[First published on Free Life.]

Politicians and mainstream economists are persistent in their warning of the so-called “deflation danger” – the idea that falling prices are calamitous for economic progress and that a perpetual, ceaseless price inflation is needed in order to bring us back to prosperity. Often, a deflation figure as small as 0.6% seems to be sufficient to trigger alarm – something of an hilarious travesty when, regardless of the merits of the deflation thesis, this figure amounts to little more than a rounding error.

The typical argument against deflation runs something like this: with continuous price deflation people expect prices to be lower tomorrow than they are today so that, as a result, they put off their purchases until a later date. This, in turn, causes prices to fall further and further and so we end up in an endless downward spiral of depression and impoverishment. Inflating prices, however, cause people to buy today so that they may insulate themselves from future price rises, thus bringing about economic prosperity and an increase in the standard of living.

The term “deflation” is used, quite confusingly, to refer to two different economic phenomena:

Although the two phenomena are related by the commonality of falling prices, the causes and effects of each are distinct and, as such, they must be treated separately. However, because of the bias of our current monetary system towards perpetual inflation it is usually the case that a general price deflation occurs only during monetary crises – i.e. the second cause of deflation. The supposedly negative effects of such deflations, which are often characterised by sharp, persistent falls in prices, are used, quite carelessly, to demonise the first type of price deflation as well so we end up with the notion that any prices falling for whatever reason are a bad thing.

The first type - secular deflation - occurs because an increase in the supply of goods relative to the supply of money causes the prices of those goods to fall gradually. It should be clear to everyone that such falling prices are the result of economic prosperity, permitting us to gradually buy more and more with the same amount of money. Hence, they are not an economic burden and any anti-deflationary thesis seeking to counteract these price falls is absurd.

The notion that people will suddenly “stop buying” during such a deflation in order to defer purchases to a later date when prices are expected to be lower is ridiculous. Every businessman will tell you that if you lower prices people will buy more whereas if you raise them people will buy less – precisely the opposite of the deflation thesis.

Goods are evaluated for the ends that they meet. The fulfilment of these ends, as a result of the logic of human action, cannot be put off indefinitely and each individual will have to consume at some point. Applying a reductio ad absurdum, the deflation thesis suggests that falling prices will cause people to starve because they will always be waiting for lower food prices in the future.

To give an actual example, although general, secular price deflation is highly unlikely under our present, paper money regimes, it can still be observed in specific industries – particularly in personal technology, such as computers and mobile phones, where productivity increases translate into price decreases in spaces of time short enough to counteract the general trend of price inflation. And yet these falling prices have not caused the collapse of this sector precisely because, however much you expect prices to fall, the value of owning a more expensive computer today is greater than that of waiting for a less expensive one in, say, three years. In other words, even if a person knows that a computer costs £1,000 today but will cost only half as much in three years, he will still spend £1,000 today if the benefit to be derived from the computer today is more valuable than saving £500 and waiting three years for that benefit.

Another daft argument is the idea that falling prices will cause business revenues, in turn, to fall, thus slashing profits and causing investment to slump. However, the success of a business – measured by its profit – depends not only upon the height of its revenue but also upon the height of its costs. The prices businesses are prepared to pay for their costs today is based upon what they expect the prices of their outputs to be tomorrow. Thus, gradually falling selling prices will transform into gradually falling costs and so profit margins will still exist.

It is, in fact, inflation that serves to damage (or at least falsify) profits at the expense of investment. The accounting practice of depreciating an asset over its useful life serves to set aside a portion of the revenue for eventual replacement of the asset. If depreciation charges are made at the old price of the asset while the replacement cost has, in the meantime, risen then this fund will clearly be inadequate. The opposite is true when prices fall – the fund will be able to afford more investment than a simple replacement of the worn out asset.

However, the bigger flaw in the theory of the deflation worriers is that it is based on the false, “consumptionist” view of economic progress – that the driver of prosperity is consumers spending increasing amounts of their money on more and more rubbish. As “Austrians”, however, we know that prosperity derives from the abstinence of consumption in favour of saving and investing, which, in turn, results from lower time preference rates. Yet that is precisely what happens if a person defers his consumption from today to tomorrow in order to take advantage of lower prices that are only available tomorrow. (Preferring the same quantity of goods in the future at a lower price is of the same ilk as preferring a higher quantity of goods in the future at the same price). Thus, there will be more resources available for investment in longer and more complex production processes resulting in a boost to economic progress. Inflating in order to make people consume more, however, will have the opposite effect.

