The Fed has begun another round of large scale money creation in the interest of fighting off the deflation boogeyman. What should we be more afraid of, deflation or "Helicopter Ben"? by Gene DeNardo
(libertarian)
Wednesday, November 17, 2010
"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
The Federal Reserve has begun a "quantitative easing 2" program in which they will create 600 billion dollars by purchasing bonds from their selected trader buddies and purchase another 300 billion of questionable bonds, supposedly from their "returns" from existing bonds in their highly secret portfolio. All this to avoid that evil monster of deflation that our leaders live in constant fear of.
While this is serious stuff and a good time to analyze the effects of monetary inflation and deflation on all of us, the following video does a fine job of making light of the situation. It has to be one of the funniest videos ever with economics as the subject matter.. [link edited for length]
How one views inflation and deflation depends much on their financial status. Inflation is viewed favorably by those indebted and by economists that favor debt based economies, because debt grows smaller in relative monetary terms under inflationary pressure. In contrast, debts grow relatively larger within a deflationary context.
This is due solely to the changing relation of the debt to the amount of money circulating in the economy. The same amount of debt is a greater portion of a deflationary economy and a smaller proportion of an inflationary economy.
Monetary inflation is an increase in the money supply. In most circumstances, monetary inflation will cause an increase in price inflation, but there are some exceptions.
The Keynesian theory is that price inflation is held in check as long as subsequent production matches the monetary supply increase. If you put the cart before the horse, Keynesians believe everything will be okay as long as the horse eventually gets back in front of the cart. Keynesian practice though, has shown that the cart seems to always stay in front of the horse and price inflation has become a fact of everyday Keynesian life, since that theory found favor with world governments.
There is a saying that it isn't the actual money supply that is important, but the money that is circulating. If money isn't circulating, then prices won't necessarily rise in reaction to greater money "supply". The problem with this assumption is that modern coercive banking practices really don't allow true storage of money. While the "circulating" amount of money changes proportionally to the total amount of money and the velocity or turnover of money changes, virtually all money in the world is circulating in one way or the other.
Debts grow smaller with inflation because the money that is used to pay the debt back has been devalued. There is more of it and that lowers its value. Creditors are in a sense receiving a lower return on the initial debt. But, don't worry about the major creditors, the banks; since they are ones causing the inflation by creating the new money, they benefit coming and going.
The greatest deflationary fear is that of spiraling debtor default due to the increasing value of the currency, which makes the original debt amount harder to come by. If enough creditors don't get paid, then they also can fail to meet their obligations and the descent into widespread bankruptcy spreads.
While it may seem odd that deflation can occur without a corresponding drop in the money supply, it is similar to what we hinted at above concerning monetary inflation during a period of stable or deflating prices. If people don't circulate money at the same velocity or hold cash reserves, price or asset deflation can occur during a time when money is freely available, such as the present, but being held rather than spent.
The very poorest, those who are damaged by just about every economic condition, cannot be hurt by deflation. Without material wealth that can depreciate, without a job to lose in the downturn, they have little to lose. Any price deflation that occurs can only benefit them and help their minimal finances stretch a bit further.
Those in the middle, neither poor nor rich, will be affected by deflation dependent upon their individual relationship with debt. The more debt one possesses, the greater risk monetary deflation poses. This is due to the likelihood that businesses will cut back not only on wages but positions. Finding reemployment might be tough. Any debt load might prove insurmountable. While assets, including homes, lose their value, they may also lose their owners. Price deflation will also benefit the middle tier, if it accompanies a tightening of the money supply.
Price deflation is of little concern to the wealthy. They spend a very small percentage of their overall income on consumer goods. Assets, which can double and triple during monetary inflationary periods, reverse that trend with monetary deflation. Usually the debt ratio of the well off isn't as much a concern, but since the wealthy are usually creditors in one way or the other, payments there are receiving may falter and investments decline. They own businesses and those enterprises may face insolvency if revenue declines appreciably. Some wealthy folks have "lost it all" during deflationary periods, but due to the large financial buffers most hold, that is the exception rather than the rule.
The world is dominated by "fiat" economics. Deflation in the fiat economy is the reaction of the economy to monetary inflation that is the result of governments creating currency at will with no value backing the currency. Currency production usually causes price increases that exceed the "inherent" or economic value of goods, most especially assets such as real estate and stocks. This soon causes inflation within the commodity markets and consumer goods. When the value gets too far removed from the reality of economic decisions, continuing in an inflationary manner becomes impossible, no matter how much currency is created. Deflation begins and attempts to return the system back to a reasonable price and value relationship.
We commonly hear that "purchasing power" increases during deflationary periods, but this is somewhat of a false assumption. Monetary inflation destroys purchasing power. Prices rise not due to some great shortage or natural catastrophe, but because there is more money available for every good and service. Monetary deflation attempts to restore what would occur naturally; prices that are related to actual value. While prices may even drop a bit below real value in certain sectors during fiat caused deflation, this is usually a short lived phenomenon.
The fiat economy is not a temporary occurrence, but a condition of the existing capital system itself. Money seldom "leaves" the economy it instead "takes a break". As long as there is abundance of currency and shortage of goods and services, prices will soon revert to inflationary levels and beyond.
The total aggregate amount of wealth that exists is unaffected by monetary policy, although the creation of wealth is much influenced and downturns can actually cause foolish destruction of wealth. What predominately occurs is wealth redistribution. While the underlying value of wealth cannot be altered by currency fluctuations, the price certainly can.
Also, the "rent" of land, assets and capital improvements are altered and distorted in relation to their actual value. The "rentier" class is able to draw more income in price terms from their assets as long as the inflation cycle holds out. They aren't necessarily receiving greater "value". Inflation is of little value to the working class as wage increases almost always are too little and too late, while price increases are instant and constant
.
Both monetary policy inflation and deflation are destructive. They override and destroy the value system which we utilize to carry on and interpret our economic lives. They have no purpose other than to enable the administrator of monetary policy, the state, to afford its own careless expenditures. It is a covert tax on the economy and every person within the economy to pay for an uncaring government and those wards that directly benefit from the policies of government.
Price deflation that comes as a result of more efficient production methods shares little in common with monetary policy deflation. It is instead the product of cooperative economic effort that permits us to produce more in the same amount of time or the same product in less time.
It is said that true price deflation is a friend of labor and production and an enemy of speculation and high finances. With our controlled fiat money producing economy and Ben Bernanke at the wheel, we are unlikely to ever reap the benefits of true deflation. However, we can most likely look forward to the drawbacks of inflation.
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