I’ve never really got why a gradual deflationary bias was a problem. Consumers know, for example, that just about any electronic good (computers, plasma screens etc) will get cheaper in the future, yet this does not seem to stop them from being made and bought. The fact that only those people who really really want the good will buy it and those are no so enthused will wait until it gets cheaper does not seem to stop business from making money.
If it was conspicuous consumption fueled by debt (and an inflationary bias) that got us into this mess, then would not a system with a deflationary bias be the solution? It has a built in frugality: your money will have more purchasing power in the future, so only buy today what you actually need. People would also only want to take on debt if they were actually going to be productive/efficient rather than just trying to bubble up asset prices. Now maybe if we can convince Greenies that a Gold Standard would work against consumerism and thus be good for the planet, we’ve got a chance.
The above thoughts were prompted by these comments left at this article Gold Standard … Debunked or Another Bubble?:
Dirk, on November 24, 2008 at 12:58 pm, said:
I’m happy someone gets it- that constraining global economic activity based on a single metal that doesn’t really correlate to economic activity makes no sense.
Clearly, the gold standard is deflationary in absence of either major gold finds, or major negative economic shocks. More goods and services chasing a fixed money pool will create massive downward pressure on prices. And downward pressure on prices and assets equals lower incentives for investment, more difficulty paying off debt, and a negative wealth effect that creates real economic stagnation.
Inflation, on the other hand, creates pressure to invest money- not hoard it. As long as a currency promises a future redemptive power, it will keep its value. Perhaps fixing currency values to a “total energy” metric- the sum of all oil, coal, gas, solar, nuclear, etc. reserves- would allow for both economic growth and a guarantee of some future redemptive power for something really useful.
16 Stanley Pinchak, on November 25, 2008 at 2:03 pm, said:
Wow so much muddled thinking in one place. It is amazing that my browser didn’t pop up a warning.
1) Any stock of money sufficient to be accepted by the public as a money and selected as the medium of exchange is capable of serving as money. There is no need to grow the stock of money. Despite this false criticism, the gold stock does grow at a predictable (by mining engineers) and low rate between 1% and 3% per year.
2) The purchasing power of a money is related to the stock of money and the demand for money. Its purchasing power is also related to the supply and demand for all other goods in society for which it is exchanged. Thus as productivity increases, the purchasing power of a stable or slowly increasing money will increase. This has the effect of making daily expenses of those with debts easier to bear.
The only time a debt would become harder to pay off would be if the debtor was in a field of employment where his pay decreased in line with the increase in purchasing power of money. This might be a possibility, but at the same time that human actors today judge their debt burdens based on future expectations of income, those operating under a regime of increasing purchasing power of money would be capable of determining their expected future debt load capabilities. Those who guess wrong in such a situation are no different than those who bite off more debt than they can chew under our inflationary regime.
The biggest improvement that increasing purchasing power has is for savers and those on fixed incomes. Savers would earn interest + the difference in purchasing power between when they started saving and when they start consuming. This is the opposite of today where the difference in purchasing power subtracts from the interest and reduces the incentive to save. This will have the effect of greatly encouraging saving and the stock of loanable funds, driving interest rates to natural and sustainable low levels. This will benefit the saver/consumer in the future as well as the entrepreneur and the durable good consumer in the present.
Inflation on the other hand encourages debt based financing. It favors instant gratification, but since there are fewer savers since debt is the preferred method of financing, the purchases of today are not sustainable. The increase in consumption fueled by new money is not fully offset by the preferences of a ever shrinking class of savers who abstain from present consumption. This results in a business cycle like we see continuously under a system of bank credit expansion (ex nihlo). Inflation encourages capital consumption and not investment as Dirk claims. Empirical evidence of this is present in the dilapidated factories and rotting machinery of the American Rust Belt.
3) All business cycles (as in repeated and not caused by something like war or famine) are the result of fractional reserve banking and its concomitant ex nihlo credit expansion. There can be no stable and sustained economic growth under a fractional reserve banking regime. There will always be over-expansion combined with malinvestment, and and then retrenchment as the bad investments are liquidated. Attempting to tie a money to a commodity standard while maintaining a fractional reserve banking system is unsustainable. There will inevitably be calls for the creation of a central bank and lender of last resort as the bust causes bank runs.
