Wednesday, August 11, 2010

The Deflation Mind Trick

Words are so cheap but they can turn out expensive
Words like conviction can turn into a sentence
--General Public

Propaganda claiming that inflation is good and deflation is bad has been around a long time. It is misleading for a number of reasons.

One is that it distorts the meaning of inflation and deflation. Classically defined, inflation is an increase in quantity of money and credit while deflation is a decrease in the quantity of money and credit. Modern definitions deflect attention away from quantity, which is something that bureaucrats perpetually want to increase, to price, something that may or may not change immediately with a change in monetary quantitiy. As such, we fixate on whether metrics like the consumer price index go up and down, and by how much. All the while, the real focus should be on money and credit quantity. A neat Jedi Mind Trick...

Next, consider the condition likely to prevail in an unhampered economy. In an unhampered economy, no central bank or other entity intervenes to create more paper currency. What is likely to happen when the quantity of money stays relatively constant yet economic output increases over time due to productivity improvement? The natural condition is for prices to decline (constant money spread across more goods means lower $/good). This is the opposite of what we've been conditioned to believe. We're told that a 'little' inflation is a good thing for long term prosperity. Of course, it has been that 'little' inflation that has devalued the USD by about 97% over the past 100 yrs.

Finally, considered the sequence of events that motivate the business cycle in a hampered economy. Policymakers, for political reasons, prefer to expand the money supply. This inflation motivates a boom, as borrowers gorge on cheap money and credit. At some point, however, the optimism hits an extreme and people decide they have overdone it. At that point, the inflation peaks. Subsequently, people begin to dial back. They borrow less, save more, and poorly chosen projects funded with credit default. This is deflationary.

In a hampered economy, inflation cannot last forever. This is much to politicians' chagrin; they are likely to try to perpetuate inflation with every tool at their disposal. At some point, however, the mountain of debt that builds under inflationary regimes is likely to sink under its own weight despite interventionary efforts.

In a hampered economy, deflation counterbalances inflationary excess.

position in USD

1 comment:

dgeorge12358 said...

     
“If Americans ever allow banks to control the issue of their currency, first by inflation and then by deflation, the banks will deprive the people of all property until their children will wake up homeless”
~Thomas Jefferson