There Is No Deflation

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get something clear: there is no deflation.

Let me
put it another way: deflation, there is not.

are newsletter writers who do not define deflation, and then
say that there is some. Lots of it. Just around the corner.
Real Soon Now.

Let me
define deflation: a decrease in the money supply.

it. The easy definition is the reliable one. Stick with this
definition, and you won’t make any big mistakes in monetary
theory. Abandon it, and you will make lots of mistakes.


is no deflation in computer prices. This is because computers
are not money. So, there can be neither deflation nor inflation
of computers. There are falling prices for computers. For ninety
years, there have been steadily falling prices for computation.
There is no “crisis in computation.” Companies come and go,
but the consumer wins. Are we agreed?

is no deflation in energy. There is also no inflation. Energy
is not money. The same applies to all other commodities, excluding
only gold, and not all gold — only that gold which serves as
part of some central bank’s asset base.

Then where
is this much-heralded deflation? In prices? They tell us that
there is deflation in China. This is amazing, given the fact
that the Chinese central bank admits to an increase in the money
supply of 18% over the last year.

Can prices
fall when the money supply rises? Yes. Computer prices fall
continuously, no matter what the Federal Reserve System does.
Chip efficiency rises. Benefits to computers rise. Nobody is
yelling in the streets, “Computational deflation is coming!”
The sky is not falling.

Can all
prices fall when the money supply goes up? Who knows? We cannot
monitor all prices. We do not need to monitor all prices. I
need to monitor the prices of a few items, such as the things
I buy regularly and the things my competitors sell regularly.
Anything else? The things I may buy and the things my competitors
may sell. Anything else? Only the price of my wife, as compared
in rubies. “Who can find a virtuous woman? for her price is
far above rubies” (Proverbs 31:10).

The price
of consumer goods is falling, we are told. I respond: Which
consumer goods? And what if they are? As long as the price of
investment newsletters isn’t falling, that’s good news for me.

I think
maybe that’s the root of the problem. Demand for investment
newsletters is falling, mainly due to the rotten advice they
provided in 1999 and following. So, newsletter editors look
around them, see reduced demand, and start worrying about falling
prices, a phenomenon they call “deflation.”

The issue
is this: What is happening to the money supply in China? It
is going up. It is doubling every 5 years.

What about
China? Are prices falling in China? Not the price of real estate
in Shanghai. Not the price of luxury condos anywhere else. Some
prices may be falling, and probably are falling. Others are
rising, such as the black market prices of goods whose production
is still monopolized by the government. I suppose the price
of justice is going through the roof. I mean bribes. No more
Third World, Mao-era prices. New, capitalist prices!


The money
supply in the United States keeps rising. Rates change; the
direction doesn’t.

What about
prices? The rate of increase has slowed. I use the Median CPI
figure issued by the Cleveland Federal Reserve Bank. It removes food and energy. It was up by
2.2%, May 2002 to May 2003. It was rising at 3%, December 2001
to December 2002.

So, where
are there signs of deflation? Not in the money statistics. Not
in the price statistics. When we eliminate money and prices,
however, deflation is just around the corner. You can see it
lurking over there, right next to inflation. They play “good
cop/bad cop.” In times of rapidly rising prices, deflation is
the good cop. But, usually, deflation is the bad cop. So it
is these days.

The public
worries about whatever it hasn’t planned for. When everyone
(meaning 80% of 20% of the population) is hedging against inflation,
everyone worries about inflation, but they worry even more about
deflation, which will create losses in their inflation-hedging
portfolios. When inflation is making investors feel rich, they
can complain about inflation, but it’s like the man who lives
in a rent-controlled apartment in New York City, who complains
about the shortage of apartments. He isn’t so upset about the
apartment shortage that he is willing to vote for someone who
promises to abolish rent controls.

the public — anyway, newsletter readers — is worried about
deflation because (follow this, please) the public is buying
larger homes by taking on large mortgages. Home buyers are taking
advantage of the FED’s inflation and the economy’s slow growth.
When you load up on mortgage debt, falling prices do threaten
your net worth, which is down to zero anyway because you just
took on a debt that ate up your equity.

As to
debt, the public cares only about the monthly bills. People
care nothing about how much they owe totally; only how much
they owe next month. We can see this in the amazing stability
of the Household Debt Service Burden statistics, which range between 12.5%
and 14.5% of personal income. Year after year, decade after
decade, this figure inches up or down, but it never changes

With interest
rates down, especially mortgage debt, the public is refinancing
or buying larger, more expensive homes. It doesn’t cost them
more on the first of the month to finance their new lifestyle.
They don’t care about their net worth; they care about paying
next month’s bills. They care little about equity and less about
their total debt. They might as well be Congressmen.

