It’s an exciting time to be alive, boys and girls. Our economy is in trouble and it’s our generation’s job to figure it all out before things get (really) nasty. Luckily for you, here at Search for Solid Ground we work through the misinformation and competing ideologies to bring you the facts you need to keep your knowledge bank safe from the barbarism of the orthodoxy. So let’s leapfrog past the mainstream media mumbo-jumbo and crack open the true dimensions of our currency crisis.
You’ve heard by now about the “deflation threat”, and why we need inflationary monetary policy to keep us free and clear of it. Well, the truth is far more sinister: there is no deflation threat – it’s a straw man used by the government to keep us blind to the real menace, the ruinous inflationary policies used to fund government spending while depleting the dollar’s purchasing power. Even worse is how government actively hoodwinks the populace by misinforming us with goofed-up statistics on the inflation rate, which in turn masks the full extent of the dollar’s plummeting value. If we let the process continue, Americans will see their generations of accumulated wealth vanish in a matter of years.
To begin, let us define inflation and deflation by taking a page out of the Austrian playbook. Whatever your qualms with the Austrian School, you’ll have to admit they might be onto something when they insist that to define inflation (and deflation) in terms of the price level is to confuse the symptoms with their cause. Instead, Austrians prefer to define inflation/deflation as expansion/contraction of the money supply relative to the total amount of goods and services. Expanding the money supply when the supply of goods/services remains unchanged raises prices – or, as we often observe, keeps prices level when they should be falling.
The distinction between causes and symptoms is important because it reveals the arbitrary nature of price. A given price level is the natural result of how much money is in play relative to what can be purchased with that money, and thus it is counterproductive to speak of a “target” price level in the context of monetary policymaking; prices reflect what an economy is capable of producing at a given moment in time.
Consider a Fed spokesman’s advocacy for “price stability”. It is necessary to keep prices level, he reasons, because the alternative – prices that drop in step with productivity gains – would lead to some kind of disaster. The Great Depression, he reminds us, was caused in part by deflation. Businesses, he cries, would fail en masse if prices fell! ”Gentle”, “natural” inflation at a rate of 2% to 3% a year is the necessary preventive medicine for keeping such ailments at bay. Never mind the bitter aftertaste of rising consumer prices; Deflation Fever is much, much worse!
In truth, there isn’t anything natural (or necessary) about inflating the money supply at regular intervals. That all-too-familiar gag reflex brought on by rising costs of living is your brain’s natural response to seeing your dollars artificially cheapened and its holder made unnecessarily poorer. ”Controlled” inflation isn’t an antidote: it’s a poison.
Deflation, on the other hand, is only ever a real threat when demand disappears completely due to a collapse of income – one of the symptoms (not a cause!) of the Great Depression. In all other cases, demand necessarily exists at some price level; if incomes fall relative to consumer prices, then those prices fall to reflect supply that outpaces demand. Goods, now cheaper, again become affordable as a reflection of market forces. Those who argue that this somehow hurts business owners (in turn weakening their ability to employ, invest, and produce) are forgetting that profitability is about margins – and margins remain constant as costs and prices fall together. (One could even argue that falling prices often reflect in increased sales, which in light of constant margins, often lead to greater profits.)
Here’s a happy truth about market economies: successful producers who cover their costs, achieve economies of scale, and streamline their operations are able to lower their prices, increase sales, and make larger profits. Meanwhile, consumers benefit from this rise in productivity by seeing lowered costs of living. Without a central bank to increase the money supply, the money supply stays constant while the amount of goods and services increases; deflation results, forcing prices down. It was deflation during the Industrial Revolution that allowed Americans to upgrade from candles to electric lights, and deflation today that lets us buy flat-screen TVs at a fraction of the price they were a few years ago. In fact, deflation has been the hallmark of our economic success: between 1780 and 1913, prices consistently fell – sometimes, sharply – while living standards steadily improved (an exception being the Civil War era, when the introduction of paper money jacked up prices – effects that quickly wore off when the new money was taken out of circulation.)
But wait! In today’s dire economic times, when the balance sheets of our nation’s largest credit institutions are being torn apart by loan defaults and toxic assets, unimaginable quantities of wealth are disappearing as defaults pile up! Surely this will lead to uncontrollable deflation that must be countered with inflationary monetary policy!
