There is almost full unanimity among economists, academicians, various commentators and voters that inflation is about general increases in the prices of goods and services. There is this “conformed belief” that a fall in unemployment or a rise in economic activity is seen as a “potential” inflationary trigger. Some other triggers, such as rises in commodity prices or workers’ wages, are also regarded as potential threats. If inflation is just a general rise in prices, as the popular thinking has it, then why is it regarded as bad news? What kind of damage does it do?
[dropcap]M[/dropcap]ainstream economists maintain that inflation “causes” speculative buying, which generates waste. Inflation, it is maintained, also erodes the ‘real incomes’ of pensioners and low-income earners and causes a misallocation of resources. Inflation, it is argued, also “undermines” real economic growth. Now, I find it odd when economists find the idea of falling prices to be a bad thing. Likewise, it is peculiar that policymakers would fear deflation and be willing to take drastic measures to insure the so-called “defeat” of deflation without realizing with their real eyes that central banking is a grand ponzi-scheme founded on the basis to reserve fractionally, mondustrial policing and printing money out of thin air. Policymakers and politicians, after all, would supposedly want the general public—their constituency—to experience the beneficial effects of falling prices over time. Lower prices create a gain of utility or satisfaction for consumers, who can either purchase more of a good or use the money saved to buy larger quantities of other goods. Deflation, thus, has the same effect as an increase in income.
As malinvestments from the bubble are liquidated, the economy begins the correction process. The value of the malinvestments plummets. The values of loans backing these investments falls, and the money supply contracts as banks reduce lending. The price of capital and labor falls, and entrepreneurs discover new profit opportunities to redeploy the capital and labor that had been misdirected by any putrescent Central Bank’s boom or bubble. As the price of goods falls, potential consumers become actual buyers. The key thing is that the price of producer goods has to fall faster and farther than consumer goods for the correction process to proceed. If money and credit are deflating, the process will be faster. If the Central Bank and other forms of government “stimulus” curtail the deflation of producer goods (e.g., by auto and financial bailouts), then the process will be slower and more painful.
In a monetary expansion, monetary growth cannot produce economic growth. The economy is being pulled in two directions. Entrepreneurs want more capital goods, at the same time that consumers want more consumer goods. The decline in interest rates means it pays less to save, so consumption is raised beyond levels that would have otherwise taken place. At the same time, more real funding seems to be available for businesses. More resources are used for the production of consumer goods and less for the maintenance and improvement of the wealth-producing infrastructure. This lowers the economy’s capacity to produce final consumer goods and so it weakens the pool of funding – contrary to the popular idea that a central bank can grow the economy by keeping interest rates as low as possible. The needed correction comes in the form of a recession, during which many projects are liquidated and unemployment rises.
That is, artificially low interest rates generated by the Central Bank would encourage entrepreneurs to start new investment projects. Assume that this in turn would stimulate the demand for oil (where supply is relatively inelastic) leading to higher oil prices. As these entrepreneurs would have to pay higher prices for oil, gasoline, and energy (and many other inputs) and as their customers cut back on demand for the entrepreneurs’ goods (in order to pay higher gasoline prices), some of their new investment projects turn from profitable to unprofitable.
In 1940, Ludwig von Mises wrote, “The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers’ stone to make it last.”
Since deflation is the cure for the economic crisis, why are central bankers so afraid of it? Is their apoplithorismosphobic (fear of deflation) attitude really just a psychological ailment? Is the collective of mainstream economics just misinformed?
Contrary to the popular definition, inflation is not about general rises in prices but about increases in money “out of thin air”. Inflation is ‘an act of embezzlement’. On a gold standard, inflation is about the increase in receipts unbacked by gold money. On a paper standard, inflation is about an increase in the supply of paper money. The general increase in prices, as a rule, develops on account of the increase in money. The harm that most people attribute to rises in prices is in fact due to increases in the money supply out of thin air. Therefore, policies that are aimed at fighting inflation without identifying what it is all about only make things much worse. When inflation is seen as a general increase in prices, then anything that contributes to price increases is called inflationary. It is no longer the central bank and fractional-reserve banking that are the sources of inflation, but rather various other causes. In this framework, not only does the central bank have nothing to do with inflation; on the contrary, the bank is regarded as an inflation fighter.