Analyzing Murphy on Mish's Deflationism

Robert Murphy over at the Mises Institute thinks that there are some questions on Mish's "deflationist" stance. You can find Murphy's full article here.

As I've understood it, Mish's basic argument is that attitudes, which are not easy to alter, have changed. Soon-to-be retirees are not going to spending as they thought they would given the dwindling of their retirement portfolios, the decline in their home prices, etc. They won't be dining out as much or doing as much traveling as they had looked forward to. As Mish pointed out in one of his posts, "In the meantime, cash strapped consumers spent recklessly for decades and need to save. They are. Proof is easy to find: US Savings Rate Hits 6.9%, Highest In 15 Years."

Another element of this that Mish has pointed out: mere printing of money and capital injections to banks is not as automatically inflationary as many would think. The banks are not lending the money, so it's just sitting there (not bidding up the prices of goods). Mish makes a compelling point: If I printed a trillion counterfeit dollars and just stashed them in a hole in my backyard, no inflation would ensue. The newly created money is likewise being stashed in the holes of banks. The banks have no creditworthy people to lend to and, as much as Congress tries, banks are simply not lending.

Murphy quotes from Mish:

[Some] inflationists look at consumers prices, some look at commodity prices, still others look at the price of gold as a measure of inflation. Of those watching money supply, some concentrate on Base Money supply as Gary North does, others M2, M3, MZM, or even Austrian Money Supply as a measure of inflation…

Every one of them is wrong.

We have a credit based economy and anyone watching money supply and not watching credit is simply wrong. This is a statement of fact, not idle conjecture. Only those watching and expecting the collapse in credit and understanding the role of gold got things correct. This is a very small group of people.

Murphy takes on this point, which he sees as Mish's core argument. He uses a hypothetical in which a gold-based monetary system creates a system of credit and says:

Actually, it's not at all obvious that the new credit card system would push up prices, because credit cards don't create new money. When Jim swipes his Rothbard card to buy a suit at a price of one gold ounce, the merchant still gets paid in gold. What happens is that Rothbard Express makes a short-term loan of one ounce of gold to Jim, who then spends it on the suit.

After the transaction clears, the tailor has one additional ounce of gold, Rothbard Express has one fewer ounce of gold, and Jim has the same amount of gold. On top of that, Jim's outstanding debt to Rothbard Express has increased by one ounce of gold, while on Rothbard Express's books, the claim on Jim has increased by one ounce of gold.

In other words, Murphy argues that a collapse in credit would not necessarily be deflationary because the credit system would not result in bidding up prices in the first place. Any money issued on credit must be accounted for and stored up by the lender, the net inflationary effect being zero. Murphy admits that people with credit cards will reduce their cash holdings because they know that in the case of an emergency they will still be able to tap their credit lines (not sure how inflationary this would even be). However, Murphy notes, the decrease in cash holdings by the credit card holders, would be offset by the great expansion of the credit issuer's cash holdings. Murphy "guesses," however, that the expansion of the plastic issuer's cash holdings would only partially offset the reduction of the rest of the community's cash holdings.

Murphy continues:

Having made that concession, I still don't see why the bursting of the housing bubble will lead to mass price deflation. If American households are trying to pay down their credit card debts, that's not the same thing as taking away their option to charge a true "emergency" purchase, which most households can still do. It's true, households did in fact expand their cash holdings in 2008, but I think their actions were more attributable to the general uncertainty of the future, than to the tightening of credit standards.

This is where I think Murphy's argument is really weak. Firstly, to say that the pullback from credit issuance will not be as deflationary as Mish argues based on the fact that "emergency" purchases will still be in place seems to exaggerate the effect of such purchases. Whereas before consumers and retirees planned to spend on TVs, cars, vacations, traveling, etc., emergency purchases will be only a fraction of their previous credit usage. Furthermore, Murphy seems to (without any real explanation I can see) abandon his strict logical argument from earlier that credit issuance is not inflationary in the first place since those that extend credit must expand their cash holdings. So is credit inflationary or not? In other words, first Murphy argues that credit is not inflationary, but then he says that emergency purchases (which is hard to see just how inflationary that can be) will still be in place thus combating the deflationary force.

I think the issue of credit as an inflationary force needs to first be settled. Mish seems to accept that it is inflationary. If you accept that, then it's hard to disagree that attitudes have changed drastically and that the spending habits of consumers and retirees will fall accordingly.

Comments

[BlackyBlack:]

I also would add that Murphy is ignoring the previously very inflationary effect of securitization on all that credit. If at every stage of the game, credit is securitized (or leveraged), then the (almost total) collapse of securitization on all that credit is way more powerful a deflationary force than just the pull back in credit itself.

Jul 20 01:49 PM

[Jakester:]

Jonah,

Good article. I had the same misgivings about Murphy's arguments when I read his rebuttal. In fact, if credit is not inflationary, it sort of nullifies the whole Austrian argument as far as I can see.

Jul 21 09:13 AM

[Gregman2:]

Mish also factors in excessive debt levels to an asset deflation understanding, moreso than simply deflation-as-disinflat...

Jul 21 11:03 AM