the politicians, are trying to tell us that inflation will cure everything. Right. And Zimbabwe is the world’s richest country.
{ 24 comments }
I would be curious to know what Mr. Anderson thinks about Steve Horwitz’ discussion of deflation in his book _Macroeconomics and Microfoundations_. He questions Rothbard’s view that deflation has no disruptive consequences. For example, there is the problem of “who goes first” when price cutting must commence.
January 18, 2009
Don’t Flee To The Dollar!
Look around! What is safe?
We are at the precipice, one similar to the high cliff at the beginning of the Great Depression – the Crash of 1929! What looks safe? Just like was done then put everything you own in that and even borrow and invest in that. No wonder people lost everything and even the desire to live.
Stocks are way too volatile and generally overvalued. Bonds are in a nosedive. Gold is good but it is taxed.
The dollar is looking strong and it is easy to convert assets into dollars. The government is now promising to insure dollars as never before. Dollars are liquid, again making it appear as a very attractive way to design safety into your portfolio.
Stop right there! What does the dollar bubble mean to you?
Since 2000 we have seen the inflation bubble move from NASDAQ to housing and now it is attached to the dollar. When the dollar bubble bursts the age of hyperinflation will be upon us! Before hyperinflation the dollar still has value. Afterwards it will become exponentially worthless.
Do you want your assets to be like a bubble that bursts?
Protect your assets by following the advice of Peter Schiff.
-there is the problem of “who goes first” when price cutting must commence.-
Iwaaks, I really don’t see that as a problem. Those that cut their prices first are those that will obviously succeed in the new market for falling demand, since obviously prices that were set during the Fed induced boom are not clearing. In other words, those that can cut costs and appeal to their customers/demand the fastest will be successful…those that fail to lower and cut costs and compete will fall by the way-side, as they should. I hope I understood your question…
Well, in the old days (Like 100 years or so), deflation or inflation referred to the change in the money supply. It seems to me that it is the view of those who adhere to the Austrian school of economics. Naturally, this affects the prices of goods and services in the sense that money usually is exchanged for these items. What is the correlation factor is hard to pinpoint (After all, items and goods are affected differently), which is one of the reasons for the confusion when attributing the fall in the prices of goods and services. I think such distinction between change in the money supply (deflation and inflation) and change in the prices of goods and services is accurate and needed in order to prevent deleterious policies.
But we should also realize that change in money supply will not uniformly affect the price level (Some goods and services are exchanged with money more often than others). Therefore, whenever people claim the data does not link inflation in money supply with rise in the price level, we should, besides questioning how the data was collected, ask which items were most often exchanged for money. For example, the rise of share, bond, and house prices in the 1990s might be a clue to where most of the price level went to. But that is something that has been already pointed out in this site and other books (Peter Warburton’s Debt and Delusion for example). But given the number of articles in the newspapers, that is worth pointing out again.
Is it possible that Rothbard’s money formula does not reflect the true amount of money? What if the quadrillion of derivatives had money characteristics? They were good for collateral, they could be used as (very) short term credits. Their money characteristics dropped by their “Level 1-2-3″ regulations. Their regulations, however, just preceded inevitable market forces and it coincided with the start of the “credit crisis”. Consequently, they count much less now in the total amount of money. Is it possible to invoke this argument, especially here at Mises.org?
Then our current price drop is still a monetary phenomenon.
By the way, I agree this price drop and, in my opinion, rightly named deflation is only temporary.
There is a difference between disruption and harm. The disruption comes because the relationships between the factors already is out of balance, and the balance has to be restored if there is to be a real recovery. Deflation is part of that process.
If we could magically stop deflation, we still would have to deal with the problem of the factors being out of balance, so in that sense, deflation is part of the necessary adjustment. What Heyne and others were saying is that deflation puts the factors out of balance, and that is not true.
Deflation is NOT harmful in the way that inflation is harmful.
The Fed respsonse to the current economic crisis is like a man slashing his wrists and then begging for transfusions of blood to save his life. Sure, we can continue pumping blood into his body and money into the economy to keep things going.
But unless you stop slashing your wrists, you are going to die eventually. Right now the Fed has gone from wrist slashing to throat slashing. That does not bode well for the efficacy of transfusions of fiat money.
Fear of deflation has us headed for outright decapitation of capital altogether. As we are dragged to the guillotine, government and banking are consoling us saying “At least its not deflation!” Is worthless money preferable to a half-price sale?
40% cumulative deflation was enough in order to fix the distortions? 25% unemployment, the rise of fascism, millions going hungry, thousand bank failure, lives destroyed. This is the legacy of the gold standard and we are so lucky that this barbarous relic today is just a commodity and an investement for idiot goldbugs.
