“Experts” Assert that Inflation is an Agent of Economic Growth

For most experts, deflation, which they define as a general decline in prices of goods and services, is bad news since it generates expectations for a further decline in prices.

 

PigUmbrellaIllustration via dailyreckoning.com

 

As a result, they hold, consumers postpone their buying of goods at present since they expect to buy these goods at lower prices in the future. This weakens the overall flow of spending and in turn weakens the economy.

Hence, such commentators hold that policies that counter deflation will also counter the slump. If deflation leads to an economic slump then policies that reverse deflation should be good for the economy.

 

1-Purchasing Power of the BuckThis is a chart we have shown before. While acknowledging that it is simply not possible to measure the so-called “general level of prices” (no such thing exists), money certainly possesses purchasing power which is subject to constant change (this principle is valid regardless of what is used as money, even though some types of money, such as e.g. gold, are obviously more stable than others). Deflation as defined by the mainstream (i.e., “price deflation”) is the one thing that practically never happens under a fiat money standard. In fact, the Fed was only confronted with it twice in its history, even during  the  time when a bastardized version of the gold standard was still in place. It is fair to say that ever since the central bank has been established, the purchasing power of the dollar has been in near continuous collapse, with only the momentum of the decline occasionally changing. The fact that central bankers and a plethora of economists is actually worried about “deflation” is one of the most bizarre spectacles of modern times – in more than one respect – click to enlarge.

 

Reversing deflation would imply introducing policies that support general increases in the prices of goods, i.e., inflation. This means that inflation could actually be an agent of economic growth.

According to most experts, a little bit of inflation can actually be a good thing. Mainstream thinkers are of the view that inflation of 2% is not harmful to economic growth, but that inflation of 10% could be bad news (indeed the Fed’s inflation target is 2%).

Thus, we can conclude that at a rate of inflation of 10%, it is likely that consumers are going to form rising inflation expectations.

According to popular thinking, in response to a high rate of inflation, consumers will speed up their expenditure on goods at present, which should boost economic growth.

So why then is a rate of inflation of 10% or higher regarded by experts as a bad thing? Clearly there is a problem with the popular definitions of inflation and deflation.

 

Inflation is Not Essentially a Rise in Prices

Inflation is not about general increases in prices as such, but about the increase in the money supply. As a rule the increase in money supply sets in motion general increases in prices. This, however, need not always be the case.

 

2-TMS-2An increase in the money supply is a necessary precondition for “price inflation” – but the ceteris paribus qualifier is very important, since prices are not only influenced by the supply of money, but also the demand for money, as well as the supply of and demand for goods and services. This is incidentally one of the reasons (in fact, the major one) why measuring the “general level of prices” is literally impossible: there exists no constant which can be employed in the measurement – click to enlarge.

 

The price of a good is the amount of money asked per unit of it. For a constant amount of money and an expanding quantity of goods, prices will actually fall.

Prices will also fall when the rate of increase in the supply of goods exceeds the rate of increase in the money supply. For instance, if the money supply increases by 5% and the quantity of goods increases by 10%, prices will fall by 5%, ceteris paribus.

A fall in prices in this example cannot conceal the fact that we have an inflation of 5% here on account of the increase in the money supply.

 

Rising Prices Aren’t the Main Problem with Inflation

The reason why inflation is bad news is not because of increases in prices as such, but because of the damage inflation inflicts to the wealth-formation process. Here is why.

The chief role of money is to fulfill the role of the medium of exchange. Money enables us to exchange something we have for something we want.

Before an exchange can take place, an individual must have something useful that he can exchange for money. Once he secures the money, he can then exchange it for a good or goods he wants. Note that by means of money we have here an exchange of something for something.

But now consider a situation in which money is created out of “thin air” — this is precisely what the counterfeiter does. This type of money sets the platform for an exchange of nothing for something.

The counterfeiter exchanges the printed money for goods without producing anything useful. The counterfeiter takes from the pool of real goods without making any contribution to the pool.

The economic effect of money that was created out of thin air is exactly the same as that of counterfeit money — it impoverishes wealth generators. The money created out of thin air diverts real wealth toward the holders of new money. As a result, less real wealth is left to fund wealth-generating activities.

This in turn leads to a weakening in economic growth. Remember only wealth generating activities can generate wealth and hence grow an economy.

Note that as a result of the increase in the money supply what we have here is more money per unit of goods, and thus, higher prices. What matters, however, is not price rises as such but the increase in the money supply that sets in motion the exchange of nothing for something or “the counterfeit effect.”

The exchange of nothing for something, as we have seen, weakens the process of real wealth formation. Therefore, anything that promotes increases in the money supply can only make things much worse.

