WHY IS DEFLATION BAD?
There’s a pretty standard line from the Austrian economics crowd that deflation isn’t such a bad thing – that it is good for prices to adjust lower and for natural market forces to take control. The truth, however, is that there is very little that is good about deflation. It is destructive economically and psychologically. It can literally destroy economies if it persists. This morning Paul Krugman answered the inevitable question: what makes deflation so bad?
“There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.
So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield – Japanese bank deposits are a really good deal compared with those in America — and anyone considering borrowing, even for a productive investment, has to take account of the fact that the loan will have to repaid in dollars that are worth more than the dollars you borrowed. If the economy is doing well, all this can be offset by just keeping interest rates low; but if the economy isn’t doing well, even a zero rate may not be low enough to achieve full employment.
And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. That’s the deflationary trap we keep worrying about.
A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts. Now, you might think this is a zero-sum affair, since creditors experience a corresponding gain. But as Irving Fisher pointed out long ago (pdf), debtors are likely to be forced to cut their spending when their debt burden rises, while creditors aren’t likely to increase their spending by the same amount. So deflation exerts a depressing effect on spending by raising debt burdens – which, as Fisher also points out, can lead to another kind of vicious circle, in which depressed spending because of rising real debt leads to further deflation.
Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity. What this means is that in general economies don’t manage to have falling wages unless they also have mass unemployment, so that workers are desperate enough to accept those wage declines.”
So ultimately, one has to ask themselves this question: will you believe deflation is so great when you take a 10% pay cut next year? Methinks not….
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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64 Comments
Would work for me. Preferable to ongoing central bank driven asset price bubbles in any event.
Krugman shows his incredible ignorance yet again. Technology is nothing but a giant defaltionary event and that hasn’t stopped people from buying new tv’s, laptops, or iphones. As for less willing to spend/borrow, there would be plenty if people weren’t already in debt up to their necks from following his ridiculous ideology up to this point.
Deflation hurts the position of debtors…seriously? This is the best this guy has? Oh so let’s just completely destroy the entire nations purchasing power over it. That’s a MUCH better idea.
Regarding wages, they have risen to near crazy levels…but does he ask why?? Because the dollar has been shot to hell through the inflationary policies he preaches. Deflation in this instance isn’t bad because prices are coming back into line with wages. If both are falling then the net-net isn’t all that impactful.
All in all, his ideology is a JOKE. It’s incredibly destructive as can been seen over the last 150 years of American society. TPC, I know you aren’t a hard money guy, but I am and hard money would prevent all of this and more. The economy does not need fiat money to expand. Fiat money is a tool of politicians for political patronage. That goes back to the early 1800′s and Henry Clay in US history…then to Lincoln who really perfected the concept.
I am not advocating government intervention just because I believe deflation is bad. I think we’d agree that asset price inflation can be nearly as destructive. I am simply trying to show that deflation can be a truly horrific environment if it takes hold.
Someone called me an “apologist” for govt spending yesterday – sometimes I wonder if people even read the site or if they just glance over it occasionally and make these sweeping allegations about my positions. I can’t think of many people who have been more critical of the govt intervention than I have.
As for hard money – I just don’t think it would work in today’s global economy. The Europeans are trying what is effectively a single currency system and its been an utter disaster. Also, history does not show that hard money monetary systems are without corruption or volatile business cycles….
the dichotimy of the problem is pointed out by the fact i agree with both AXE and TPC
Exactly!!
look out axe, you’ve ruffled the socialists’ feathers……..don’t you know they know what’s best for us?……….that’s what nancy says
That is my favorite line. You’re always a socialist if you believe the govt can and should spend a few bucks on its citizenry…..
actually TPC i agree with you almost invariably and hold your opinion in the highest regard…your may DOW high pick was one of the best i have ever seen….this is THE best financial site anywhere and i should know……..i think nancy is spending more than a few bucks on our citizenry.
ruffling the socialist feathers was not aimed at your comment but another one…..only a fool would consider you a socialist.(T P C)
you are a gentlemen and a scholar sir and i salute you.