History does not serve current day economics discussions well. Economics is full of incalculable data points which are never replicated. Leave history alone and concentrate on human tenancies/behavior.
so load up with treasuries, zoro. but spare us this drivel.
Hank:
“Leave history alone and concentrate on human tenancies/behavior.”
It’s hard to see where this view leads because history is one of our most valuable sources of insight into human tedencies and behavior. Even someone who treats Austrian economics principles as inviolate will have a much easier time making his case if you allow him a couple of historical analogies!
Zoro, are you done with the emotive hysteria? No, that is the legacy of central banking and the interventionist cranks you so adore. Too bad you’re too stupid/too much of a coward to come to terms with it.
Re inflation/deflation… the terms only make sense when applied to a stock of something. How would a price “inflate”? It’s a ratio… hence the term properly applies to the money supply. Besides, many things can cause price “inflation”…
T’was funny how people here laughed about the threat of ‘global warming’ and also because a few decades it was ‘global cooling’. Yet here people can despair of inflation yet have a love affair with deflation. Presumably since most people get more income with inflation (more zeroes to the left of the decimal point) and less income with deflation (more zeroes to the right of the decimal point) they’d are going get thrilled either way. Therefore it’s the ‘lag factor’ – appparently the Bad Guys get the profit from inflation and the Good Guys get the profit from deflation. For everyone else it’s a ho-hum scalar problem.
Hank:
“Leave history alone and concentrate on human tenancies/behavior.”
It’s hard to see where this view leads because history is one of our most valuable sources of insight into human tedencies and behavior. Even someone who treats Austrian economics principles as inviolate will have a much easier time making his case if you allow him a couple of historical analogies!
As I recall from Horwitz, in order for a seller/producer to maintain his profits margins, his costs must fall as well as his selling prices. The prices of inputs may not fall immediately and this can squeeze profit margins, leading to unemployment/curtailed production. Hence, the who goes first problem.
Deflation has such a bad reputation because there is no clear economic policy to control it. Thus deflation brings no benefit for economists or politicians. It can bring a host of afflictions.
Inflation can be quiet unpleasant when experienced. But economists and politicians don’t suffer during inflations. They prosper as government tries their ideas.
But neither deflation or inflation are causes, they are results. The cause of economic woes lies with production. As a nation loses the ability to produce competitively, or chooses not to, it loses all. No amount of government tinkering will overcome that.
Losing the ability to produce can occur in many ways. The government may just impose too large a burden of regulations and taxes. Or it may reward sloth to such an extent that few choose to work constructively. Or a class system may fatally prevent effort.
And are other causes. More than once manias have led whole populations into ruinous economic behavior. Manias may be political, religous, or mystic.
The mortgage and banking debacle is such a mania. It was a wild enthusiasm based upon the idea that if only the people were to living in better homes they would be more prosperous.
And nothing could go wrong because our motives were so good. It followed as the day follows night that loaning any amount of money to those wanting to buy homes must bring good across the land, from sea to shining sea.
Mr. Anderson,
Isn’t there a difference between an economic disruption due to misallocation of resources and a monetary contraction — called deflation — that allegedly (in your view) helps speed and correct the misallocation? In my view, the neo-Austrians like Horwitz are aguing that a monetary contraction (delflation) actually exacerbates the situation. You seem to be arguing in your comments above that deflation and market corrections due to misallocation of capital are one and the same. I don’t think this is right.
-in order for a seller/producer to maintain his profits margins, his costs must fall as well as his selling prices. The prices of inputs may not fall immediately and this can squeeze profit margins, leading to unemployment/curtailed production. Hence, the who goes first problem.-
Iwaaks, I think here you get to the crux of the problem. The creation of credit through the artificial manipulation by the Fed, induced producers to increase consumption of resources driving them-up, distorting the structure of production. These resources may have not gone up had interest rates reflected real-demand-and-supply, or people’s time preferences. If the prices of these goods or inputs (labor,capital) have been driven-up during the boom, then it is imperative that the prices for these goods need to come down to reflect the new-demand-supply.
Artificially keeping prices as the FED would like to do, only hampers the recovery. Prices will not clear if they are to remain the same and demand is decreasing.
Those entrepreneurs who ran their business wisely without a heavy debt-load and quickly reacted to supply and demand and thereby adapted their prices, will succeed. Having to cut-back (on Labor, or Capital, or wages) is imperative so as to create the new savings necessary for investment to extend the round-about structure of production and get the economy on the road to recovery.
Why is this site called Mises.org? It should be called Rothbard.org so that those who so foolishly disagree with Mises don’t have to live a lie.