So while inflation is an increase in the money supply, deflation is a decrease in the money supply. We have seen that increases in the money supply, i.e., inflation gives rise to various non-productive activities, which we can also call “bubble activities.”

 

3-TMS-2 vs- stocksMoney TMS-2 vs. the stock market (S&P 500 Index). Stocks are titles to capital, and as such tend to be particularly sensitive to monetary inflation. Note however that a rise in stock prices on account of monetary pumping is not a “sure thing” either. Still, we can certainly state that the huge and rapid surge in aggregate market capitalization in recent years is one of the symptoms of “bubble activities” caused by money supply expansion – click to enlarge.

 

Easy-Money Policies Divert Resources to Non-Productive Activities

Because these activities cannot stand on their own feet (they require the diversion of wealth from wealth generators) the increase in bubble activities on account of increases in the money supply weakens wealth generators’ ability to generate wealth.

Hence, loose monetary policies aimed at countering a fall in prices (i.e., fighting “deflation”), do nothing more than provide support for non-productive activities. Such policies can produce the illusion of success as long as there are enough wealth generators to fund non-productive activities.

For instance, in a company of 10 departments, 8 departments are making profits and the other 2 losses. A responsible CEO will shutdown or restructure the 2 departments that make losses.

Failing to do so will divert funding from wealth generators toward loss-making departments, thus weakening the foundation of the entire company. Without the removal, or restructuring, of the loss-making departments there is the risk that the entire company could eventually go belly up.

From this simple example we can deduce that once the percentage of wealth-generating activities falls sharply there will not be enough wealth to support an expansion in economic activity. The economy then falls into a prolonged slump. Under these conditions, the more the central bank tries to fix the symptoms, the worse things become.

Once, however, non-productive activities are allowed to go belly-up, and the sources of the increase in the money supply are sealed off, one can expect a genuine, real-wealth expansion to ensue. With the expansion of real wealth for a constant stock of money, we will have a fall in prices.

 

Conclusion

Note whether prices fall on account of the liquidation of non-productive activities or on account of real-wealth expansion, it is always good news. In the first case, it indicates that more funding is now available for wealth generation, while in the second case, it indicates that more wealth is actually being generated.

The major threat to the economy then is not deflation but policies aimed at countering it.

 

Charts by: St. Louis Federal Reserve Research

 

Chart and image captions by PT, emphasis in text added by PT

 

This article appeared originally at www.mises.org

 

Dr. Frank Shostak is an Associated Scholar of the Mises Institute. His consulting firm, Applied Austrian School Economics (AASE), provides in-depth assessments and reports of financial markets and global economies. He received his bachelor’s degree from Hebrew University, master’s degree from Witwatersrand University and PhD from Rands Afrikaanse University, and has taught at the University of Pretoria and the Graduate Business School at Witwatersrand University.

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “Deflation Is Always Good for the Economy”

  • There are 3 purposes for inflation. One is to keep the money flowing to the bankers. The compound interest equation breaks down without it. Second is to continue to government fleecing game. The third is to keep the stock market inflated so the wealthy and Wall Street can sell stocks at high prices. The poor don’t own stocks and the middle class rarely play in deflated markets. Only when their buddies appear to be getting rich in bull markets.

    I seriously doubt people postpone purchases, waiting for lower prices. Lower prices come for 2 or 3 reasons. Imbalance in the process of production, the consumer being under compensated, thus providing temporary windfalls to the businesses involved. Lower prices restore the balance. In recent years, consumer credit has made up the difference and the bulk of consumers are either indebted or tapped out.