While it is true that defaults on loans indeed contract the money supply, this has clearly been offset by the creation of new dollars; it’s hard to deny that our economy has seen net expansion of the money supply when consumer prices continue to outpace increases in purchasing power. Beyond this, the loans that went into default weren’t intended to increase productivity in the first place – most of them went to fund consumption – so to let that bubble money evaporate is akin to letting imaginary wealth go back to being imaginary. However, even if this was a case of productive loans going bad and not simply market corrections zapping away asset bubble cash, I’m not convinced that inflationary policies are the answer. If it were true that the negative effects of defaulted loans could be made up for by the printing of new dollars without a net loss to society, then there would be no need to monitor a potential debtor’s creditworthiness – the bad loans could simply be made up for by the central printing press. But the reality is that loans (and new dollars meant to replace those loans) must go toward goods produced; otherwise, there’s nothing to give the money value.
So why do we hear so much about the “threat” of deflation, and the need to counter this threat through inflationary measures executed by the Federal Reserve and other central banks? And how, as I have claimed, does the government mask the extent of its actions from the public?
At the risk of sounding “conspiratorial”, I invite you to consider the government’s role as an agent of misinformation on this topic. Let us begin by examining how government benefits from inflation.
From the very start, the money that the central bank creates is “spent” into circulation by the government; the government alone has the power to control how those dollars enter the economy. Oftentimes, this means using the money for public services, thereby circumventing the need to tax or otherwise appropriate existing public funds, both of which can be uncomfortable for politicians. By pursuing inflationary policies and misleading the public about the impact, the government gets away with printing new money to fund the many unfunded liabilities and public welfare programs that voters love – all without raising a single tax. This, of course, is why many consider inflation to be an insidious form of taxation in its own right: artificial inflation prevents productivity gains from lowering consumer prices, robbing the populace of rising living standards in order to prop up government spending habits.
Furthermore, since the government is the world’s biggest debtor, it is not difficult to argue that the government is also the world’s biggest beneficiary of inflation. After all, inflation allows the government to repay its (considerable) debts with cheaper currency.
And let’s not forget that higher prices mean a higher GDP, creating the feel-good illusion that economic progress is being made. (The silliness behind this thought process helps reveal one of the many reasons GDP statistics are unreflective of economic health – a discussion for another time, perhaps.) Meanwhile, asset prices rise, fooling people into thinking that their stocks and real estate are appreciating in value. In this sense, inflation is government’s opiate to the masses.
Inflation also generates tax revenue for the government. When real estate appreciates, for instance, the government sees returns via the capital gains tax; meanwhile, some of those fortunate enough to see their income rise with inflation see themselves pushed into a higher income tax bracket.
In short, there are a whole host of reasons that the government benefits from inflation, none of which – presumably – are lost on the decision-makers in control of the printing press.
More complex is the notion that government actively obfuscates the true level of inflation from the public by promoting specious statistics like the CPI, PPI, and PCE. I urge readers to look more into why these and other indices, commonly relied upon to gauge inflation, in fact do much to mask the true extent of inflation’s effect on living costs. This blogger provides a worthy introduction to the topic by taking a look at how government molds the CPI to project a make-believe depiction of the economy in which prices are rising at a far slower rate than they are in reality. A more complete discussion of these flawed indices are, sadly, beyond the scope of this post. (Also, my typing muscles need a break.)
In conclusion: neither inflation nor deflation is inherently bad, except when a central authority artificially induces one or the other. Politicians and their allies benefit from inflationary policies, and scare up deflationary threats in hopes of legitimizing their harmful policies. Meanwhile, they hide the true extent of inflation from the public by touting flawed indices and framing conversations in terms of those indices.
So where does this all leave us? Well, here’s what we’re seeing today: asset prices, especially in real estate and dollar-bound stocks, are continuing to fall while consumer prices continue their rise – leading to the destruction of purchasing power for Americans whose costs of living are increasing even while their wealth holdings in stocks and home equity are losing air. I’m speaking, of course, in dollar terms. In gold terms, both asset and consumer prices are dropping through the floor; consumer prices are simply falling far slower than asset prices (which were artificially high thanks to inflation-induced asset bubbles, but are now rapidly tanking).
By distinguishing between gold and dollar prices, a key point becomes clear: if a trigger-happy printing press continues driving down the value of the dollar, Americans (whose wealth is captive in dollars, not gold), will see costs of living dramatically lowered in real terms relative to producers and consumers abroad. However, the dollar-bound American will be unable to capitalize on any of these falling prices, as his paper money will be losing value even faster. Any deflation in real terms will be masked by skyrocketing inflation in dollar terms.
This leaves us at the doorstep of the Big Question: what is the present condition of our economy, and where might we end up if we stay the current course? I invite you to ponder these and other matters as I prepare my next post.
Search for Solid Ground 