In that case it is I who owes the apology. I think another reader’s ad hominem’s have made me overly sensitive. Forgive me.
I think you’ll find that most deflation defenders are either bankers, lenders, currency holders etc…who don;t give a hoot about the average borrower tied to an illiquid asset.
As for government spending, it does exist without being socialist, for Christ sake. Just look at military spending, police, roads, firemen, teachers, etc… If everyone is so worried about spending, why not a word against the endless Iraq war by the same folks who now cry austerity?
@Axios
You can say he is a joke after you get a phd and a nobel prize and prove to be better at predicting the economic future. Until then you are the joke.
Axios is an imbecile. Technological innovation does not bring about deflation, instead, it brings about disinflation(at the most) by increasing productivity. The IPhone has created an entirely new industry which has created thousands of jobs. Think of all the new companies starting up just to create apps for it? For all those jobs lost in car manufacturing, 10s of thousands were created in the computer industry. Technological innovation DOES NOT reduce consumer spending like a post asset bubble, deleveraging scenario we are seeing now. One spurs the economy both financially and psychologically, the other destroys it.
“A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.”
Exactly. Can’t have that can we Krugs.
Without debtors his Keynesian fantasy world doesn’t get to exist to the extent he wants. The whole purpose of deflation and why its natural cyclical occurrence has to be allowed is to restrain debt in the future by making its risk fully understood. When you remove deflation you create a moral hazard such that ultimately it leads to a credit(debt) bubble. Presently with all QE that Krugs so desperately screams for he wants, again, to bail out the debtors with inflation at the cost to the creditors. A new bubble forms.
I think the kicker is WHERE the deflation should occur. We should have let the banking sector deflate. We should have let the housing sector deflate. We should have put these sectors down when we had the chance.
Why should my wages fall just because some bankers and stupid home owners decided to leverage up on stuff they couldn’t afford? Should we all enter a depression just because there are a few bad apples? But they bail these jerks out regardless.
Agreed– TPC:I think the kicker is WHERE the deflation should occur. We should have let the banking sector deflate. We should have let the housing sector deflate. We should have put these sectors down when we had the chance.
KRUGMAN ” Prices will go down forever” ?
LENIN–”Inflation and Taxation will Grind the Middle Class to Pulp”
The govntment can allways pull out Housing from the CPI calculations like Food and Energy–too volatile.
It doesn’t work in Europe, but not for the reasons you are stating. It doesn’t work primarily because there is no systemic commonality. All of the countries have differing tax systems, retirement plans, social “nets”, fiscal ideologies, etc. We don’t have that issue here and it is for those reasons I stated when the Euro was born that it would never make it. It has nothing to do with having a commodity backed currency…which of course they don’t. They have Germany which has learned about currency manipulation the hard way. Go to King World News and listen to the last 3 interviews of Jim Rickards. He lays it all out in gory detail and also explains why deflation is not always bad.
Hard money systems prevent the frivolous printing of money without which politicians cannot extend favor. That will reduce the power of DC and slowly put us back on the right path. Getting back to a system where spending must be accounted for is the key. Sure corruption will always be around, but hard money systems help minimize the institutionalization of that corruption which we see is replete around the world.
There is a reason why we have moved off hard money currency systems. They impose inherent recessionary biases on trade deficit nations. In a world of global trade without floating exchange based currencies we are all at the mercy of the trade surplus nations. This is essentially what we are seeing in Europe. The same thing occurred during the days of the gold standard. The world was not a better place back then. Sure, there are big big problems with fiat based systems, but it’s an improvement over the restrictions of the gold standard.
A single currency system would only work in today’s world if we were all united under one rule of law, one treasury and one central bank. That ain’t happening any time soon.
You’re living in a fantasy if you think hard money will keep Washington in check. Heck, the military-industrial complex began under the gold standard.
The military industrial complex did not begin under the gold standard. Bretton Woods was absolutely not the gold standard.