The second type of deflation – that resulting from a monetary contraction – is of a somewhat different nature. Here, the problem is that a reduction in the supply of money will cause the prices of dollar quoted assets to fall while dollar denominated debts that have been taken on to fund those assets will remain at their previous value. Thus, there will be a cascade of defaults, bankruptcies, job losses, etc. that will, so it is alleged, cause endless destitution and misery. As we noted earlier, this nearly always happens at the start of the "bust" phase of the business cycle, when monetary inflation has stopped and higher interest rates have served to cut off cheap borrowing.

To anyone with even a rudimentary understanding of the “Austrian” theory of the business cycle, this anti-deflationism is clearly nothing more than a case of special pleading on behalf of the banks and businesses that borrowed cheap money in order to plough it into inflating assets (such as sub-prime mortgages) during the boom. They cry out for a vigorous re-inflation so that their particular firms do not have to suffer liquidation and their chief executives do not have to sell their mansions and yachts.

This type of deflation would not be a cause of a general economic malaise but would, in fact, serve to restructure the economy away from malinvestment by transferring the purchasing power of resources from those who borrowed and wasted during the boom to those who did not, the latter still holding a large quantity of steadily appreciating cash. Once that liquidation is complete the economy can proceed on a sound footing. This is precisely the argument of distinguished “Austrian” economist Jörg Guido Hülsmann in Deflation and Liberty.

Indeed, much of the deflation fear comes from the monetarist analysis of the Great Depression where there was, in fact, a real monetary contraction (although, as Murray Rothbard argues in America’s Great Depression, the lack of inflation did not result from want of trying, and that the actual cause of the contraction lay in factors that negated the inflationary responses of the government and the Federal Reserve). However, the stagnation during this era was not due to the deflation per se but because of the widespread attempt to keep wages and prices high in spite of the monetary contraction. Had prices been allowed to fall then recovery would have been much swifter.

Here we have, then, the real reason why we are supposed to be alarmed by the “deflation danger”. Deflation would cripple heavily indebted governments and banks who rely on a constant source of cheap money. The need for perpetual inflation is wholly unnecessary for economic prosperity and the wellbeing of the general public. Rather, it is necessitated by the asset-liability mix brought about by previous inflation which would threaten the existence of large, establishment institutions if it was to reverse. They need more cheap money, more theft of your purchasing power, in order to keep their phoney assets rising in value. The deflation myth, therefore, is nothing more than a part of the big, statist fraud, benefiting a select few at the expense of everybody else.

[First published on Free Life]

One of the aspects of capitalism and the free market that the typical lay person finds difficult to comprehend is the fact that the complex structure of work, production, distribution, and trade could possibly take place without some kind of centralised, directing authority in order to co-ordinate everybody’s efforts. Wouldn’t there just be chaos and mal-coordination with everyone trying to make their own, independent plans if there is nobody at the tiller to steer the giant ship?

This fallacy stems from the belief – accentuated by holistic concepts such as aggregate, pseudo-statistics like “GDP” or “the national income” – that what we refer to as “the economy” is some kind of enormous machine that has “input”, with a single operator “processing” these “inputs” into “outputs”.

In fact, rather than being one giant, amorphous blob “the economy” is made up of millions and millions of independent, unilateral acts of production and two-way trades, many of which will never have anything to do with each other. I may sell an apple to my neighbour for 10p in London; another person may sell an orange for 20p to his neighbour in Manchester. Neither of the two pairs of people has ever met, nor need any of them have any involvement with the exchange of the other pair; and yet both exchanges would be regarded as part of “the British economy” in mainstream discourse.

Rather than being a top-down operated machine, “the economy” is a bottom up network of independent transactions – motivated by the ends desired by each and every one of us rather than by some bureaucrat – joined together only through the communication of the price system. All of the trades together, stimulated by varying and changing desires and ends that people seek, will have a constant and unceasing influence on the prices that regulate the supply of goods relative to their demand. Ironically, it is precisely because of such complexity – the so-called “knowledge problem” – that the attempts of any central authority to control and direct it are nothing short of futile. Even worse, however, is the fact that without market prices generating profit and loss such an authority would have no rational guide to apportion resources to where they are most needed. This is what Ludwig von Mises established in his Economic Calculation in the Socialist Commonwealth, a work that was published at the birth of the world’s greatest collectivist experiment – the Soviet Union – and foresaw its ultimate failure.

An oft-heard complaint, particularly from the left, is that “globalisation” – by which we mean economic globalisation, characterised by increased trade across borders, as opposed to political globalisation, which is increased co-operation between states and/or the consolidation and centralisation of state entities – has led to a decimation of local communities and economies. All that this means, however, is that the market for goods has simply expanded so that one can source one’s needs from pretty much anywhere on the globe. It is still the case that the driving force of demand is not global or holistic – it resides very locally in every individual person’s tastes and desires. Such complaints therefore fail to recognise the irony in calling for a very distant and hardly local entity – the state – to halt globalisation and expanding markets by replacing what individual, local people desire with its own ends.

