Falling Prices are “Really Bad” for You

It is quite comical how the idea that falling prices are somehow bad for society is continually pushed by the establishment and its mouthpieces. We imagine it is not easy to create propaganda in support of such an obvious absurdity. No doubt every consumer in the world would love nothing more than genuine price deflation. After all, what can possibly be bad about one’s income and savings stretching further and buying more, rather than fewer goods and services?

Consumers and savers all over the world must surely be scratching their heads by now after hearing for the umpteenth time that it will be somehow “good” for them if their real incomes decline and the value of their savings is eroded by rising prices. What exactly is the justification for this nonsense?

Bloomberg has a strongly pro-interventionist, pro-central planning editorial line. This is possibly the case because its owner is a well-known champagne socialist and nannycrat. However, the statist quo is actually supported by a great many prominent financial publications, including the Financial Times, the Economist, and several others. As far as we are aware, there are no major mainstream financial media supporting genuine free market capitalism.

 

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Image credit: Dreamstime

 

 

5-year breakeven rate

5 year US “inflation breakeven” rate – a measure of inflation expectations – click to enlarge.

 

Following the ECB’s decision to further devalue the ailing and misbegotten euro, Bloomberg apparently felt compelled to explain to the hoi-polloi why exactly their instinctive rejection of the modern monetary debasement orthodoxy is all wrong. An article entitled “Why Falling Prices Are Actually a Really Bad Thing”, presents the convoluted thinking on the topic in the form of soundbite bullet points. Think about the vast economic damage you are doing citizen, before you rush out to avail yourself of the latest discounts offered by evil price cutters like WalMart!

Here is our small contribution to blunting this propaganda effort. Below is a list of the assertions made in the Bloomberg article, followed by our rebuttals:

 

1. “When shoppers see persistent price declines, they hold out on buying things. They ask, will I get a better deal next week, next month, next year? As a result, consumer spending flails. For most nations, that’s a big chunk of their economy, and any slowdown in consumption threatens growth.”

 

One wonders how even a single computer or smart phone could ever be sold if consumers were to “hold out on buying things” when their prices decline. After all, it is absolutely certain that one will get a better deal by waiting for next year’s model – so the price declines are certainly “persistent”. And yet, the technology sector in the widest sense is one of the strongest growing industries on the planet.

Meanwhile, since savings are the sine qua non precondition for capital formation, economic growth is not “threatened” at all by consumers postponing consumption in favor of saving. The opposite is true; without saving, there could be no economic growth whatsoever. All that changes when consumers save more and consume less is the pattern of spending in the economy. While less is spent on present consumption, the savings that are thereby attained are employed in investing in production, which turn makes more consumption possible in the future.

 

2. “Businesses behave pretty much the same way. They postpone buying raw materials, hoping to get a break on costs, and delay investing in that splashy new facility or hiring an extra hand.”

 

Again, we have to ask: if that is true, why are technology companies, or any other companies for that matter, investing even a single cent? Ever since capitalist production processes have been adopted, the real prices of raw materials have been declining. This has evidently not kept businesses from investing and hiring workers. The above assertion misconceives the essence of economic calculation. It is not relevant for businesses whether the nominal prices of final goods are rising or falling. What is important for them is the spread between the cost of inputs and and the expected prices of the output that will be produced.

 

3. “Additionally, their pricing power — the ability to charge more — vanishes. That makes it harder for them to grow profits.”

 

We’re not sure why this was made an “additional” point, since it is basically the same assertion already made in point 2. Once again, business profitability is certainly not dependent on “the ability to charge more” due to an inflationary environment. It is solely dependent on the difference between input costs and output prices. Money supply inflation makes some business propositions look more profitable than others by distorting relative prices – but that only leads to malinvestment of scarce capital and capital consumption. Nothing can be gained by this.

 

4. “Lower profits = less money to go around to workers. Employees don’t get the raises they were expecting, they cut back on spending even more, and the ugly cycle repeats. That’s why they call it a deflationary spiral.”