Why should
they worry about inflation? After all, they have locked in their
mortgage payments for — say — five years. The smart ones have
locked it in for 30 years. The adjustable rate mortgage (ARM)
people — “ARM and a leg,” I call them — will start feeling
the pinch when long-term rates go up in response to the FED’s
inflation. Their monthly mortgage payments will increase. So,
they will be forced to cut back elsewhere, which will upset

The price
of housing will then slow or even go negative. Why? Because
new buyers will not be able qualify for loans at higher rates.
So, demand at prices that prevailed during this low-rate phase
will fall.

Fear of
inflation can lead to rising mortgage rates, as lenders refuse
to lend at a fixed rate, only to be repaid in depreciated money.
In other words, a fear of monetary inflation and rising prices
can force down the price of housing. So, tell me, will that
be a time of inflation or deflation? And the answer is. . .
. “It depends on the money supply.”

If the
money supply is rising, it will be a time of inflation. If it’s
falling, it will be a time of deflation. Don’t be deceived.
Stick with the definition of inflation or deflation that tells
you what central bank policy is. Don’t be swayed by changes
in the price of anything. Watch the money supply. Follow the


The price
of imports is falling. Well, they were falling before the dollar
fell by 30% against the euro. Anyway, goods cost less because
of Asia. "This is deflation! Asia is exporting deflation!"

No, Asia
is exporting goods. The only organization that can export deflation
is a nation’s banking system. I would not call what Asian central
banks are doing to their money supply “deflationary.” I would
call it Chinese fire drill inflationary.

But, newsletter
editors reply, this will create a profit squeeze for American
producers. I answer: So what? This process has been going on
since about 1955. When Asia and Europe began to recover from
World War II, they started exporting. Was this “exporting deflation”?
Or was it the United States “exporting inflation”? It was neither.
In a world of central banking unencumbered by a gold standard,
every nation is exporting inflation. Look at the price of goods,
in any nation, in 1913. Compare those prices, in any currency,
with prices today. The trend has been up. The only exception
is the cost of computation.

is buying from Wong, who lives half way around the world. This
upsets Smith, who lives across the country. It also upsets Fukuyama,
whose grandfather was part of Japan’s Greater East Asia Co-Prosperity
Sphere, which killed ten million or so Chinese civilians, 1933—45.
If Wong and Jones have worked out a deal, why should Smith or
Fukuyama complain? I can think of only one rational reason:
they wanted in on the deal, but were unwilling to make a better
offer. But they are not going to admit that this is their motivation.
That would make them look crass and self-serving.

But what
about falling demand? Won’t people who expect deflation refuse
to buy? I answer: not when we’re talking about computers. Anyone
who buys a new computer knows that it will be obsolescent technically
on the day it arrives. So what? Does anyone use the full power
of any desktop computer? Nobody I know. Does this mean the end
of the computer industry? Of course not.

Ford cut prices every year prior to World War I. Did that kill
the auto industry? No. Did it bankrupt rival auto companies?
Yes. Did Ford benefit consumers? Yes.

Why does
anyone worry about falling prices, unless he is overpriced?
Why do newsletter editors keep warning us about the looming
deflation? I’ll tell you why: because it sells newsletters.


If there
were a crisis in the derivatives market, and fractionally reserved
banks could not clear accounts with each other, that would cause
deflation on a scale undreamed of by Milton Friedman in his
wildest speculations. Could that happen? In a world of lies,
on which fractional reserve banking rests, of course it could
happen. The entire banking system is a gigantic web of lies,
all resting on one foundational lie: “You can withdraw your
money at any time, even though we have lent it out long-term.”

But the
kind of deflation that a bank payments gridlock could create
is not what newsletter editors write about. A payments gridlock,
if it were not overcome by central bank inflation, would lead
to the deaths of tens of millions of people. The international
division of labor would shrink so far and so fast that few newsletter
editors could survive.

Then what
kind of deflation do newsletter editors have in mind? One that
reduces sales? Did Henry Ford reduce sales? They worry about
the deflation of the 1930—32 era. The central banks will
produce credit, but commercial banks will not lend. I answer:
So what? Central bankers in 1930 did not have seventy years
of Keynesian economists and fifty years of monetarist economists
on their side. They were cautious. They did not take their newly
created money and buy up everything listed on the New York Stock
Exchange. They will if anything like 1930 happens again, let
alone 1932.

What can’t
they buy? Who won’t sell it to them in a time of falling prices?
When you have the power to create money, you have the power
to buy anything from people who trust your money.

The kind
of deflation that worries newsletter editors is so unlikely
that I wonder how they can keep inventing reasons for their
concern. There is only one deflationary scenario that makes
any sense: a banking payments gridlock. That’s not the scenario
that newsletter writers write about. Any editor who thought
that scenario is even remotely likely would move to Arkansas
and buy a farm with a natural gas well on it, and then buy a
power generator and refrigerators that run on natural gas.

15, 2003

North is the author of Mises
on Money
. Visit
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