This myth, of course, goes further than economics and has more than seeped into philosophy as well, stemming from a basic misunderstanding about what is required for the human race to live in peace and harmony. Such peaceful co-existence does not demand that we all pursue the same ends or ultimate goals, follow the same plan or sing from the same hymn sheet; nor do we need some centralising authority to prevent “discordance” between the actions of one person and another. Rather, what is required is that we can each follow our own plans while not conflicting with the plans of others.

This is precisely the great achievement of the institution of private property. Recognising that all conflicts have their origin in the contest over physical goods, an exclusive right is granted to the first user-producer (or to the recipient of the good in a voluntary exchange) so that he may fulfil his ends without molestation from other people; and that other people can use the goods for which they are the first producer-user without interference from him. Any person arguing in favour of “one direction” and “harmony” at the behest of centralised control really means that everyone else’s plans should be overridden, with force, by his own. Indeed, in contrast to voluntary exchange, every transaction that is compelled by the state requires there to be at least one loser, one person who does not want his funds directed to the ends desired by the state. Rather than producing harmony what results is bitterness and frustration from at least one part of the population whose needs are denied in order to serve the needs of another part. Furthermore, aside from the economic chaos that such a system brings, rather than inspiring such qualities as productivity, self-reliance, hard work, prudence, patience and responsibility, the resulting social disorder instils, in their stead, laziness, apathy, conflict, corruption, impatience and cynicism – hardly the human qualities that one would wish to exemplify as the hallmarks of a “peaceful” and “harmonious” society.

True harmony can be brought about only by allowing each and every individual to pursue his own ends with the scarce resources over which he has lawful ownership, while allowing everyone else to do the same – permitting the human race to flourish peacefully and devoid of conflict. Not only does the state fail to aid this process, it is the active cause of its destruction – and the sooner we recognise this then the closer we will be to building a lasting peace and prosperity.

[First published on Free Life]

One of the positive indicators of our so-called economic recovery bandied about not only in the media but also by our monetary lords and masters at the head of central banks is the idea that rising prices are a sign of economic recovery. This mistaken belief is part of a wider myth that views the economy as little more than a giant number – a number which, if going up, means things are good and getting better, and if going down means the situation is bad and getting worse.

Theoretically the market price for any good is never “good” or “bad”; it is simply a function of the supply and demand for that good. The only way in which we can say that the market price is “good” is that both parties to a transaction are satisfied with that price and, thus, both have received an increase in welfare as a result.

That aside, however, surely economic progress is marked by an increasing abundance of goods and services – that more and more stuff is being produced for each hour of work? Therefore, if goods and services are increasing in supply then shouldn’t this lead to decreasing prices rather than increasing prices? If so, then increasing prices must indicate the opposite – a decreasing supply of goods relative to the money used to buy them and, consequently, greater impoverishment.

Contrary to the “wisdom” of so-called experts, such facts are intuitive – stop any number of strangers in the supermarket and they will almost certainly tell you that they want everything on the shelves to be cheaper, not more expensive. They will tell you also that they would be better off if they could buy more with the money they have in their pockets rather than less. Thus it is a travesty for economists and talking heads to call for even a “modest” degree of price inflation unless they are keen to promote destitution. Such inflation means that those of us with fixed incomes are forced to sit by and watch the purchasing power of our wages drop, unable to continue to afford to buy things because the “recovering” prices put them out of our reach.

The “recovery” of rising prices is just as ridiculous when it refers to rising asset prices rather than consumer prices. This kind of “recovery” has nothing to do with whether life is getting better for Joe and Jane Average. Rather, it means that there has been a localised recovery and improvement for a select group of people – those who borrowed cheap money heavily during the boom (mostly the politically connected big banks and investment houses) and ploughed it into stocks, bonds, property, etc. They can now breathe a sigh of relief as the prices of those assets once again begin to rise with the new round of monetary inflation.

In the UK this can be seen most clearly in the specific arena of house prices. Rising house prices are great for those who already own houses, boosting their wealth and allowing them to take out second mortgages or other equity release schemes to finance increased spending on their lifestyles. At some point, however, the prices rise so much that purchasing a property becomes an almost impossible expense for those who are not yet on the so-called “property ladder”. Government schemes to help “first time buyers” simply exacerbate the situation as they permit more money to chase the existing stock of housing.

A general economic recovery is not based upon rising consumer or asset prices buoyed up by paper money. It is created by a sound monetary order that allows entrepreneurs to allocate resources to where they are most urgently desired by consumers and to, slowly but surely, increase the economy’s accumulation of capital goods. The result should be a gradual secular price deflation as more and more goods are produced, meaning that the money in the hands of the lowest earners gradually increases in value. Consequently, everyone grows wealthier and more prosperous instead of just the super rich.