by Gary North
Let's get something clear: there is no deflation.
Let me put it another way: deflation, there is not.
There 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.
That's 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.
There 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?
There 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!
DEFLATION AT HOME
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.
Today, 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 significantly.
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 them.
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 money.
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.
Jones 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.
Henry 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.
Copyright © 2003 LewRockwell.com