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Dispelling The Deflation Myth 2 comments
Are There Any Deflationistas Left?
As I have said and written over the past year: Deflation is not a threat, instead inflation is the greater threat. Significant and sustained Price Deflation is not a threat under a Fiat Currency and a profligate free spending Congress.
The Rise And Fall of Deflation
The modern inflationary era began in 1933, when the U.S. was taken off the Gold Standard, and the dollar became a fiat currency. It took the dollar many decades to be fully delinked from gold, culminating in the early 70's when the dollar was finally delinked from gold. Since 1933, the dollar has gone through progressive devaluations. The dollar became a fiat currency to give the US the ability to fight economic depressions. In a fiat money system, the central bank has the ability and the mandate to print as much currency as it sees fit and to issue as much credit as it sees fit to counteract the deflationary pressures experienced during recessions and depressions.
And indeed, as Rob Viglione's excellent chart shows above, the Fed has been remarkably successful at preventing price deflation. We have had only two bouts of mild deflation since 1933. The conversion from a Gold standard to a fiat currency, has effectively eliminated deflation in the past 75 years, and has replaced it with inflation.
For a closer look at deflation since 1933, refer to a more detailed chart from the St Louis Fed. Both bouts of deflation lasted less than a couple of years, and levels of deflation were below 5%.
The Cure As Bad As The Ailment
The "cure" has had it's side effects: persistent inflation and a devaluation of the U.S. Dollar. The central aim of a Fiat Currency was to loosen money during recessions and then tighten money during booms. The U.S. Government addicted to easy money, neglected to tighten money during booms, as they found a way to print money and borrow with abandon during both good times and bad. Milton Friedman put it best:
Bad Money
Inflation has become a hidden tax on the American Saver, as it erodes the value of their fixed income and cash, to the benefit of the issuer of the currency as Alan Greenspan said:
The above statement doesn't mean that I am advocating the private ownership of gold. Instead, it means that every private citizen is better off under a stable currency policy.
Asset Deflation vs. Price Deflation
There are two types of delation: price deflation and asset deflation. (Price Deflation being the opposite of price inflation). Asset deflation is a drop in the prices of assets including real estate and equities. When the stand alone word "deflation" is used, it nearly always refers to Price Deflation. During the bust of the late 80's, Japan experienced a simultaneous Asset Deflation, along with a mild Price Inflation. Japan did not experience a Price Deflation.
The same thing has happened here in the U.S. as we have witnessed an Asset Deflation. We have not seen a Price Deflation in the U.S., and due to the reflationary powers of the Federal Government, nor are we likely to.
Any more deflationistas left?
DISCLOSURE: Author is long U.S. Equities, Foreign Developed Equities, Emerging Markets Equities, US TIPS and WIP. You should perform your own due diligence and consult with a professional before investing.
Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.
This post has 2 comments:
"Msoane:
Good article. Incredible graphic.
Large productivity gains in the 1990's coupled with constant downward price pressure on consumer goods as a result of the growth of inexpensive Asian imports kept the lid on price deflation and hid the effects of large money supply increases. The money supply increases showed up in financial assets and homes, which don't suffer from a technology cost curve or overseas competition; therefore you certainly can have some sectors of the economy or asset classes experience asset inflation while others don't."
Comment 2: there were also many comments about the accuracy of the US Official CPI
Comment 3:
Nathaniel C: "Von Mises warned that central banks always use the deflation argument to print money and debase the currency. Anyone who lives in the real world realizes that the US has not experienced deflation since the Depression. It is unfortunate that people associate delfation with the Depression and blindly listen to government officals and central bankers who claim that we have to "defeat" deflation and cause inflation to protect the economy.
Deflation can be a good thing. Look at the computer industry which experiences massive delfation and yet reports increased profits and high margins. In an advanced economy like the US we should be experiencing delfation as a result of increased productivity and technological improvement--not perpetual inflation like we are used to. The only way the US could experience deflation is if the Fed dramatically reduced the money supply (LOL).
Marc Faber noted that deflation is a good thing and that many countries have experienced prosperity during price deflation. Deflation increases your purchasing power and rewards savings (which forms the capital in capitalism as oppposed to debt financing).
It is bizarre that people like inflation and belive it to be a natural part of capitalism. Greesnpan in his memoirs noted that the US did not experience inflation between 1787-1913. The dollar maintained its purchasing power and prices were truly stable (there were of course periods of inflation during war times but that was followed by deflation). The US economy did very well during this period but of course we were under a gold standard. Jun 14 01:54 AM "
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