TPC, listen to Rickards latest that ZH posted yesterday. It’s awesome. It is right on topic for this post.
TPC, we got off of gold so that our politician could expand social programs and not have to accurately account for where the money came from. The restrictions of the gold standard are the restrictions of sound money and thus a sound economic system. This has been happening since the creation of the Fed (really since the mid to late 1800′s). Only a hard money system can slow the destruction being caused by politicians.
So is it the system that is bad or the politicians?
Power corrupts; absolute power corrupts absolutely.
Thus, it the system that creates such incredible power that corrupts those who control its power. Part of that is due to moral/religious decay, but that’s an argument for another time.
this fact of human nature is exactly why the FED is not an independant entity and will always overshoot QE and inflation and bond vigilantes are in our future……no, not tomorrow but in the future.
Hey Boatman…what would be the best definition of a bond vigilante? I keep hearing the term, (as in Bond Vigilantes Gunning for Greece) and suspect I should know what is meant by the term.
And, why would they be good, or bad?
If trade deficit nations are forced into recession, overconsumption in the deficit nations would be curtailed and oversaving in the surplus nations reduced. So under the gold standard there would be no accumulation of trade imbalances as we see today.
The reason why the US was a trade surplus nation after WW1 is because the world went off the gold standard in WW1 and never fully returned to it. Though it looked like the world returned to the gold standard in the 1920s, it was actually on the gold-exchange standard, somewhat like the bretton woods system.
I’m interested in your views and all others on both sides of the argument. Your fundamental premise must be that credit and debt are essential to the prosperity of the nation. I can’t say that you are wrong, of course, but in opinion I disagree. The nation grew at what all who lived then considered to be a very acceptable pace before credit (and debt) became widespread. I believe that debt benefits bankers 100% of the time and benefits citizens part of the time, so I am willing to live without it. And yes, for one (and an Austrian), I would be willing to take a 10% pay cut in exchange for equivalent lower prices. It would reduce my taxes, an immediate benefit, and eventually it would get us closer to the type of barter system that made the country prosper without transfer payments. It is a lot tougher for politicians to pick your pockets when the numbers they are talking about are numbers you can add in your head, so to speak.
Arguing that “deflation” is bad is like trying to argue that “winter” is bad. Deflation is an economy’s natural response to excess and imbalance. Deflation MUST happen to correct the course of the ship that has gotten off course due to rampant manipulation by governments and unrealistic purchasing by the populace. Deflation is no fun, not at all, but I will take deflation and the reality punch in the face that comes with it for 5 to 10 years so that my children can have a better life on the other side. Every hundred years or so a generation must suck it up so that future generations can benefit from that sacrifice. Thats deflation, and it aint so bad if you can look at it from a 100,000 feet instead of 10 feet like so many so called economists, politicans, and public company CFO’s.
will you believe deflation is so great when you take a 10% pay cut next year?
Dude, it’s happening anyway. There is no way the American worker (factory worker, knowledge worker, etc.) can compete with low-cost regions in Asia and other parts of the world.
Anecdotally, this is the second straight year I’ve gone without a raise, and I don’t expect one next year, either. Yet, I know I would have a hard time trying to find a better paying job anywhere else, so I’m staying put. I actually consider myself fortunate because I know people who are unemployed and are having a tough time finding a job.
P Sean, oy vey! Comments like yours make it clear that the inflationsistas have won, which is about as depressing as it gets. Considering how well funded they are, and considering their opposition, the deflationistas aren’t funded at all, I suppose that the end result should not be surprising. That doesn’t make comments like “deflation’s just part of life” or “what’s wrong with a cheaper can of Coke?” any less frustrating.
Jon
Not entirely sure what you are trying to say here. So some clarity would be appreciated.
It is all very simple: after a huge credit crunch and a totally broken financial system you get either deflation or hyperinflation. Period. Each fiat system has failed, so will this non-gold-standard system. Not accepting deflation is not accepting the essence of capitalism, which is that markets can go up and can go down. Each mania has ended in the same tears, over and over again. Bubbles burst, deal with it.
