Deflation

Awhile ago, I participated on the “American Thinker” blog regarding deflation vs inflation.

It was interesting on many levels.

One, there are a lot of people who are interested or becoming interested in economics. This is a good thing

Two, most people are totally clueless about economics.

This is not a good thing, but inevitable as people start to learn about economic theory. Initially, they fall into the theories of crackpots simply because they either sound very complex (and are wholly incomprehensible) and ‘therefore must be true because it is incomprehensible’ or are easily repeatable because the theory is made up on the fly by simpletons.

Thirdly, they often get confused between Depression and Deflation (they aren’t the same thing), or What is Inflation/Deflation (they use a poor definition), or the difference between Recession and a Depression (matter of degree or time).

But fourthly, I was surprised by the fear the word “deflation” causes in people. It goes to show how powerful propaganda is.

Deflation – opposite of inflation – is a decrease in the money supply. Inflation is, simply, an increase in the money supply.

Since money is just another economic good in an economy – thus, obeys the same laws of economics as any other goods or services in an economy -money will demonstrate the same economic consequences of supply and demand as any other good or service.

Most people understand that if there is a decrease in the supply of apples, generally the price of apples goes up – signaling that apples are ‘more demand’ vs supply to consumers. Conversely, it there is an over-supply of apples, generally the prices of apples goes down – signaling that apples are ‘less demand’ vs supply to consumers.

However, most people are confused about this feature if we replace apples with money.

Whereas people will value other goods and services with a reference to money – called “the price” – they find a hard time to find a reference to money to value money – it makes no sense to value something objectively while using that same object as its measure – the statement “a yard stick’s length is a yard” tells us nothing more about a yard stick and is a redundant statement.

Since all other goods are measured against money – how does the economic good of money get measured?

The price of goods is measured in reference to money – we can use the amount of goods money buys as  a measure of the value of money.

So if money becomes more valuable – the amount of other goods that are ‘traded’ for money increases. That is, you buy more goods for the same dollar. People are willing to trade more ‘stuff’ for the same dollar because money is more valuable. Or in other words, the price of other goods falls in terms of money – the price goes down.

If money becomes less valuable – the amount of other goods that are ‘traded’ for money decreases. That is, you buy less goods for the same dollar. People are trading less goods for the same money because money is losing its value. Or in other words, the price of other goods increases in terms of money – the price goes up.

The effects of inflation (price of all goods, except money, goes up) or deflation (price of all goods, except money, goes down) are systemic throughout the economy. Almost all goods and services move the same price direction when inflation or deflation affects an economy.

Because money is the absolute center of an economy and the economic good that all things of value are measured against, any change in its value will be reflected in a change in price of all goods/services in an economy.

So why do many people fear the increasing demand (and hence, increasing value) for a good or service?

If they bought a house, and over time, that house increases its value (that is, there is higher demand for houses), people rejoice – if they are home owners. Non-home owners grumble  – but many are eager to get into the game so to participate in the increasing value. But no one throws out cries of threatening economic disaster because houses gain value!

But with money – many people seem to go into a deep dread if money increases its value over time. Prices are going down. Their money buys more, or if they buy the same things, they have money left over and now can save money.

And there is a hidden, and potentially huge, extra benefit.

As deflation increases the amount of goods money buys, it is like a wage earner getting a raise. With more money in his pocket after the raise, he can buy more things. Deflation is like getting a raise in pay, but and here is the nice kicker, without paying income tax on the increase!

If the wage earner got a raise, much of that raise would disappear in taxes. But with deflation – his tax bill is unchanged – but the amount of goods he can buy increases! The virtual ‘wage increase’ is gained without losing it to the tax man.

All good things.

But many people still fear that people will not spend their more valued money – ‘hoarding it’ (that is saving it) for the future, therefore there will be no economic transactions, and therefore no jobs to earn money.

But they fall into the trap of an incomplete premise. People need to spend money to live. People cannot not spend money.

If people need to spend money to live, there will be economic transactions, and therefore there will be jobs that earn money.

When this argument hits home, these same fearful people then claim that in deflation some jobs may not be desired or required.

Well, yeah, so what? That is a constant occurrence in any economy. If they fear that in deflation, they fear that in inflation or in an economy of monetary stablity! They must be a very terrifed group of people!

Further, people who do not spend their money are called ‘savers’. They save their money.

What do savers do with their money? Deposit it into a bank account or invest it.

What does the man do with investor’s money? Spend it (thus, creating economic transactions and jobs) or deposit it into a bank account.

What does a bank do with money on deposit? Lend it!

What does a borrower do with the money lent to him from a bank? Spend it (thus, creating economic transactions and jobs).

The deflationists fear is complete misplaced. The economy moves along just fine; there are lots of transactions; lending and borrowing and spending and saving; and jobs galore.

Up to now, I’ve been working on the assumption this is occurring in a free market system – free of imposition of government edicts. Deflation in a free market system is a sign of a robust and healthy economy – stable money with increasing productivity.

With increasing productivity, there are more and more different goods being introduced into an economy with the same amount of money. With more competition for money, the value of money increases (hence, the price of all other goods decreases).

All very good.

In a government-controlled economy, deflation can also occur when by policy the government or its central bank reduces the money supply by writ of policy.

This can be bad.

More on this, next post.

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One Response to “Deflation”

  1. MutantJedi Says:

    Very good and clear presentation about money, inflation, and deflation. 🙂

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