 

Profits don’t depend on inflation (see points 2 and 3) and neither do wages. To this it must be kept in mind that what counts are real, not nominal wages. When consumer prices decline and wages remain the same, employees will continually get “raises”, and will have no reason whatsoever to cut back on their spending. On the contrary, rising real wages will enable them to buy more goods and services over time. Hence, there is no “ugly cycle”. Note that it is capital accumulation that makes it possible for real wages to rise in a free market economy. The more capital is invested per worker, the higher real wages will tend to be. In a progressing free market economy (i.e., an economy without central bank intervention), the prices of consumer goods will decline over time, reflecting the increase in economic productivity. Increasing productivity at the same time ensures that companies will be able to afford paying ever higher real wages. “Deflationary spiral” sure sounds scary, but there is really nothing to fear.

 

5. “The sad thing is, even when prices are falling, the amount you owe doesn’t. Borrowers get crushed under the weight of that debt. In a mild scenario, companies and consumers hold back on other purchases to continue meeting their obligations. When things get really bad, they go bust altogether.”

 

Here we are finally getting to the heart of the issue. The inflationary fiat money system has impoverished the middle class and the poorer strata of society and many have been forced to go into more and more debt as a result. In a free market economy this impoverishment would not have occurred. Consequently debt would not pose such a big problem.

However, if the sustainability of debt is dependent on inflation (which in a fiat money system inevitably implies that more and more debt will have to be created), then this reveals ipso facto that this debt is unsound. In other words, it will eventually be subject to default anyway, in one way or another. The question is only whether it will happen sooner or later, and what precise shape the default will take. There can be outright default, or indirect default via hyperinflation and the repudiation of the currency. Creditors will lose big either way.

What is not mentioned in the Bloomberg article is the fact that the biggest debtors by far are governments, and that inflation works like a “hidden tax” that allows them to surreptitiously appropriate wealth from those forced to use the currencies they issue. Savers, retirees as well as widows and orphans are especially vulnerable to this theft , i.e., all those who act prudently or are depending on some form of fixed income.

 

Price Stabilization and Bubbles

The sixth and last point is a bit different from the rest:

 

“6. Policy makers usually have an antidote to economic slowdowns, but it’s trickier when interest rates are already near zero. That’s exactly the situation with the ECB and much of the industrial world. That forces officials to turn to unconventional tools.”

 

Here the author is transitioning from trying to explain why declining prices are really, really bad for us, to making excuses for central bankers and their current mad-cap policies (it was of course clear that the article would eventually progress to this point).

The notion that the economy needs “policy makers” dispensing “antidotes” is just as misguided as the rest of the article. The economy would work best if left alone. No central planner can possibly improve on the outcomes that an unhampered free market economy would deliver. Moreover, officials are certainly not “forced” to turn to so-called unconventional tools. Given that money printing cannot possibly enhance economic prosperity, these policies are only likely to eventually produce an intractable economic catastrophe. One should not forget that we have already had several previews of this upcoming event.

Japan’s central bank has implemented unconventional policies on several occasions, with the same result every time: as soon as the policies were discontinued, an economic downturn reasserted itself. The crisis of 2008 was also the result of heavy monetary pumping, which was implemented as an “antidote” to the slowdown following the bursting of the technology bubble of the 1990s. While the “zero bound problem” was not yet an issue at the time outside of Japan, central banks lowered interest rates to extremely low levels and kept them there for an extended time period. Money supply and credit expansion took off as a result (at one point in 2001, the US true money supply grew at an annual rate of more than 21%), which caused another bubble in asset prices and an unhealthy boom concentrated in the real estate sector. The result: a few boom years which were widely mistaken for a sound economic recovery, followed by a crash that nearly wiped out the financial system. In the end, the economy was in even worse shape than before the “antidote” had been administered.

 

SPXBooms and busts as reflected in asset prices – click to enlarge.

