Wednesday, 7 March 2012

Should we fear deflation?

From another excellent article by Detlev Schlichter:
After the United States joined Britain on what became the Classical Gold Standard in 1879, prices declined on trend for the next 19 years at an annual average rate of just over 1 percent. This compares with a still positive inflation rate of 0.3 percent in Japan over the 20 years after that country’s money-induced real-estate bubble burst in 1990. Japan is today regularly cited by mainstream economists as an example of the evils of persistent deflation. Yet, the United States, during its two decades of gold-standard deflation, experienced solid growth and rises in income and wealth. In fact, even prior to joining the gold standard, the United States had gone through 12 years of almost no money supply growth and had experienced an almost halving of the price level from the elevated levels that prices had reached during the Civil War inflation. But still, U.S. economic performance was vibrant during this time, causing even such prominent advocates of state-paper money and central banking as Milton Friedman and Anna Schwarz to conclude that this constellation ‘casts serious doubts on the validity of the now widely held view that secular price deflation and rapid economic growth are incompatible’.” (Paper Money Collapse, page 136, 137)
Gradual price deflation is a good thing - the natural result of technological progress (think of the falling cost of computers and other electronic equipment).

A much scarier form of deflation is possible under our system of debt-based elastic money. If debt repayments outpace borrowing, in the absence of significant expansion of the monetary base (money printing by central banks), the money supply will fall, the purchasing power of money will increase, and debtors will be left in a very difficult position.

This is not to say that quantitative easing is justified. A much better solution would be to move to a system of inelastic, apolitical money.

But anyone who conflates secular price deflation with a catastrophic collapse of the money supply, or who claims that price deflation is incompatible with economic progress, is being thoroughly disingenuous.

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