Topic: Economics
Deflation the Great Wealth Builder Deflation is usually a natural reaction of the economy rather than something to be avoided at all costs. It can inflict considerable damage but also restores equity and balance. by Gene DeNardo
(centrist liberal libertarian)
Saturday, December 27, 2008
"By means of these operations, the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and to fulfill their engagements with a smaller quantity of silver than would otherwise have been requisite."
Adam Smith..The Wealth of Nations
Deflation is usually looked upon with disdain and considered to be a "wealth destroyer". This certainly can be true, but the inverse is also true. Viewed within the framework of an equilibrium, deflation is also tremendously effective in building wealth and bringing equity to those who are normally get the short end of the stick in inflationary times.
The definition of inflation is hotly debated. Economists have differing ideas on its exact meaning. Government defines and quantifies it to be a much smaller entity than the consumer actually experiences. This retains their monetary policies in better light. One thing we do know though, the symptoms of inflation are always either higher prices and/or decreased purchasing power.
Inflation signals its presence in two ways. Monetary inflation is considered excessive growth of the money supply which correspondingly lowers the currency's purchasing power. Price inflation is just that, prices rise above their past levels.
Either way, inflation and deflation go hand in hand with supply and demand. Monetary inflation concerns the supply and demand of money and price inflation is determined by the supply and demand of the good or commodity also taking into account the relationship with currency. When the money supply is kept in balance with the economy the boom-bust cycle of inflation and deflation is usually much less extreme with highs not as high and lows not as low. Still, the segment of the economy that distributes money, the financiers so to speak, always seem to devise ways to increase the money supply even without the aid of a printing press. After all, if you deal in money, more always seems to be better, regardless of the effect on the rest of us!
Disinflation is defined a lessening of previous inflation. A lower rate of inflation than the previous time period. When prices head into negative territory from the previous time period, it then becomes deflation.
Traditionally the creditor makes out big time with deflation as the same debt is repaid with higher value currency. And the debtor is thought to gain, although this is somewhat an oxymoron, during inflationary times as the debt appears smaller when numerical monetary values climb. It is important to consider that insolvency is common during deflationary times and debts can be abandoned. When this happens the creditor experiences the risk that prompted his original return. Too much of that and the creditor can also become insolvent, which can spur a cascading effect.
If you happen to be fortunate or leveraged enough to be an investor, then you are also fundamentally a creditor. If you are locked into a specified return for a specified time period, you will experience the same benefit that is mentioned above for creditors, when your investment matures, you will receive your principle and interest with an increased purchasing power as a bonus. If deflation is serious, then it becomes more important that your investment is backed or insured, again being aware of the greater chance of insolvency that is possible.
If you are an investor in the markets, you have willfully released your money to someone you may not even know, basically on a handshake and a signature. You may get your money back, you may receive a huge return, you may take it in the shorts. Really, no guarantees. The creditor-debtor guidelines are reversed in this case; as an investor-creditor in inflationary times you are usually rewarded, in deflationary times, the party on the other end may need every dime and that includes yours. It's a complicated subject and of course depends on the particular market and many other considerations.
The poor and the working poor should have little fear of deflation. Most of this is because when there is little to lose, there is little to lose. Since prices normally will be falling and to the struggling every dollar counts, deflation can be beneficial. The necessities of life become more affordable. Unless there is an actual depression, jobs on the lower tiers are usually not in jeopardy. These are jobs that are somewhat undesirable but necessary to the structure of our daily lives. Wages in these positions are already suppressed and don't have much room to fall. This segment of our population is more than likely to experience a bit of breathing room during deflationary times. This also applies to anyone on a fixed income at any income level. Lower prices have the effect of a raise while receiving the same monetary amount.
The biggest single factor in the middle income tier is amount of leverage. If one has mountains of debt, then deflation can hit hard. The highest percentage of job loss or displacement will occur here. The reason is simple, if your boss is in the upper tier, he or she will hesitate to fire him or herself! If you are pretty much in the same social strata, then either of you could go! However, if your job is secure or a replacement job is available and your debt is under control, deflation will bring you increased purchasing power. Wages may fall, but they seldom fall with anywhere near the same force as other indicators in a deflating economy. Conversely, they never rise with the same intensity as inflation and when they do it is usually too little too late.