The problem with the Keynesians is that they embrace the boom phase of the fractional reserve lending cycle and the problem with the Austrians is that they embrace the bust phase of the cycle. In fact, both phases are evil. Fractional reserve lending is evil, period. It is fraud and theft.
I am sorely disappointed in the Austrians. They supposedly understand the evil of FRL yet propose no solutions for its victims. Thus, I see them as part of the problem.
Austrians have always maintained an answer – hard money. Does that help people betrayed by FRL? No, but you have to look forward to preventing more disasters. I’m not sure what miracle salve you expect Austrians to have. If people had followed the Austrian path to begin with this wouldn’t be a problem.
Austrians have always maintained an answer – hard money. Axios
The solution is not hard money vs paper but liberty in money creation. Gold is in fact a tool of the central bankers so those who support any government enforced gold standard are themselves tools.
I’m not sure what miracle salve you expect Austrians to have. Axios
Justice. However many Austrians would rather the country suffer a depression to clear out “malinvestments”. Perhaps if the clearing out started with their jobs, they might begin to see the light.
Deflation is not good or bad it exist like gravity.
Its a consequence not something we should appreciate or avoid.
For politicians the Keynesians approach is always more in line with there short term reelection goals.
It’s a fantastic illusion. Ho can argue that a trillion dollar created jobs?
The the cost of those jobs is rarely mention. It’s like filling a lake with a pump that is connected to the same lake. The public and the media only sees the water coming in.
The problem, as I see it, is poor fiscal and monetary policy that has built up over a long period leading to MASSIVE debt. If we had managed our finances and policy better all along we wouldn’t be in the predicament we’re in. However, going so far out on the debt limb has left our society hooked (addicted) to debt. To get off now will be really painful and nobody wants that, just like any addict. As Doug Noland recently put it, we’re in a position of “just one more bout of money printing to get us over the hump. Just get through the pressing crisis and then it will be time to find monetary religion.” Problem is this strategy has never worked long-term, ever. We just got ourselves in a fix of our own doing and we either fix it by cleansing the system or natural market forces will correct them for us involuntarily. The severity of the fix is a function of our own doing and the resulting pain of the fix is our fault and we should take responsibility for that. Or do you think we can forever keep growing debts and using physical resources as though they are infinite (another function of the fiat financial system out of control) with never any consequences. Krugman is just another typical out of touch with reality academic putz.
Or do you think we can forever keep growing debts and using physical resources as though they are infinite (another function of the fiat financial system out of control) with never any consequences. JG
You speak of the debt as though it were legitimate. In fact, what we have in the US is a government backed counterfeiting cartel that DRIVES people into debt by cheating them of real positive interest rates on their savings.
The solution is not more debt but an equal and sufficient amount of new legal tender fiat just GIVEN to every US adult so the the debtors can escape the debt trap and savers can be compensated for years of suppressed interest rates.
Private and corporate debts are legitimate: it’s a legal and binding contract between two parties. Just because it’s corrupt doesn’t mean it’s not legitimate. You are however, correct about government debt and money printing – the population has no direct and significant control over its creation/assignment and so we are lambs to the slaughter. Problem is we have way too much of both and a society that continues to believe that debt is the answer to all ills and wants.
But giving fiat to every US adult to pay off debt? Though my populist side would rather see that than it having been given to the banksters, it’s still moral hazard. Do you think people will pay off their debt with said cash and then find monetary religion (and if I’m remembering your position correctly, including your desire for monetary liberty and independent money creation)? Not likely as it will not fix the “system” and just encourage people to go out and leverage up again in anticipation of the next bailout.
The bailout of debtors and savers should only be a one time event to be combined with leverage restrictions on the banks to prevent a repeat of the problem. Afterward, private currencies could fill the needs in the private sector.
All I’m saying is bailout the victims of the government backed counterfeiting cartel and then abolish it.
Its a consequence not something we should appreciate or avoid. first
That’s like saying that stolen goods should not be returned to the victim. FRL cheats both savers and borrowers and ironically ruins the banks too.