The only viable solution is to realize that fractional reserve banking on demand deposit money is clearly a case of conflicting views of a contract and thus an untenable and invalid contract. How can a depositor demand a physical object which the banker (rightly?) assumes is lent to him for his purposes. A physical object must have a clear owner and can not be subject to control simultaneously by two parties of differing opinion under which direction to place the object. Thus demand deposits must be maintained in a warehouse fashion with 100% reserve maintained at all time. This eliminates the possibility of a bank run (in the historical sense and in the practical sense of potential damage to the depositor). Furthermore by limiting bank loans to funds deposited in time accounts (i.e. true saving) there will cease to be a business cycle.
4) The idea of a world central bank is superfluous with a free monetary system and 100% reserve banking. The main purposes of the central bank are to ease governmental expansion and to act as a lender of last resort. A world central bank will only lead to world bureaucracy. If banking is on a firm economic and legal foundation, there is no need for a lender of last resort. A world central bank is only an excuse for the establishment of world government. It can not prevent world wide business cycles while maintaining a fractional reserve banking system. Furthermore, if it maintained a 100% reserve banking system, it would still be subject to political considerations in open market operation and would still cause misallocations of resources, though not of the intertemporal kind as explained by the business cycle theory. The misallocations would result in privileged borrowers being able to bid resources from those who obtain the increase in the money supply last.
5) The myth that a gold standard would limit growth is preposterous. One of the greatest periods of economic (and population) expansion was obtained under a gold standard and under a period of increasing purchasing power of money (Cf. the 19th century). There is no theoretical nor physical restriction on the growth of economy based on a sound monetary system besides the subjective actions of individuals to save which allows for the implementation of longer and more productive production techniques.
The claim that unemployment is higher under a gold standard is also ridiculous. All non voluntary unemployment is the result of artificial restrictions on the movement of labor or its price. One must be careful not to make the mistake of comparing the unemployment rates of a central bank and fractional reserve banking boom period to an average or bust phase unemployment rate under the fractional reserve banking system which has persisted in the United States prior to its inception. Under a free market, all labor wishing to be employed will be. All state intervention attempting to reduce the ranks of the unemployed can only be obtained by reducing the well being of other actors in the economy. As such interventionist attempts to reduce unemployment, though they may increase productivity (doubtful), will not be optimal as compared ex ante in terms of the satisfaction of wants of all economic actors. On utilitarian and natural rights grounds, state intervention in the labor market is counterproductive, misguided, and should be avoided.
6) The idea that there is not enough gold to back all of the fiat currencies of the world is the most foolish statement of all. Logically one can take the stock of gold available and divide it by the weighted sum (by exchange rate) of the currencies of the world. This could provide backing for every single dollar, ruble, yen, etc. However, this is a bad policy, for the market should be left free to choose its own money, it should not be instituted from on high via state decree or central bank policy.
All that needs to be done is to eliminate legal tender laws and taxes on market selected monies. Since we have several thousand years of history showing that Gold and Silver are typically selected as money, we should start by eliminating taxes on them. If there is a push for a different medium of exchange, it should be treated in the same fashion. At the same time, all fractional reserve demand deposit banking must be subjected to traditional legal principles regarding property rights.
This means a reversion to 100% reserve banking. From these two changes, the market will perform the transition to a sound money with the minimum disruption and transfer cost. A state imposed system can only result in higher costs, as well as a retention of particular privileges for the state, most commonly in the form of a central bank, liable to interfere in the money supply through open market operations and subject to the political whims of demagogues.
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I vote for Ralph Borsodi’s idea of money known as the “Constant” from the 1970’s. A mini index of 30 commodities with all of them listed on the back of the note.
http://www.scribd.com/doc/13266703/3-09-Ralph-Borsodi-Constant-Currency
Otherwise I agree with Bron, just let the air out of the tires, the economy will still run…sans bubbles.
Mark
In many people’s minds deflation is associated with falling prices for a representative basket of goods. Although this definition is incorrect, for brevity most people continue to call this deflation, which in reality is CPI or Consumer Price Index as reported by US Government. The true definition of deflation is contraction in money supply as represented by M0 through Mn aggregates published by the Federal Reserve, plus credit outstanding (or simply debt). Credit accounts for anywhere between 90 and 95% of total “money” in today’s economy out there. It is also a fact that most of the mass media in today’s world is owned by multinational corporations that also control the politicians in the Government, and so no impartial opinion on the issue of inflation/deflation should be expected to come from the talking heads’ mouths. And then there is the Federal Reserve bank, the FED, that ostentatiously proclaims as its main goal as price stability and inflation targeting. A critically thinking person will observe, however, the the FED is the only source of inflation in US economy, so it seems it is fighting to maintain price stability with one hand, while issuing massive amounts of money with another. In fact, since the FED was created in 1913, the US dollar lost 96% of its value due to FED’s policy of “price stability”. There is nothing stable in continuously rising prices that erode wages and savings.
