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Written by Barry Donegan
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Wednesday, 22 October 2008 08:13 |
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Inflation vs. Deflation: A Practical Examination
There is a great critique of the gold standard which is leveled by the believers of Keynesian managed-market views. This critique raises the specter of massive deflation and alleges that growth is limited by lack of liquidity. The argument is that deflation would stop production of goods as there would be no incentive to invest with prices dropping on currently existing products with each additional item you produce.
Before I delve into that logical absurdity, I will address the question of whether it would be better to solve a market correction with increased liquidity (a code word for monetary inflation), or through pegging to a gold standard and deflating. First off, from a purely mathematical standpoint, a market correction tends to take the form of a fast, unexpected push in a single direction. Right now, the market is desperately trying to lower housing prices. Falling home prices and the attendant debt defaults are accepted by most as the source of the fundamental correction that is driving our economy in a harmful direction. Correcting these artificially high prices in the housing market by inflating the currency can be achieved with one of two approaches. The first is to inflate the currency until it collapses, allowing for a replacement currency which would then rapidly deflate the home prices to the point that they would reflect their true market value. The second possible correction would involve global coordinated interest rate cuts aimed at creating the type of poverty that would lead to the disrepair and destruction of the surplus homes, thus reducing the supply. Both of these approaches would cause home prices to match their market value. Both of them would be terribly painful for consumers and workers.
The problem with the hyper-inflationary version of this correction is that it is essentially an effort that quickens in pace exponentially leading up to a collapse. There is no way to stop the disparity between worker’s wages and consumer goods in that type of environment. It grows so quickly that the distortion in the value of money causes a total failure in trust of money. This leads to a lack of means of exchange for productive services, which leads to a failure in jobs and resources. It is an absolute step backwards in the social evolution of humanity. If your job pays $20,000 a year, and in a short span of time inflation reaches the point where milk costs you $30 a gallon, you now can no longer provide for your family through working and producing in the mainstream market. You begin to have a need to deal with the black market for consumer goods, which is why so-called banana republics have drug cartels which actually retain the support of the people who live within their areas of control—they provide goods and services which can’t be had at market prices outside of the black market.
The alternative, deflation, does not come without its problems as well. When one deflates the currency too rapidly, the buying power of the currency grows too fast for the corporate business model which provides the goods. While many corporations plan their expenditures a quarter in advance, there would still be a need to lay off workers at the end of a quarter when prices fell 20% across the board. This layoff event would be painful for a number of the workers in the market. However, the increased buying power of the dollars they did have would largely soften the blow. In the meantime, after two months of watching their monthly payments fall, the workers would realize that they could apply for the same job at another company, ask for a lower wage, and still live better than they did before the event occurred. This would be the stabilizing event that would end the crisis. It would be a hard couple of quarters while workers and businesses readjusted their balance sheets to make sense with less zeros on the currency, but each step backwards would transfer wealth into the hands of the citizens, and not the headless corporations.
Ultimately, increasing liquidity is an exponential race towards infinity; there is no highest number that the money available in the market can reach. Deflationary spirals, however, are sharpest at the beginning and softer at the end. Deflationary spirals head towards the number zero(in actuality towards the real price of the goods), and cannot go below. This means that as it moves closer to that number, its pace slows.
Ultimately, the Keynesian objection to the gold standard is that it limits growth. That is to say that if increasing the amount of goods causes the value of the current goods to be diminished, no investor or businessman would be encouraged to make anything. This is based on an assumption that the businessman or investor is permanently rich, that his wealth is infinite, and that he can never become poor. This is absurd, however, because obviously there is no profitability in creating one automobile, destroying all other automobiles, and preventing the manufacture of any further. This would not be a model to create wealth, it would simply be a model for possessing a car and angering your community. Clearly, increasing the quantity of cars on the market while decreasing the price of each car gives the businessman more and more wealth through the volume of goods he is providing. The increase in production would be beneficial under a gold standard because it would allow the businessman to lower prices, which would give him a leg up on the competition. What corporations don’t like about the gold standard is that it prevents them from taking measures to artificially distort the price of goods by forming cartels and blocking new productivity. Under a gold standard, each corporation is forced to take the reins and try to become the best provider of goods and services.
Let these home prices fall; six months from now we will be wealthier than ever. |
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