Your Right to Deflation

In addition to big government, debt, and war, let us add one more item to the list of wicked legacies that the Bush administration has given to this country: inflation. The newest price data raise serious concerns that we are being robbed (that is what inflation is) by this government more than we know.

In some ways, the return of constant upward price pressures on a level exceeding economic growth is a telling act of destruction, and a testament to the power of government to create messes where none need exist.

We have been robbed of our right to deflation by a massive countervailing force.

We’ve all been stunned at the price increases in tuition, medical care, housing, and energy. And yet not all prices are rising and no prices rise in tandem. In fact, we can all think of recent times when we’ve experienced reverse sticker shock. “Only $35 for a CD player?” “This huge jar of olives for only $4?” “This set of screwdrivers and sockets for only $10?”

Those of us with access to Wal-Mart, Sams, Big Lots, or any number of other large discounters experience this sense every time we shop. Low prices impart optimism about the future, and somehow provide a glimmer of the prelapsarian might-have-been, with all goods and services priced at zero: a world in which scarcity imposes no barriers to all-round prosperity.

Hurrah! Our intuition tells us that falling prices are great for our pocketbooks because they leave more left over for savings or other forms of consumption. It is just as good for society at large. Our money becomes worth more and more, and hence our remunerative labors grow in value too. If inflation works as a stealth tax, deflation works as a tax refund. (For more on the issue of definition, see Mises on inflation, Salerno on deflation, and the special issue of the QJAE on these questions.)

Falling prices are a gift that the free market grants to all people, provided that the market’s natural benevolence is not thwarted by central bankers and government officials. The market does this through technological innovations that make production more efficient, and a widening division of labor due to the much-derided phenomenon of globalization. We all benefit from computers and from trade with newly opened economies in Europe and Asia.

Socialists used to talk about working together as a community but global trade shows that the best way to work together as a community is to work separately and exchange to our mutual benefit. In this way, all people of the world can unite in the effort to raise productivity, increase efficiency, and — hugely important — drive down prices now and forever.

Sadly, in our times, we are being robbed of our right to deflation by a massive countervailing force: the central bank. Thanks to the Federal Reserve and its monetary spigot, the value of our money continues to decline overall rather than increase as it should. We now face the largest increase in consumer prices in 2.5 years. The Fed promptly assured everyone that it would swing into action to prevent inflation from getting out of control. But it said nothing that would indicate that it might bear the responsibility for existing inflation. This familiar posture has been compared to the driver who watches only the rearview mirror but assures his passengers that all is well up ahead.

In the most recent inflation report, overall prices are climbing: 7.5 percent annualized for May and 5.5 percent in the last quarter. Within the structure of the index itself, however, we find wide variety, with many prices falling but enough rising to generate a rapidly rising index (there is no such thing as an “inflation rate” as a scientific measure).

The big increases were in food and energy, particularly dairy and gasoline. So getting from place to place costs 5 percent more now than it did the same time last year (12.4 percent annualized from 3 months ago!). Medical care is still outpacing everything but food and energy. Housing too is rising.

Given productivity increases, globalization, technological improvements, and the world dollar standard that permits a seemingly limitless export of paper, it is darn difficult these days to cause across-the-board price increases. All pressures run the other way. These very pressures have enabled the Fed to keep interest rates at rock bottom, pump the money supply whenever they saw the need, and otherwise provide backup for the massive amount of debt that is being created by the federal government.

Food and apparel are two sectors that have benefited enormously from the impact of globalization, with constantly falling prices, despite monetary pressures for higher prices. Housing can’t benefit from globalization, energy production is hugely shackled by state controls, and everyone knows how viciously government intervenes in medical markets.

The point is not to say that regulations and market impositions cause inflation, but rather that inflation will tend to hit sectors the least where free markets are working to push prices down, as they have in the apparel industry. The more the pressure for lower prices, the less impact the Fed’s relentless inflation will have on the industry (at least in the short term).

In the same way, there are additional factors contributing to the high price of medical services and energy. Socialism has inflated the demand for medical services and government restrictions have artificially limited supply. The insane War on Iraq, coupled with sanctions before that, has had a lot to do with restricting supply relative to demand for oil — and this exists alongside environment regulations, government land and water ownership, and taxes that limit profit opportunities from production.

And yet, despite all of this, the real culprit behind the price increases that have stolen your right to deflation is the Federal Reserve. The bout of money-supply increases began after September 2001 and soared above trend line for the two years following. Finally, late last year, the Fed pulled back a bit and the money supply even fell for a time. But now we look again to find that this real deflation was only temporary. The money supply is currently rising again. Since 2001, the money supply has risen above its trend by more than $400 billion.

Inflation robs us of our savings, redistributes wealth from savers to debtors, reshuffles property from consumers to those connected to the government, makes conducting business more difficult, and subsidizes short-term thinking at the expense of long-term planning. It drives people into the workforce who would otherwise not be there of their own choosing, and prevents the market economy from working its magic of raising living standards every year.

So how do we guard our future against future inflation? We could wish for better central-bank managers and more responsible presidents, but our founders hoped that we would not become a government of men. Instead consider again the ideal method for securing the value of money against the depredations of state power: the gold standard. It takes away from the state the right to create money and forces those who rule to live according to their means.

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