I was participating in Stocktwits' MacroTwits discussion last night, when someone brought up the idea that inflationary policies by the Fed were a necessary "cure" for a looming deflation.
Although I've tuned out most of the mainstream discussion on "inflation vs. deflation" and related debates, I have heard and learned enough in the past to know that the fear of deflation is a widespread phenomenon in modern America (and probably throughout the developed world).
Considering the high amounts of debt carried at all levels of our society (personal, government, corporate), this fear is very understandable. Deflation, a decrease in the supply of money and credit, results in an increase in the value of money in circulation.
In a deflation, debtors must pay back loans to their creditors with money that is steadily increasing in purchasing power. The onus is on the debtor to pay back his loan with money that is more valuable than the principle he was originally lent.
Compare this scenario with one of an ongoing inflation, in which borrowers repay their loans with money whose value has steadily eroded over time. A fine deal for the borrower, but not so much for the lender.
Now that we know where our present sympathies lie, and why, let's take a look at Doug Casey's response to these persistent fears of deflation. Here is an excerpt from "Doug Casey: 'Deflation is actually a good thing'":
"Q: Doug, according to a recent article called "The Greater of Two Evils," The Economist recently stated that inflation is preferable to deflation. What is your take on that?
Doug: "...let me get into the article itself. The author points out that inflation is distant and containable while deflation is at hand and pernicious.
Look, in a free-market economy, without central banks and without fractional reserve banking, both inflation and deflation as chronic events are really not possible. In a completely free-market economy, money is just a medium of exchange and a store of value. It is not used as a political football where the supply is pumped up to make people feel that they are richer than they are. It is not created by fiat encouraging people to consume and live above their means. That’s why inflation feels good at first… it makes you feel richer than you really are.
Deflation is actually a good thing, because in a deflation prices drop and money becomes more valuable, so deflation encourages people to save money. Deflation rewards the prudent saver and punishes the profligate borrower. The way a society, like an individual, becomes wealthy is by producing more than it consumes. In other words, by saving, not borrowing. And during a deflation, when money becomes more valuable, everybody wants money. They want to save.
Whereas during an inflation, you want to get rid of the money. You want to consume. You want to spend. But you don’t become wealthy by spending and consuming; you become wealthy by producing and saving.
Inflation encourages people to borrow, because they expect to pay the debt off with cheaper dollars. It encourages people to mortgage their future.
The basic economic fallacy in this is that a high level of consumption is good. Well, consumption is neither good or bad. The problem is the emphasis on consumption financed by debt -- which leads to the national bankruptcy we’re facing. It’s much healthier to have an emphasis on production, financed by savings..."
Related articles and posts:
1. The Imaginary Evils of Deflation - Christopher Mayer at Mises.org.
2. The Anatomy of Deflation - George Reisman at Mises.org
Although I've tuned out most of the mainstream discussion on "inflation vs. deflation" and related debates, I have heard and learned enough in the past to know that the fear of deflation is a widespread phenomenon in modern America (and probably throughout the developed world).
Considering the high amounts of debt carried at all levels of our society (personal, government, corporate), this fear is very understandable. Deflation, a decrease in the supply of money and credit, results in an increase in the value of money in circulation.
In a deflation, debtors must pay back loans to their creditors with money that is steadily increasing in purchasing power. The onus is on the debtor to pay back his loan with money that is more valuable than the principle he was originally lent.
Compare this scenario with one of an ongoing inflation, in which borrowers repay their loans with money whose value has steadily eroded over time. A fine deal for the borrower, but not so much for the lender.
Now that we know where our present sympathies lie, and why, let's take a look at Doug Casey's response to these persistent fears of deflation. Here is an excerpt from "Doug Casey: 'Deflation is actually a good thing'":
"Q: Doug, according to a recent article called "The Greater of Two Evils," The Economist recently stated that inflation is preferable to deflation. What is your take on that?
Doug: "...let me get into the article itself. The author points out that inflation is distant and containable while deflation is at hand and pernicious.
Look, in a free-market economy, without central banks and without fractional reserve banking, both inflation and deflation as chronic events are really not possible. In a completely free-market economy, money is just a medium of exchange and a store of value. It is not used as a political football where the supply is pumped up to make people feel that they are richer than they are. It is not created by fiat encouraging people to consume and live above their means. That’s why inflation feels good at first… it makes you feel richer than you really are.
Deflation is actually a good thing, because in a deflation prices drop and money becomes more valuable, so deflation encourages people to save money. Deflation rewards the prudent saver and punishes the profligate borrower. The way a society, like an individual, becomes wealthy is by producing more than it consumes. In other words, by saving, not borrowing. And during a deflation, when money becomes more valuable, everybody wants money. They want to save.
Whereas during an inflation, you want to get rid of the money. You want to consume. You want to spend. But you don’t become wealthy by spending and consuming; you become wealthy by producing and saving.
Inflation encourages people to borrow, because they expect to pay the debt off with cheaper dollars. It encourages people to mortgage their future.
The basic economic fallacy in this is that a high level of consumption is good. Well, consumption is neither good or bad. The problem is the emphasis on consumption financed by debt -- which leads to the national bankruptcy we’re facing. It’s much healthier to have an emphasis on production, financed by savings..."
Be sure to read the full piece and pass it along to your friends and colleagues. If you'd like a more scholarly read on the Austrian economists' view of deflation, please refer to the articles in our footnotes below.
Related articles and posts:
1. The Imaginary Evils of Deflation - Christopher Mayer at Mises.org.
2. The Anatomy of Deflation - George Reisman at Mises.org