All Things Considered ran two back-to-back segments on the supposedly looming threat of deflation. The primer presented by Adam Davidson before an interview with a Fed official was full of confused thinking. I’ll just pick apart what it leads with, but the whole thing must be heard to be believed:
Ladies and gentlemen, I have an amazing investment opportunity for you. Give me $100, just a hundred, and in one year I promise it will be worth 93 bucks. We call it the deflation special.
If, by “worth,” Mr Davidson means the commodity-price of the dollar — that is, what you can buy with $100 dollars now versus how much that will cost in the future — then this is just plain wrong. It is under inflation, not deflation, that you get less bang for your buck over time. So, I assume that this is not what he meant, but, since this is probably what most people will interpret as his meaning, it was, at best, a poor example to present to a lay audience.
What Mr Davidson appears to mean by “worth” is that if you buy something for $100 today (say, stock in Microsoft), then, after a 7%* deflation in a year, you try to sell the stock, you will only be able to sell it for $93. But he makes it sound like if you put $100 in a CD, the CD won’t pay you interest** and you will only get $93 back, and, furthermore the real value of the dollar remains unchanged, so you take a net 7% loss.
But, what this disingenuous explanation fails to explain, is that since the price of all goods and investments are falling at this rate, you can still buy the same quantity and quality of goods for $93 in a year as you can buy for $100 today. The real value of the dollar also changes. To the extent that inflation and deflation are just simple increases or decreases in prices, neither one is a bad thing.
The problem comes with how the inflation or deflation comes about. And, of the two, inflation is decidedly bad, while deflation is actually to be welcomed, as explained in Guido Hulsmann’s monograph, Deflation and Liberty.
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* This is a blatant scare tactic to compare the current (supposedly) 2% inflation rate to a 7% deflation rate. But it wouldn’t be as effective if he told you that you’d lose $2 in a year, because we’re all losing that much right now in our retirement accounts.
** Perhaps he doesn’t understand that interest is due to time preference, not to inflation.
