Deflation

I’ve written about deflation twice before: Deflation and Deflation 2. Third time’s the charm?

The common wisdom is that deflation of the currency is bad. When money deflates, it becomes more valuable, even when you do nothing. So the theory is that people won’t spend their money, because it will become ever-more valuable.

That theory cannot be true.

Look at the PC market over the last 30 years. In each one of those years, the PC became more reliable, faster, came with more memory and storage. The original MDA display was one color and text only. The CGA had 16 colors and 640×200 bits. The price — of the computer you really want to have — has stayed constant, at about $5000.

If the story told about deflation was true, then you would always be better off delaying your purchase of a PC by 6 months. You could be confident that the PC you would buy would be a more valuable PC.

Except … that people did that very rarely, if ever. The standard advice was always “don’t wait to buy a computer, because there will always be a better computer on the horizon.”

So, in a situation where people can predict a constant stream of increase in value, people STILL made the trade. Thus, I think it’s safe to predict that in a similar situation, where people could predict a constant increase in the value of their money, they would spend their money as needed.

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