    The other reason is productivity and innovation. When the computer boom hit, there were 2 kinds of consumers, those that had to have the latest model and those that waited for an even better one. If you had to have a new computer, it didn’t matter. The iPhone is a recent example. A new one comes out and some people rush to get it, regardless of whether they need a new phone or not. The next guy might just wait for the next issue and limp his current model along.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Speculative Blow-Offs in Stock Markets – Part 1
      Defying Expectations Why is the stock market seemingly so utterly oblivious to the potential dangers and in some respects quite obvious fundamental problems the global economy faces? Why in particular does this happen at a time when valuations are already extremely stretched? Questions along these lines are raised increasingly often by our correspondents lately. One could be smug about it and say “it's all technical”, but there is more to it than that. It may not be rocket science, but...
  • Speculative Blow-Offs in Stock Markets – Part 2
      Blow-Off Pattern Recognition As noted in Part 1, historically, blow-patterns in stock markets share many characteristics.  One of them is a shifting monetary backdrop, which becomes more hostile just as prices begin to rise at an accelerated pace, the other is the psychological backdrop to the move, which entails growing pressure on the remaining skeptics and helps investors to rationalize their exposure to overvalued markets. In addition to this, the chart patterns of  stock indexes...
  • India: Still the Fastest Growing Large Economy?
      India’s Currency Ban - Part X It has now been four months since Narendra Modi declared about 86% of monetary value of currency illegal. Linked here is the last in my series of updates, which was written soon after the deadline to deposit the demonetized currency. Most of the banned currency was eventually deposited, making a mockery of Modi, who had claimed that unaccounted money would not reach the banks.  Perhaps 3% of the cash never reached the banks.   A cunning plan...
  • Gold Sector: Positioning and Sentiment
      A Case of Botched Timing, But... When last we wrote about the gold sector in mid February, we discussed historical patterns in the HUI following breaches of its 200-day moving average from below. Given that we expected such a breach to occur relatively soon, the post turned out to be rather ill-timed. Luckily we always advise readers that we are not exactly Nostradamus (occasionally our timing is a bit better). Below is a chart of the HUI Index depicting the action since the January...
  • They're Worried You Might Buy Bitcoin or Gold - Precious Metals Supply and Demand
      Bitcoin Mania The price of gold has been rising, but perhaps not enough to suit the hot money. Meanwhile, the price of Bitcoin has shot up even faster. From $412, one year ago, to $1290 on Friday, it has gained over 200% (and, unlike gold, we can say that Bitcoin went up — it’s a speculative asset that goes up and down with no particular limit).   Bitcoins are a lot less tangible than this picture implies, but they are getting a lot of love recently...
  • Welcome to Totalitarian America, President Trump!
      Trump vs. the Deep State If there had been any doubt that the land of the free and home of the brave is now a totalitarian society, the revelations that its Chief Executive Officer has been spied upon while campaigning for that office and during his brief tenure as president should now be allayed.   Image adapted from the cover of “Deep State #5” - depicting an assassin from the future   President Trump joins the very crowded list of opponents of the American...
  • Boosting Stock Market Returns With A Simple Trick
      Systematic Trading Based on Statistics Trading methods based on statistics represent an unusual approach for many investors. Evaluation of a security's fundamental merits is not of concern, even though it can of course be done additionally. Rather, the only important criterion consists of typical price patterns determined by statistical examination of past trends.   Fundamental considerations such as the valuation of stocks are not really relevant to the statistics-based trading...
  • The Long Run Economics of Debt Based Stimulus
      Onward vs. Upward Something both unwanted and unexpected has tormented western economies in the 21st century.  Gross domestic product (GDP) has moderated onward while government debt has spiked upward.  Orthodox economists continue to be flummoxed by what has transpired.   What happened to the miracle? The Keynesian wet dream of an unfettered fiat debt money system has been realized, and debt has been duly expanded at every opportunity.  Although the fat lady has so far only...
  • Why the 21st Century Sucks - Turtles All the Way Down
      A Truly Sucky Century BALTIMORE – What an awful century! Worst we’ve ever seen. Household incomes are down. Employment is down, with 7 million people in the U.S. of working age without jobs. Productivity growth is down. GDP growth is down – to only about 0.5% per capita last year. Even life expectancies are down. Drug overdoses are up. Suicides are up. One out of every eight children lives in a family getting food stamps. One of out every eight adults takes psychoactive drugs...
  • Searching for Truth
      Heresy or Truth? RANCHO SANTANA, NICARAGUA – In the fifth century, Christian scholars counted 88 different heresies. Arianism. Eutychianism. Nestorianism. If there was a way to “offend” God, they had a name for it. One group of “heretics” argued that there was no such thing as “original sin.” Another denied the trinity. And another claimed Jesus was not divine. Which one had the truth?   Depiction of the first Council of Ephesus in 431 AD, convened by Emperor...
  • Gold and the Fed's Looming Rate Hike in March
      Long Term Technical Backdrop Constructive After a challenging Q4 in 2016 in the context of rising bond yields and a stronger US dollar, gold seems to be getting its shine back in Q1. The technical picture is beginning to look a little more constructive and the “reflation trade”, spurred on further by expectations of higher infrastructure spending and tax cuts in the US, has thus far also benefited gold. From a technical perspective, there are indications that the low at $1045.40,...
  • Off the Beaten Path in Mesoamerica
      Greeted by Rooster There’s an endearing quality to a steadfast rooster call at the crack of dawn when overheard from a warm country farmhouse.  There’s a reassuring charm that comes with the committed gallinaceous greeting of daybreak that’s particularly suited to a rural ambiance.  The allure of a morning cock-a-doodle-doo somehow falls flat in all other settings.   Good morning everyone! Before meteorological forecasts were available on TV and smart phones, people...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com