The upper tier of our society has a unique role in the inflation-deflation cycle. Price increases or decreases are of little concern in the daily lives of these folks as the percentage of their total income they require for subsistence is low, irregardless of relative cost. Job security as we have mentioned is good, for they are the ones calling the shots. The businesses that are integral to the wealth of the upper class can be threatened with liquidation during deflationary times; again the crux of the matter is liquidity and credit standing. If the debt cannot be serviced, insolvency occurs. Well, unless you use your influence to convince Uncle Sam you are too important to the greater economy to fail! In this case, poor planning and bad investment pays a bounty.
The biggest shift usually occurs in the asset area. Deflation causes a devaluation of assets of all types. Buildings, machines, houses, bridges, roads, natural resources, all the things that make up the physical nature of our economy are still there, still producing but the monetary value we place on them has decreased. Whether reacting to a general slowing in the economy, fear of the future or just returning to a more real value, asset devaluation is a fundamental of deflationary times.
This asset devaluation is a seismic shift in the distribution of wealth. Ownership of assets is the single most important factor in the stratification of wealth. Monetary values, as opposed to value [numeric values as opposed to purchasing power] represent the distance between citizens of small or average means and those of great means, distance between rich and poor. Deflation in a "Fiat" economy almost always causes monetary values to fall while purchasing power rises. This is a return to "real" values that have been left behind by the concentration of wealth created by inflation. The economy is attempting to reconnect with "working" numbers, to again reflect the absolute relation between resource, labor and capital.
It must be noted again, Capital itself has not changed. It may be experiencing less use or utility until values readjust, but unlike a War where massive amounts of Capital {most importantly people} are destroyed forever, Capital remains intact. This is the sole reason the above is true. Numbers have been distorted by inflation to benefit the owners of capital and deflation is correcting the accounting. It is bringing back value to those who labor, to those who are salaried, to those who have finished their working life and are subsisting on existing funds, to those who are starting their working lives with little savings, to all who haven't been blessed already with copious amounts of capital and the privileges it brings. By closing the gap, it is providing fair opportunity for all to partake in the workings of the economy and be compensated justly.
We would have to be without heart to believe there are no tragedies during deflationary times. A wrong decision, lack of knowledge about an investment, being at the wrong place at the wrong time, all these events can lead to economic devastation for an individual during deflation. Most of the negative effects remain in plain view for all to see. But we can look at this process as a remedy for the inflationary disease. And remedies can certainly have side effects.
On the other hand, inflation carries on its destructive work under the cover of darkness. Weeks and months and even years pass until hard working people wake up one morning and realize they have been working harder and harder and yet are in worse shape than they were. The see conspicuous displays of wealth around them and in the media, yet they seem to only make negative progress. Certain people become extremely rich, but the majority seems to slowly slip down the economic slope. On a worldwide scale, this can happen within segments of particular societies or to entire nations.
For every gain there is loss. Deflation is not the perfect method, but it does return some of the unearned value that has occurred during periods of inflation. When inflation is not a real market reaction to supply and demand but instead a result of directed or indirect actions by those with the means or monopoly powers to inflict such damage, deflation is the hand of economic reason attempting to restore equilibrium. In this respect, we should be glad to see it.
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The views expressed in this
article are those of Gene DeNardo only and do not represent
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Posted By: Jake, the champion of the constitution
Date: 2008-12-29 04:36:56
Gene -
good stuff. Perhaps a succinct way of saying it is deflation is pro-saver, inflation is pro-elite and anti-saver? I think the poor and people on fixed incomes get hit hardest by inflation, while deflation is bad if you are a debtor, as you pointed out.
Which explains a lot.
You wrote:
"Weeks and months and even years pass until hard working people wake up one morning and realize they have been working harder and harder and yet are in worse shape than they were."
Hey, I have a time for you - 5 years, 11 months, and 10 days. :) peace!
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