There were three episodes of deflation in the US during the 1800s when growth accelerated and living standards were raised. This was because of the industrial revolution when it became cheaper to make things and profits were passed onto the consumer in the form of lower prices. Since formation of the Federal Reserve in 1913, deflation is deemed as bad because it is hard to control and becauses it reduces bank profits.
No one cares about consumers anymore except that we must borrow as much as possible to buy things we don’t need to support bank profits.
I wonder if we had to pay our Plasma TV with Gold how long the trade deficit would last ?
Deflation Fears are WAY OVERBLOWN..
People will ALWAYS buy what they want when they want. Just look at Electronics, EVERYONE knows that the prices will drop on every single new fancy digital gadget. YET people still camp out in lines for days to be the first to pay TOP DOLLARS for items that will basically be worthless in a few years or less.
Electronic Items are the Deflationary version a a BLACK HOLE.
How about Cars, ever heard of a new car loosing value as soon as it leaves the lot?
Yet MILLIONS of NEW cars are bought each year.
It may go without saying, but I think part of the disagreement stems from not everyone acknowledging that we have to accept the consequences of the Ponzi economy we have built on the back of extreme credit expansion. From this position there is no solution, only different forms of pain and adjustment. The question, what is the most equitable and least disastrous form of adjustment?
As TPC and others have tried to articulate, when we have an over indebted private sector that is deleveraging, and a trade deficit nation, the only way to avoid a depression is for the government to run a net deficit (dissave). This is simply a matter of accounting flows. This too, however, has its weaknesses, because there is also the issue of the stock of assets and liabilities that are accrued in the course of government deficit spending. If such spending is misallocated into boondoggles and bubble sectors, e.g. iBanks and real estate, then we are no better off as a result. This simply kicks the can down the road.
The least disastrous course, as opposed to disorderly deflation and a collapse of the credit markets, is for government spending to for once get it close to right and invest in high return areas that have gone underinvested until this point. That, by the way, would be the exact opposite of what this administration has done to this point… useless bailouts and transfer payments with no return on investment.
Paul Krugmann? The same guy who believes we should be spending double than what we’re spending now? It shows that they hand out Nobel Peace Prizes to anyone. Heck, even Bush was nominated for one. Yikes!
Deflation is not scary, inflation is. Fearing deflation is supposed to make dumb people sound smart. Inflation is the increase of the money supply, therefore, buys a lot less. Just ask Bolivia. Just ask Zimbabwe.
Let’s all be smart and listen to Jim Rogers and buy commodities!
Your comment is a great one. It shows the pure pedestrian thought of the unedified common man who has no idea what in hell he’s talking about. I used to laugh at the dems, now you teabaggers are the ones providing much fodder for my amusement.
Deflation is simply the opposite of inflation, no worse, no better; it is a necessary correction when inflation has been allowed to spiral out of control as happened with real estate. To try to avoid it by deficit spending is not only harmful, it is pointless. You cannot help the public by increasing what they owe. The bill for excess must be paid; it cannot be avoided by alchemy economics. The Japanese have been trying to avoid it unsuccessfully for 20 years with the only result being a stifled economy and now the danger of sovereign default.
Ultimately deflation often leads to war as debtors will revolt against the spiraling cost of debt servicing. Mild inflation is preferable which is what the Great Moderation was all about. Of course the Great Moderation came about at the expense of developing nation as excess inflation from developed nations was exported to them. Hyperinflation leads to sudden and often violent regime change. If given a choice between hyperinflation and deflation current regime will often choose deflation as the wars do not always lead to regime change. What we have now is an understanding from China, India, et al is that it is preferable for them to still support some inflation import into their nation rather risk possible wars that may set themselves back several decades. Ultimately though, I think a Great Cleansing happens. Unfortunately in these periodic Great Cleanings the total world population are often reduce by >20% or more. That’s about the only way for growth to reassert itself in a finite world. In this next Great Cleansing, I do not know who will suffer disproportionately more. My guts say developing nations but it is very possible that developed nations may be worse off this time. Also the Great Cleansing does not always come at the hand of man. It could be some as yet to mutate super bug or catastrophic disaster like a huge asteroid impact, increased incidents of severe droughts, etc…
The math is very simple: the value of gold is not high enough to support this wonderful utopia of a gold standard universe free of fractional reserve banking.
