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Thursday, November 18, 2010

The D-Word

Richard Salsman deflates deflation:

Many economists presume, falsely, that deflation necessarily coincides with (or causes) a contraction in economic output. In fact, deflation by itself in no way curbs the motive to produce, because it doesn’t preclude the maintenance of business profit margins. During the Industrial Revolution, deflation was common. It was also a bullish phenomenon in the second half of the 19th century, the period of the fastest economic growth in human history. Consider the empirical record during the three to four decades between the U.S. Civil War (1861-65) and the First World War (1914-18). There was a huge increase in output (and profits) in the world’s major economies during this period, even as price levels increased only marginally or even declined (“deflation”).

But what about the Great Depression? Milton Friedman warned us about deflation and depression!

That deflation and economic depression seem to have coincided during the Great Depression of the 1930s has caused generations of economists to improperly indict (and fear) deflation. In fact, that debacle was instigated and prolonged not by “deflation” per se, but by a series of wealth-destroying public polices: (1) a deliberate inversion of the treasury yield curve by the Federal Reserve in 1928-29, (2) huge tax hikes on a broad array of imports, starting in 1930 (the protectionist tariffs imposed by the Smoot-Hawley Act), (3) a massive hike in the federal income tax rate on the rich, from 25% in 1930 to 66% in 1932 (which slashed in half their incentive to produce income, since it cut the after-tax retention rate from 75% to 34%), and (4) a 41% devaluation of the U.S. dollar, in March 1933 (i.e., a one-time massive inflation).

Oops. Richard Salsman is a professional economist. In other words he puts his money where his mouth is. Unlike government officials.

Posted by Richard Anderson on November 18, 2010 | Permalink


The best quote in the whole article:

"The so-called “fear of deflation” is nothing but disguised sympathy for over-leveraged deadbeats (or high-cost firms), coupled with a thinly veiled disdain for greedy lenders, bankers and investors."

Today, by far the biggest over-leveraged deadbeat on the block is the government. And not just the federal government, but all levels of government. Almost all central banks today are feverishly stoking inflation because it will allow governments to essentially walk away from their direct debt obligations not only to bondholders, but from future obligations that arise from unsustainable middle-class entitlement programs like medicare and various pension plans.

Most government know they cannot possibly meet all the obligations that they have promised to the masses in real terms; instead they will honor them in nominal terms with worthless paper.

Posted by: Dennis | 2010-11-18 11:30:47 AM

Various Keynesian dingbats typically maintain that if you allow deflation to take hold, the economy will collapse as people avoid purchasing things today in the knowledge that they will be cheaper tomorrow. How do these people explain the explosive growth in the personal computer market which has been characterized by a massive deflation in prices for these goods? If the Keynesian thesis were true, the computer industry should have imploded long ago.

Posted by: Dennis | 2010-11-18 11:42:47 AM

What must be recognized, while liberals are too stupid to see it, is that the marketplace will find its equilibrium by adjustments in supply or demand. In the movements of both, one can have inflation and deflation -- that occurs naturally as markets move toward their equilibrium. Statists fear inflation and use this bugga-boo to no end because their are, via taxation and the cost associated with their regulations, the sole cause of inflation. The second someone mentions deflation, statists are called into account for their excesses, which they want to avoid public discussion of, because the harm they cause to the economy is surely revealed. Statists love inflation because it reduces the size of the deficits they create via currency devaluation.

Posted by: AB Patriot | 2010-11-19 9:07:12 PM

It's interesting that some central banks are acting (somewhat) responsibly, particularly Australia's. This is an excellent article.

Posted by: Cytotoxic | 2010-11-21 1:45:56 PM

It is important to watch the situation in Ireland, as what develops there will serve as a method by which governments will be dealt with in crises such as these. In Ireland, the government have been found out to be bold-faced liars on the state of Ireland's finances. First they declare no need for a bail-out. Now they say a bail-out is required, but they are not willing to admit the extent of the government's excesses, particularly in bailing out Ireland's commercial banks in sums of monies that remain secret to this day. Now, the size of the bail-out has been estimated in the range of hundreds of billions of Euros. The media is Ireland is calling for the government to leave office quietly and of their own accord or else. Or else? Now, that is the call I would like to hear more of. My sincere hope is that Ireland governments stubbornly stay in office so that they maybe ousted, hanged, and cast into landfills with the rest of the rubbish. The time is clear that citizens must consider the inescapable fact that we must begin executing governments. Hopefully, Canada will follow suit where Ireland is headed.

Posted by: AB Patriot | 2010-11-21 2:33:19 PM

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