The logically contradictory and “terrifying” deflationary spiral fallacy

One of the most persistent and dangerous myths of modern economics, and especially economic policy, is the idea that deflation, defined as a general decrease in prices or the aggregate (averaged) “price level” (another misleading and erroneous concept), is dangerous because it could generate a mass deflationary spiral, with continually falling prices and depression due to the expectation of further falling prices. Indeed, if one happens to be institutionalized at a school somewhere within the EU, you may be unlucky enough to be force-fed the following propaganda video, courtesy of the ECB:

Most of the video discusses inflation and how “too much” money in the economy causes prices to generally increase and create problems. Of course, we are assured of the truly heroic victories the central bank’s planning bureau is achieving in fighting the alleged “inflation monster” by targeting its policy to keep inflation stable, between 0 and 2%. It’s too bad neither of the children near the end of the video asked the ECB bureaucrat lecturing them who was creating the money, and how they were “controlling” interest rates. Printing money and giving it to your friends, allowing them to fraudulently steal wealth and buy goods while destroying the purchasing power of everyone else’s money savings is a heinous crime. If you’re a central banker working for a government, it’s monetary policy.

At 6:45 into the video, our kindly bureaucrat warns us to be doubly wary of the other monster his agency keeps in a jar: deflation. Like any ordinary person, the girl in the video says this sounds great! Indeed, in a growing economy, and especially a modern one, we should be expecting deflation, given the extraordinary increases in real productivity that have been achieved in the private sector over the past decades.

However, the Eurocrat responds to dispel our enthusiasm: “You see, just like inflation it can also damage the economy, for example if all prices are falling you’ll delay buying something, expecting it to cost less a week later, and even a month later. For the same reason a company might decide to postpone its investments, and the economy suffers.” At its root this reasoning is rather childish, and we must hope that our schoolchildren will be able to disassemble it, without any special knowledge of economic theory.

A price is an exchange ratio at which acting individuals agree to buy and sell goods. Every transaction, by every individual, has a purchase and a sale. By selling my TV I’m “buying money”. For the purpose of this simple demonstration, let’s even dispose of the word “money” for now, and just note its definition. Money is a good that is a commonly accepted medium of exchange, originally an ordinary good with a wider marketability in its uses than other goods, causing it to eventually also be valued and used by other market actors to indirectly exchange goods. They sell to buyers producing products they did not fancy, while using it to buy goods from sellers who did not wish to buy the specific goods they themselves sold. This avoidance of the need for a “double-coincidence of wants”, and the expansion of exchange possibilities allowed, is how all media of exchange through the ages emerged in the market, whether salt, cigarettes, gold or silver. They were originally useful goods valued by a wider proportion of individuals on the market than other goods. This was before governments managed to monopolise and debase currencies “for the common good”.

In this light, we may consider a simple scenario. I am a “buyer” in a market, desiring to purchase good B, in exchange for which I can offer my good, C. I may agree to buy b of B for c of C, hence at the price c/b. In another sense however, I am a “seller” of the good C to my trading partner Jane, who offers in exchange her good B at a price of b/c.

According to the ECB, a “general” price decline of B in terms of C, however small, will mean that traders like me will resist buying B, expecting the ratio c/b to fall further and further. We are assured however that in the opposite case, such problems will not arise. Deflation must be avoided at all costs, while inflation must be considered a comparatively lesser evil. If c/b remains “stable”, or only rises at a “gradual” rate, no problems will occur.

Such reasoning contradicts itself, however. Every buyer is a seller, and every seller is a buyer. To Jane, the exact opposite scenario is observed. With c/b rising, b/c will be falling. By the same logic, she’ll be reluctant to buy C expecting its price to fall further, causing the price to fall even further. This would lead to a general deflation, depression of trade and stagnation.

Now, replacing the words C with money and B with goods, and applying the above “deflationist” conclusion, we should be expecting a drop in the price (or rather, the purchasing power) of money to mean a drop in the activity of sellers. This would imply an eventual grinding halt to all economic activity following general price increases (“inflation”).

Now the reader may have realised that this has not been the case, despite the distortions created by the credit expansion policies of central banks, due to the ultimate fact that sellers and buyers have not been motivated by, and indeed do not care one whit about, the aggregate price level. The profits they make, both psychic and monetary, are governed by the differences in the prices and perceived values of goods and services across the economy. They seek to gain exchange opportunities that allow them to profit by exploiting these mutually unequal valuations and price differences.

However, when confronted with the assertion that the “deflation” of one good relative to another will produce deleterious effects, while told that for the same reasons, the same cannot be said the other way round, I must express exasperated bafflement. Like Bastiat, we must continue to confront these strange arguments composed by self-styled intellectuals, who seem to assert “that an addition gives a different sum, according to whether it is added up from the bottom to the top, or from the top to the bottom of the column.”