The value of global output well exceeds the value of gold or the ability to produce more gold. A gold standard is inherently deflationary as a matter of course, because it isn’t worth enough and not enough of it can be produced to motivate and monetize future production. Gold would have to be worth quite a bit more than it is now in order to support the gold standard.
The markets have clearly decided that gold isn’t worth that much. Ironically, the goldbugs among this crowd must not believe in free markets, as belief in this gold god requires a belief that the market is fundamentally stupid, so much so as to have grossly undervalued what the bugs believe to be money. But they obviously haven’t done, and aren’t interested in doing, some basic arithmetic that would allow them to figure that out.
The goldbugs see gold as a restriction on the amount of new money that can be issued. I suppose if it were up to them, gold mining would be outlawed to prevent any dilution of the current above ground stock of gold. But goldbugs dare not suggest such a thing so then they have to explain how the rate of mining new gold just happens to be the optimum rate for economic growth (which they can’t).
The solution is not gold vs paper but eliminating the government backed money monopoly. That way free market competition will decide the best money solutions. Common stock and modern versions of tally sticks are solutions that do not require PMs and do not suffer from their limitations.
I agree with Axios’s arguments. Correlation is not causation. The euro crisis has to do more with europeans not having fiscal union than with single-currency issues.
As for Dimm’s comment about Krugman’s nobel prize, Long Term Capital Management (LTCM) had two nobel prize winners on its staff; look what happened to them. And btw, the nobel prize was given on earlier unrelated work. Please don’t use that to justify everything he does. Al Gore got a peace prize related to specific work on Global Warming awareness; that does not make him an authority on, say, cap-and-trade.
Why people keep believing that we can live in a world of In-flation, without having to deal with De-flation, is beyond me. They are like yin and yang, summer and winter, etc. “It is destructive economically and psychologically. It can literally destroy economies if it persists.” These same words from the top can be easily applied to Inflation; just ask the Germans or Zimbabwans.
Why people keep believing that we can live in a world of In-flation, without having to deal with De-flation, is beyond me. Raza S
That’s because under FRL credit money is created as it is lent and destroyed as it is repaid. It is conceivable to have a money supply that steadily grows at approximately the same rate as the economy. That way there would be neither price inflation or deflation. I believe the central bankers aim for that but can’t achieve it because they are wedded to the FRL money model.
Thank you Beard: I should have explained my point better. As credit money is created, it increases inflation (or asset price inflation, if you will) and as it is destroyed, it causes deflation. If we are ok with inflation, we should be ok wih deflation. I define inflation, btw, as a net expansion of money supply and credit. Also, I’m not for FRL and I do not think we need to grow the money supply with the economy. As Grandpa mentioned above, it only really helps the bankers who sit at the source of inflation. Mish’s Global Economic Trend Analysis explains it in much more detail.
I think you and I agree on most things. Keynes died decades ago. Niall Ferguson, the brilliant British historian, has been having an intellectual battle with Krugman for some time. He recently mentioned on Yahoo Tech Ticker that he does not think that Keynes would approve of the things being done in his name, if he were alive today.
I agree that a sudden and unexpected increase in deflation can bring the economy to a screeching halt. That happened during the Great Depression. The strange thing is that we were under a fiat currency system during the 30′s, and deflation is what the fiat system is supposed to prevent. But prices fell by almost 30% during the early 30′s and remained low throughout the decade. Price levels didn’t reach their 1929 levels until 1942. I think that a decade of suffering could have been prevented if the Fed had just reinflated to 1929 levels early on.