The media and the Government officials go on almost daily rounds of spooking us, the docile populace, about the dangers of deflation. Their main argument being that if deflation were allowed to take hold then it would lead to wage/price downward spiral and economic contraction. A typical “warning” about dangers of deflation would run something like this as described in Paul Krugman’s writings on MIT’s website. Krugman coincidentally won Nobel Prize in economics for his gargantuan works in this field. Here is a sample of his brilliant work in his now famous piece CAN DEFLATION BE PREVENTED?:
…
Deflation, not inflation, is now the greatest concern for the world economy.
..
Yet here we are, with deflation turning out to be a serious problem after all – and with policymakers finding that it is not as easy either to prevent or to reverse as we all thought.
And so on. If you read the news, you will find unending examples of news with similar verbiage.
Now we need to stop and think, who benefits from inflation and who benefits from deflation and who is concerned almost to point of self-induced panic attack that inflation is not getting any traction. While we don’t know the precise names of individuals in a position of high power of business and finance, we know this one principle of life for sure: If something is good for them they will stop at nothing to making sure it happens and they be the first to reap the benefits of it, which in this case is inflation. That is so because they run ahead of the curve by printing money, then buying up assets on the cheap and then selling it to the public when the prices have risen du to increased supply of funds. That is why it has been the policy of the Federal Reserve since inception to making sure inflation is perpetuated. As it has just been stated the ones that print the money are ahead of the curve, meaning that the rest of us who don’t print money (or extend credit) are behind. And while wages are rising during inflation they are rising behind and slower than the prices, thus making the wage earners and borrowers always find themselves in a position of needing either to work harder and more or borrow more to pay off previous debts. Now that is an exciting economic model, is not it? Not unless you own the printing press.
In short, according to these guys, rising prices that erode your purchasing power is somehow a good thing. You better believe it.
Of course, a sensible individual that has to work for his or her money, rather than printing it, which is an illegal practice called counterfeiting, would shrug from the idea of getting excited from sinking deeper and deeper into poverty.
And here comes deflation to the rescue. Deflation that is properly defined as a contraction in money supply that occurs, for example, when debts and credits that were used to bid up asset prices begin to be defaulted or liquidated. That in turn leads to decrease in CPI through lower prices for production input components, which is what most consumers care about in their daily needs.
If a gallon of gas goes down from $4 to $2 in a matter of months, as it happened in the second half of 2008 in USA, this is a very good thing and every consumer understands it and feels it. This is rational and desired. But not so fast. If you were to listen to the news media propaganda, you are almost committing a heinous crime by buying gas at 50% discount, because according to them that will lead to wage/price downward spiral and the monsters of deflation will eat everybody. Of course, now that we know who produces and benefits from inflation and increasing CPI, we can discern dishonesty when it is heard from commentators and “experts” screaming at the top of their lungs DANGER, DEFLATION, RED ALERT, RUN, HIDE. And to stop deflation they are throwing trillions of both tax payer and printed dollars at the problem not understanding that in an economy that has reached its insane speculative bubble top in almost every asset class the only way is down. Way down, until asset prices get back in line with individuals’ incomes and ability to pay for them.
Ben Bernanke and his buddies don’t understand or don’t care to understand and admit that monetary manipulations will not bring back demand. We are now experiencing a DEMAND DEFLATION in everything. The sub-prime real estate buyers are not coming back to market, and the credit worthy borrowers are not going to get into debt any time soon to support the speculative bubble blowing any longer. We don’t need to “unfreeze lending” if nobody wants to borrow (while assets are depreciating). Mr. Bernanke somehow believes that he can magically circumvent creating economic product, which is always based on labor and goods it produces, by just hitting a button on his computer to add a few zeros to FED’s account in a coup of counterfeiting. This illegal act does not provide employment to anyone except Mr. Bernanke and does not result in any economic product on the other end of this labor intensive operation. His academic theories, being tested on live human beings, will be proven wrong and disastrous soon enough. The prices will go where they naturally want to go. All FED can do is slow the process of decline, not arrest it – and that will only prolong this recession that has all the underpinnings of becoming another Great Depression.
National Deflation Association wholeheartedly and vigorously endorses deflation and the benefits of lower prices that it brings to the common person.
- NDA executive committee.