Time for a mildly radical proposal?

Why the Tories should abolish the Bank of England, and why they will politically benefit from doing so

The Conservative Party, since forming their coalition government have seemed to suggest, both from the actions they have taken and the announcements they have made, that they are ready to make radical reforms. Recent statements by Francis Maude would seem to suggest that this government is quite ready to continue in the direction of radical reform. Indeed an excellent article that recently appeared in The Spectator provided some hints as to direction the Conservatives, and in particular George Osborne, seem to be taking in order to wrest this country from its relentless state dependency. From this, a few things are clear.

The idea behind public sector cuts, devolution of schooling authorities tax breaks in particularly state employed areas, as well as removing the £545 child benefit tax cuts for families earning £50k a year seems to have been to cut the bloc of voters relying on state handouts to survive, and to begin to produce, in a Thatcherite fashion, a bloc of economically independent voters with what Shirley Letwin called “vigorous virtues.” Central to much of this is to reverse the tactics Labour had previously used against the conservatives, any further attempts to reintroduce state benefits and subsidies will have to face the burden of justifying where their funds will come from, in much the same way that Labour used to chide the Tories in opposition, whenever any hints of cuts or movement toward a balanced budget were made, as cruelly proposing the cutting of “critical services.”

Taking this as a given, it seems puzzling at least to this writer, why money has not entered the debate. This is since the inflationary phoney boom created through credit expansion, was the primary means of smoke and mirrors the former government used to so effectively mask the disastrous consequences of its unsustainable spending policies. One could compare the modern economic boom as a tool of statecraft comparable in character to the bread and circuses of the Roman Empire. It is time for this nation to cast the wool from its eyes.

A printing press, can be a terribly convenient tool of conducting “monetary policy”, if you own one.  Statists and their apparatchiks have long been fond of it, and it provides a great vehicle for the growth of the state, since it allows them to gorge the wealth of the people they rule over, without encountering direct resistance. Why is this, you might ask? As Adam Smith pointed out a long time ago, money is not wealth.

Printing money, or producing electronic credit, or rather “inflation”, as it used to be understood, never can and never does produce neutral effects. Quite obviously, those that receive the new money first can enrich themselves at the expense of others since they can spend this new money first. By doing so they increase demand for certain goods, causing their prices to get bid up relative to what they would have been, while others must cope with paying these increased prices whose income has not been raised have thereby been robbed of their wealth and had the purchasing power of their money destroyed. What is most sickening about this process is that it hurts the poor, the ones who have the least money to begin with, the most; while the same sycophants and interventionists who espouse these destructive policies nowadays are the very ones who claim to have their interests at heart.

Even more insidiously, while dumping newly created money to buy government and “high quality” private bonds, the Bank of England through its irresponsible quantitative easing policy is keeping interest rates at 0.5%. In much the way these easy money policies created this crisis, they will continue to exacerbate it. The manipulation of interest rates causes capital to appear less scarce than it otherwise would have been, causing submarginal long term investments to appear more profitable, producing an inevitable cluster of errors down the road, once the interest rates correct and the real scarcity of capital is revealed. This occurs since the consumer savings to needed to make such projects have any hope of being sustainable were never made.

Yet economic booms are a political tool, and really the most insidious among them. If the Tories continue to allow the Bank of England to operate as it does, they are preventing a real correction, and are fermenting a crisis that will surely punish them in 4 years time. Yet if they truly are wanting to be radical this time around, there is no better way of consolidating their political position than allowing the privatisation of money, allowing people to use non-monopolised currencies like gold and silver not controlled by mercantilist bigwigs who seek to actively destroy the savings of the citizenry.

This would “shut the door”, preventing any future Labour government of allowing itself to engage in profligate and damaging spending; removing their ability to hide the robbery of the citizenry through inflation, since they would now have to account for any spending increases through taxation. Predictably, people would resist this much more vehemently. What better way to create Shirley Letwin’s kind of people!

Repeal of the legal tender laws would be a place to start, with the ultimate goal being to abolish the demonic institution that has been at the heart of our troubles: the Bank of England. Alternatively, any of one of the excellent plans for monetary reform that have already been suggested on this website can begin to be considered.

Furthermore, as already noted such a reform, when clearly stated as above would shame any opposition from either Labour or the Lib Dems if they even once tried to state they were doing so in favour of the poor. By advocating inflation they are and have been destroying both the poor and the middle class! Therefore, I must ask the Tories out there, what are you waiting for? Privatise money!