 

People may have forgotten that the same arguments that are forwarded in favor of monetary pumping today were forwarded after the bursting of the technology bubble as well. The “price stabilization policy” was used as the justification for generating massive money supply and credit growth. Incidentally, the same excuse also accompanied the monetary pumping of the “roaring 20s”.

 

Conclusion

It is not true that declining prices of consumer goods are economically harmful. In fact, the period in US history during which the by far greatest spurt in real economic growth occurred, was an era of mild price deflation (approx. 1866 to 1913). It is certainly true that those carrying large debts would find repayment more difficult if the real value of these debts were to increase. However, to the extent that this is the case, the soundness of such debt is questionable anyway. Lastly, if the age of centrally planned inflation masquerading as “price stability” were to end and be replaced by an unhampered market economy characterized by mild price deflation, it is a good bet that economic power in society would shift. Currently, a small group is benefiting from inflation to the detriment of society at large, which is a major reason for the constant barrage of pro-inflation propaganda in the media. Don’t be taken in by it.

 

US-GNP-per-capita-1869-1918US: Real GNP per capita growth from 1869 to 1918. With the exception of the war period this was a time of gentle price deflation, with consumer prices falling from the end of the civil war until 1913, as economic productivity took off. It was the strongest economic growth ever recorded in US history. Not surprisingly, this period of strong economic growth came to a close roughly around the time of the founding of the Federal Reserve – which is not a coincidence – click to enlarge.

 

Charts by: St. Louis Fed, BigCharts, Equilibrium007

 

 

 

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6 Responses to “Mainstream Financial Press Promotes Economic Illiteracy”

  • antgermano:

    Pater,

    Numbers 1 and 2 were thoroughly demolished by Tom Woods in one of his recent books (I don’t remember which), but I’m sure others have demolished them, too, as you have.

    The key point to remember in debunking those arguments is that, no matter what the anticipated price might be tomorrow, whether higher or lower, people generally want things in the present, not the future. It might seem counter-intuitive that people might want to buy today if they think prices will be much higher tomorrow but not wait until tomorrow, or some date in the near future, to buy even if they thing the price might be marginally lower. The reason for both of these seemingly contradictory behaviors is time preference – the propensity for people not to want to wait for satisfaction of their wants.

    Until I read Tom Woods’ response to those arguments, this never occurred to me, even though I knew of the concept of time-preference. This piece just cements my understanding.

  • JohnnyZ:

    A minor quibble. Pater, you say:

    “if the sustainability of debt is dependent on inflation (which in a fiat money system inevitably implies that more and more debt will have to be created)…”

    I think here “fiat” needs to be replaced with “debt-based”. Actually the fiat system seems to be primarily there to:
    1. Support, enrich and bail out the FRL system (which I consider legalized fraud)
    2. Allow for almost unlimited government spending and growth of bureaucracy (the spoils for the government for providing 1) above)

    Best,

  • WhirledPeas:

    I took Econ 101 at the U of Minn. in 1966. My instructor taught that a little inflation was a good thing, for exactly the same reasons given today and dispelled here. As Yogi Berra said, “It is deja-vu all over again.”

    But I got the impression that my instructor did not really believe it, yet he had to teach it or he would damage his career prospects.

    Inflation is the natural result of gov’t budget deficits which are a natural result of a large statist government.

    • m111ark:

      Actually, debt-money is the cause of inflation. Budget deficits are the inevitable result of a debt-money monetary system(a government that elects to borrow is no longer sovereign) The last person to learn economics from is an economist. A debt-money monetary system always has an expiration date; in our case, 2008.

      Just waitin’ for the inevitable.

  • No6:

    Charlatans run the financial world. Their coven is in Davos.

  • Kreditanstalt:

    Point number five is the key one. Protecting borrowers…but the borrowers who count are not you and your mortgagee neighbor.

    They’re big banks, funds, insurers and companies. And, most importantly, GOVERNMENTS.

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