Main stream economics teaches that deflation is a bad thing, while inflation is beneficial if held to a certain level. How this arbitrary level is ascertained is known only by those who believe in their macroeconomic models. Just what is inflation and deflation?
In recent history the term “inflation” has taken on new meaning when referring to the economic version of the word. The reality is, the word is actually closer to it’s non-economic definition than it’s newer meaning. Dictionaries have been updated regularly over time and with each update “inflation” changes it’s definition. To understand what is implied we have to determine what the meaning of terms are. The term “inflation” refers to the creation of a monetary unit. To inflate the money supply is to create more units of money than specie on hand to exchange for it. Since 1971 and Nixon’s default on the Gold Exchange Standard, the term “inflation” has taken on a new meaning. The frame of reference to a commodity backed currency no longer made sense since the monetary unit now was only backed by the confidence that the U.S. government and it’s central bank wouldn’t over produce dollars. Fiat currency is backed by nothing more than a hollow promise.
The phenomenon of rising prices in a fiat monetary standard has everything to do with the amount of new money created and then, circulated in the economy. The more money created, the more diluted the purchasing power of that money becomes. More units of currency are required to purchase the same goods priced in those monetary units. This rise in prices has become known as “inflation” today. Actually, the rise in prices are a result of an increase in the money supply when that money is circulated throughout the economy. It may be easier to understand “inflation” to be “dilution”. When the Federal Reserve announces it’s new round of Quantitative Easing it is actually beginning a new round of monetary dilution. In return, as this new money circulates, prices for goods that receive the new money begin to rise. Those closest to the source of the new money receive it first, with all the advantages of being on top of the pyramid, and retain the most purchasing power. Those consumers on the bottom of the pyramid receive the new money last and suffer under the higher prices it had created. This is how central banking, through it’s fiat currency, transfers wealth from the poor to the “well connected” without notice from the general public. In other words, inflation is legalized counterfeiting. Inflation is a hidden tax.
If we were to price those same goods in another unit of exchange the price would change. An example would be, if a man were to purchase a good suit in 1813, it would cost in the area of one gold ounce (about $19.39). The same quality of suit in 1913, it would still cost that same gold ounce (about $20.67). Today in 2012, that same suit would still cost about that same gold ounce (about $1667.00). The cost and price of the suit doesn’t change, but rather the units used to exchange for it have. In dollar terms the price for the suit has skyrocketed. Price does not determine value. In this case, the exchange value for the dollar has. It requires more dollars to exchange for that same one ounce gold coin. That suit could have hung on the rack for 200 years and had the same one gold ounce price tag on it and still would be correctly priced. This is what central banking and it’s fiat currency has done to our purchasing power. Wealth isn’t determined in the amount of paper a bank can print, rather wealth is determined in the goods a currency can purchase.
Modern economics is Keynesian based. It is void of a sound capital theory. To a Keynesian, capital is mysterious and can take any form and come from any source. Not unlike Modern Monetary Theory (MMT) the easiest source for capital is the central bank’s printing press. They believe by simply creating more units of currency an economy will grow. Having easier access to this new currency through lower interest rates will cause a “jump start” in the economy. On the other hand, Austrian economists Carl Menger, Eugen Bohm-Bawerk, Ludwig Von Mises and Friederich Hayek have forged an excellent, a priori theory on capital and credit. The Austrians understand that this currency mischief only creates economic bubbles which are unsustainable. We have seen this played out, over and over again, since the Federal Reserve System was created in 1913. Inflation destroys wealth, causes unemployment and lowers standards of living for the wage earner. A monetary system based on fiat currency, fueled by inflation, is in fact a legalized Ponzi scheme designed to keep the cronies on top of the pyramid.
Deflation: Fiat’s Kryptonite
A fiat standard is better understood as a debt standard. Under an inflationary fiat regime, as in fractional reserve banking, creating money from nothing is key. Keeping people indebted is paramount. This debt is where the banks get their income. To charge interest on nothing is a pretty easy way to get more money. Under a fractional reserve banking system, where only a fraction of the money is required to cover a small portion of demand deposits is held in reserve, a bank can loan money that doesn’t even exist. It can charge interest on those loans and roll in the profits. It is important though, for the general public not to be aware of this. Under fractional reserve banking all depositors are considered as creditors. When money is deposited in the bank, the depositor has surrendered ownership in the money to the banking institution. This is what happened recently in Cypress when depositors lost upwards of 45% of their money to “bail in” the banks. Although the Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000, legally, the bank doesn’t have to honor withdrawals on demand. It is not the bank that insures the deposits, rather the tax payers.
It is understandable then under such a system of finance and debt creation that money continues to be produced. It is this fractional reserve banking system that contributes to most of the monetary inflation in the economy. If this process where to slow then profits would be negatively effected. Hence, the great fear of the deflation boogeyman.
Just as inflation is correctly understood as the creating of more money, deflation is decreasing the creation of new money. The net effect is an increase in purchasing power for the consumer as prices in dollar terms drop. The great misnomer that this will begin a “deflationary death spiral” is greatly exaggerated. Consumers will still continue to purchase those goods that they require. The major difference is that after those purchases are made, they may have money left over to put into savings. Keynesians fear this outcome and have redefined savings as non-consumption and even hoarding. They believe if consumers slow their spending then the economy will plummet off of an economic cliff. This is due to their lack of a capital theory. They do not understand the importance of savings as the source of capital in a free market economy. This ignorance is what fuels the current debt based fiat standard that we find ourselves in today. The truth is, throughout American history, deflation has been the norm. Not until the Federal Reserve has this changed. Standards of living were increasing, not decreasing, during the American deflationary history. Many detractors will point to the 1950s as the greatest increase in American living standards, even under inflationary money creation and high income taxes. This is true. But they fail to realize how much greater the standard of living would have been had those hindrances not been there. Setting a record in the long jump with a ball and chain on your ankle is one thing, but how much further the jump may have been without it?
The next time you hear a pundit scream about deflation being the death knell of our economy, it would be good to remember for whom they speak. Mainly, the banking and financial interests. Since the Great Recession began in 2008, the financial sector has literally exploded in profits. Almost all new economic activity happens in this once small sector. Job creating manufacturing has been pushed out and shuffling of new money, commissions and fees has gained prominence. As Murray Rothbard always asked, “Who benefited?” Who benefits from keeping consumers indebted? Who benefits from inflation? Once the “Who” is understood, the “Why” and “How” fall right into place. This unfortunately, will continue to be business as usual until the average man in the street becomes economically educated. Don’t hold your breath.