Everyone’s freaking out about the Big D these days, but are falling prices actually that bad? Writing recently at Mises.org, Doug French argued that it’s all bunkum:
“The curse of deflation is that it increases the burden of debts,” frets Evans-Pritchard, who goes on to contend, “Deflation has other insidious traits. It causes shoppers to hold back. They wait for lower prices. Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop.”
Yes, the current economics brain trust is worried that consumers will collectively show the good sense to delay purchases, pay down debt, and increase their savings. After all, this liquidation of malinvestments will likely take a while. The prudent thing to do in times of uncertainty is not to ramp up debt and spend money you don’t have.
But now, all of a sudden, “saving” is a dirty word. According to Evans-Pritchard, savings “also redistributes wealth—the wrong way. Savings appreciate, which is nice for the ‘rentiers’ with capital. The effect is a large transfer of income from working people with mortgages to bondholders.”
Of course sounder-thinking economists don’t see deflation as evil, as Jörg Guido Hülsmann points out in his just-published Deflation & Liberty: “it fulfils the very important social function of cleansing the economy and the body politic from all sorts of parasites that have thrived on the previous inflation.”
In other words, this horrifying deflation is the process of realising things like the fact that building and buying more and more houses doesn’t actually create wealth. Or the fact that there’s a limit to how much the slicing and dicing of financial instruments can actually create value. Conversely, think of who will benefit from the reflation the pundits are talking about (hoping for): Homebuilders and banks with lots of mortgage-related junk on their books.
It helps to think about why inflation is bad. It’s not just that more money means your current pile will be worth relatively less, but that in a system swimming in cash, mechanisms like price signals don’t work as well. Manufacturers sometimes refer to lowering the water in the stream to see where the the jagged rocks are on the shop floor. With too much cash (too much water) the market can’t identify the location of the rocks.
French offers another excellent quote from Hülsmann:
“There is absolutely no reason to be concerned about the economic effects of deflation—unless one equates the welfare of the nation with the welfare of its false elites.”
As a counterpoint at the same site D.W. Mackenzie offers a compelling reason why we should worry:
Why then should we worry about deflation? The answer is simple: because minimum wage laws combined with deflation result in rising unemployment. It is already the case that minimum wage laws cause high unemployment among teenagers and other low productivity workers. Minimum wages currently keep unemployment for teens in double digits. In some instances teenage unemployment rates have exceeded 40 per cent.
Deflation would automatically increase the real minimum wage, and with it unemployment. This is not only economic theory, we have seen this happen in US history. FDR imposed a system of 515 minimum wage rates for different categories of workers. Deflation during the Great Depression combined with these minimum wages rates to cause mass unemployment.
We’ll note a couple things here. One is that not everyone accepts that there’s a causal relationship between higher minimum wages and unemployment. Several economists have chimed in on both sides of this controversial issue. The other point here is that the debate is narrow, and obviously a lot of people seem to think deflation is the biggest evil known to man. But it’s worth being aware when everyone starts jumping up on the “Reflate! Reflate!” badnwagon that not everyone accepts that wisdom.