But constant low levels of expected deflation do not seem harmful. These were present throughout the 19th century when most of the world was on the classical gold standard. To produce price stability in a gold based monetary system the amount of gold would need to expand at the same rate as GDP. But GDP growth averaged around 3%/year while gold supplies only expanded by 2%/year, resulting in about 1% deflation. There were booms and busts during the gold era, just as there were during the 20th century but on the whole it was a period of relatively stable economic growth. The world did just fine (arguably better than we are doing now) without inflation.
Rob,
We were using paper money in the 30′s but the currency was fully convertible to gold. What we now have is a non-convertible floating currency that is proving to be quite robust in combating deflation. The issue right now is the austerity policy pushed by the politicians which is defeating the positives of our currency system.
Mike,
In early 1932, Roosevelt required everyone to turn in their gold coins and made ownership of gold illegal. At that point we were fully switched over to a fiat system. Before then, gold coins and paper gold certificates (which the government promised to redeem for gold on demand) coexisted. But during WWI, the government had issued a lot of gold certificates without owning enough gold to back them up. So throughout the 20′s the gold certificates were only 50% backed by gold. This didn’t seem to bother anyone until Great Britian and other countries devalued their currencies. Then people in the US started worrying, and people began closing out their bank accounts and demanding their withdrawals in gold coin. So there was a run on the banks and the banking system collapsed. This resulted in a shortage of money and prices collapsed.
Oh really?
“There are actually three different reasons to worry about inflation, two on the demand side and one on the supply side.
So first of all: when people expect rising prices, they become more willing to spend, and in particular more willing to
borrow. After all, when prices are rising, just sitting on cash becomes a tax – and they will spend even if it is not a
productive investment, because their cash is becoming worthless by the day..
If the economy is doing well, all this can be offset by just keeping interest rates high; but if the economy isn’t doing well, even a high rate may not be high enough to achieve full employment, as all liquidity goes into unproductive investment or simply speculating trading of assets and hoarding of some assets. People fight for wage increases, and there is labour unrest, leading to falling productivity.
And when that happens, the economy may stay depressed because people expect inflation, and are unwilling to work until they get wage increases, and inflation may continue because the economy fears spiralling wage demands and rising basic prices, and of course the supply shock from falling productivity. That’s the inflationary trap we keep worrying about.
A second effect: even aside from expectations of future inflation, rising prices worsen the position of the asset poor, by
increasing the real cost of living. Now, you might think this is a zero-sum affair, since creditors experience a
corresponding gain. But as Maine Fisher pointed out long ago (pdf), the asset poor are likely to be forced to increase their spending when their real cost of living rises, depressing their saving rate, while the asset rich aren’t likely to decrease their spending by the same amount to offset rising prices. So inflation exerts a “depressing” effect on spending by raising the real cost of living – which, as Fisher also points out, can lead to another kind of vicious circle, in which depressed real spending because of rising real cost of living leads to further inflation, as even the poor must buy whatever they can as soon as they have money hoping to trade it’s value later. I.e. they themselves are forced tinto unproductive investment and speculation which further depresses their neighbours net worth.
Fractional reserve lending seems to be a good way to kickstart economic activity . A static reserve rate assumes that future economic performance will fulfill the expectations according to the rate at the time loans are made . A static rate is obviously an unrealistic assumption . With todays computerized technology it would be possible to modulate the reserve rate between 0% and 100% – even on a per day basis if necessary – to correlate with any relevant and current enough real economic valuation in such a way as to eliminate any significant boom/bust cycles given that any pertinent systemic anchronisms , corruptions and inadequacies are sufficiently absent from the operation . In other words , a dynamic reserve rate could be implemented to expand and stabilize an economy .
In other words , a dynamic reserve rate could be implemented to expand and stabilize an economy . ron
You are asking a centralized authority to determine the optimum amount of new money to be issued which is impossible. Generally, it is called the “socialist calculation problem” which I believe Mises and Hayek identified. What we need instead is the minimum amount of centralization. Let the government issue money that is legal tender for government debts only (taxes and fees) and let the private sector develop monies for its needs and let there be floating rates between them all.