And then maybe someone who actually agrees with Mises on monetary matters can start another site where money cranks don’t praise deflation.
to dick fox:
mises himself invited more study on deflation. give tmc a rest and read some of his other, later stuff. this is from “mises’ suggested research topics: 1950-1968″ by b.b. greaves (on pdf, too).
May 9, 1962
• A history of deflations. There has been a great deal written on inflation, but deflation has received much less attention.
@Dick Fox:
Nobody here is praising deflation, and wish for deflation to continue ad infinitum. (This would be impossible by-the-way, because eventually prices come down to the level it meets demand) Mises and Rothbard were in agreement that the manipulation of credit increases demand for goods and services. Since these prices of have been driven up through distortions of production, it is necessary that these prices come down to meet the new demand.
Let me ask you this: Do you think the U.S. economy would recover more quickly if home prices, food, clothing, cars, etc were to remain at the level they were in 2007….given that demand for these things have decreased.
I think the problem lies in that most people think BECAUSE prices fall it creates less demand, causing a slow down in the U.S. economy. This is something Krugman, probably excepts. Which is contrary to what is happening. This crises was created by the FED manipulating credit markets, which in turn distorted production and caused the malinvestments, which thereby drove prices upwards. These projects that producers undertook could not be maintained or were less productive, because of the false “credit” signals given by the fed. The correction which is the immediate cut back on production is causing the DEMAND to drop, this pushes people out of work. The natural remedy for this cutback is for producers to also cut prices (or deflation) to the point it meets the new demand. You see, deflation is necessary in order for the recovery to begin. If prices remain at 2007 or 2006 levels and demand is falling, how will this help those that have less money to purchase goods and services?
newson,
I agree. Deflation needs much more study and much more literature. What I usually see here is not analysis of deflation but glee that deflation is punishing those evil inflationists.
Misesian (and others),
Let me tell you why I make such an issue of deflation. Deflation is as much or more a problem heaped on an economy as inflation. The negative effects of inflation are more easily seen and Keynesian praise of inflation as a way to “stimulate” the economy is an easy target. Contrary to common economic thought under a true gold standard deflation is impossible as is inflation, but under a fiat currency both are nearly inevitable.
We understand that an inflation will create the boom-bust cycle and the ABCT clearly shows us the results, but what is not seen is the disaster that comes from the deflation that follows the inflation.
The monetary authority seeing the results of inflation attempts to cure it by pulling back on the money supply. Because their indicators are backward looking they always over-shoot. Now because of the Cantillon effect inflation and deflation are not spread equally through the economy. The result is that with a fiat currency we are constantly dealing with the effect of both inflation and deflation at the same time. Some businesses or industries over-expand while others neglect their infrastructure. Suddenly there is over-production in one segment and under-production in another. The monetary authorities attempt to fix the problem by attempting to hit two targets with one arrow. This is impossible and they simply compound the problem. (This can be seen in the conflict the FED has trying to balance inflation and recession)
If there were an honest assessment of deflation it can be demonstrated that the floating currency and Keynesian monetary “stimulation” actually create deflation and the destruction of capital just as does inflation only the method of destruction is different (neglect of infrastructure versus malinvestment) and the economic segments hit are different.
A floating currency is a disaster from all sides.
What of the demand side of the equation? If I have a fixed number of dollars, inflation requires that I have more dollars of buy less. Given the repeated statements on the web and in the press that (2/3?) of the GDP comes from consumer spending. The public is not capable of spending our way out of this crisis. People that live on a fixed income have seen this problem coming for years. Make cheaper cars and we can replace them more often. Less custom houses (exchanged for more mass produced units) and the price of the units decrease due to economy of scale and experience in constructing them.
We make the dollars that we do have in our pockets do more and not less. WE MUST CHANGE OUR ATTITUDES ABOUT WHY WE BUY HOUSES AND CARS. Houses give us places to live and that is all. Give up the idea that housing is an investment. Cars give us modes of transportation and not an increaser of status.
What of the demand side of the equation? If I have a fixed number of dollars, inflation requires that I have more dollars or buy less. Given the repeated statements on the web and in the press that (2/3?) of the GDP comes from consumer spending. The public is not capable of spending our way out of this crisis. People that live on a fixed income have seen this problem coming for years. Make cheaper cars and we can replace them more often. Less custom houses (exchanged for more mass produced units) and the price of the units decrease due to economy of scale and experience in constructing them.
We make the dollars that we do have in our pockets do more and not less. WE MUST CHANGE OUR ATTITUDES ABOUT WHY WE BUY HOUSES AND CARS. Houses give us places to live and that is all. Give up the idea that housing is an investment. Cars give us modes of transportation and not an increaser of status.
Comments on this entry are closed.