|
January 2009
By Tim McMahon
The average annual inflation rate dropped again this month.
At a monthly rate of -1.01%
October's drop was touted as "the largest monthly drop
on a seasonally adjusted basis since 1947 when the Bureau of
Labor Statistics first started tracking seasonal
adjustments" and it brought the annual inflation rate off
its highs and down to a more reasonable 3.66%.
November's monthly rate was almost twice as
large at but it was hardly mentioned in the news. This
month the annual inflation rate has dropped down virtually
zero-- 0.09% with a monthly drop slightly larger
than the one two months ago.
Just a few months ago the annual inflation rate was 5.6%
and now it is virtually zero. The slightest decline in
inflation this month will bring us into deflationary territory
on an annual basis... the first time since 1955.
The specter of deflation has thrown the news media into a tizzy
and the central banks are panicking and cranking up the printing
presses.
Over the last six months we have actually seen true DEFLATION. Prices
have fallen 3.92% over the last six months.
Everyone likes price deflation because things are getting cheaper.
November's -1.92% monthly
deflation rate would result in a 23.04%
decrease in prices if it continued for 11 more months.
It's like seeing a 25% off sale on
everything every time you went to the store!
In 19th century, (prior to government meddling in the money
supply) deflation was the norm. As
productivity increased, things got cheaper to produce, prices
went down, wages went up and everyone was richer.
So price deflation is a good thing from a consumer's point of
view. In times of high inflation (think back a few months)
when gas prices are higher every time you go to the gas pump,
you hear a lot of complaining. Funny, I haven't heard a
single complaint about falling gas prices. If deflation was bad
you'd think someone would be complaining.
Maybe it's businesses that are hurt by deflation (falling
prices)? True the amount they can charge is less because money
is becoming more valuable but their costs for materials and
labor are falling too. So as long as they remain efficient
producers they will remain competitive.
Let's look at the computer industry for a moment, they have been
in a deflationary market for quite some time now, i.e. as they
became more efficient they charged lower and lower prices.
Did this hurt the industry? No actually it was one of the only
truly profitable industries during a highly inflationary period.
Look at Microsoft and Dell do we feel sorry for them? I
didn't think so.
So deflationary forces don't hurt industry. and yet the news
media says we should worry about the "destructive forces of
deflation".
A perfect example is Martin Wolk of MSNBC, who says: "As prices
keep going down, money grows more valuable" . . .
Sounds good to me, but he says this is bad because it creates
"an enormous disincentive for consumers and businesses to spend
money. Economic activity slows, unemployment rises and demand
continues to decline."
So he is saying, it is bad because... as your money becomes more
valuable you might be more likely to save it, instead of
throwing it away every chance you get? And as you save it your
purchasing power will actually increase as it will get more and
more valuable. And this will hurt who?
According to Llewellyn H. Rockwell, Jr. president of the Ludwig
von Mises Institute in Auburn, Alabama, "It's true that
falling prices create incentives to save, but so long as the
preference of consumers is to save instead of spend, that can
only prepare the way for a future of economic growth. Consumers
save for a reason, namely, to spend later".
I seem to remember the media constantly decrying the low
savings rate in this country which reduces our reserves and
makes us less able to withstand an economic downturn.
Conversely, as the government increases the money supply, we see
price inflation and the demand for money actually decreases,
i.e. people don't want to save it because if they do, it will
buy less later. So the demand for goods increases and the demand
for money decreases. But this is to the detriment of the
consumer's economic health and long term to the health of the
country because people are encouraged to spend more than they
would have under normal circumstances.
In a deflation the exact opposite happens, people want to
hold onto their money so the demand for money increases and the
demand for goods decreases. But this is just a short term
effect, will they stop eating to keep their money? Of course
not? Will they reduce their lifestyle to keep more money
in the bank? No. Once they have a comfortable level of
savings in the bank they will begin spending again, the only
difference is that they will be able to get more for their money
and actually have a savings cushion. The only thing they will
reduce is their borrowing! Who wants to borrow money if
you have to pay it back with more valuable dollars? Better to
save up your money, get more value for your money (and higher
quality) and pay cash.
So a deflation actually promotes fiscal responsibility and
higher quality. Hmm.
One problem for deflation is that it is tied very closely to the
word depression in the minds of most Americans. As a
matter of fact, the majority of Americans think they are
synonymous. But that is hardly the case. One is the state
of low economic growth and economic activity while the other is
falling prices due to a decrease in the supply of money.
A depression as in "the Great Depression" is a major economic
downturn, i.e. a recession on a massive scale. It just so
happens that "the Great Depression" was also a time of
deflation. But deflation was not the cause of the
depression actually it was the other way around,
depression caused the deflation. See the chart in the
upper right
What is worse than a deflationary depression? An
inflationary depression which happened around the world in
Germany at the same time as our Great Depression. Would
you rather have a slow economy and falling consumer prices or a
slow economy and rising consumer prices? Personally, if I had
very little money I would prefer that it bought more (i.e.
falling consumer prices).
The great economist Murray Rothbard said, "rather than a
problem to be dreaded and combated, falling prices through
increased production is a wonderful long-run tendency of
untrammeled capitalism. The trend of the Industrial Revolution
in the West was falling prices, which spread an increased
standard of living to every person; falling costs, which
maintained general profitability of business; and stable
monetary wage rates—which reflected steadily increasing real
wages in terms of purchasing power. This is a process to be
hailed and welcomed rather than to be stamped out."
One fear is that consumer price deflation is twin of falling
asset prices. The one price that people like to see
increase is the price of their stock portfolio (i.e. their
assets). What we saw recently was massive asset deflation
as the stock market crashed and everyone scrambled for
liquidity. This of course is another side of the increased
demand for money. As the supply of money (actually in this
case it was the supply of credit) dried up people sold assets to
raise liquidity (cash). Showing a classic sign of deflation i.e.
the demand for money increased while the demand for goods
decreased. But this is a short term result of a panic
situation and a flight to quality, not the long term effect of
deflation itself.
The main problem is the current system is a house of cards built
on credit and the deflation is not the result of increased
productivity but of decreased credit
So deflation helps consumers, businesses, savers, and the
country as a whole... So who is fighting against deflation?
The answer is the central bank and bankers in general.
Why? Because in times of deflation their source of customers
dries up. You'd think banks would dislike inflation
because they get paid back with cheaper dollars. But they factor
that into their costs (i.e. they increase the interest rate they
charge you to cover the cost of inflation). So as long as
inflation doesn't get too high they see an increase in business
and thus profitability during moderate inflation.
But they can't loan money when no one wants to borrow, so their
profitability is zero. Thus the big push to "re-flate the
economy."
Today at the first whiff of deflation the Central
Bank (the FED) begins massive credit creation, and begins
cranking up the printing presses. They so worried
about deflation that they have begun a policy of monetary expansion of
historic proportions to correct it.
So the FED is fighting the implosion of credit by injecting
massive amounts of money into the system rather than allowing
the system to return to its natural state.
Robert Prechter of the Elliottwave Theorist is actually
projecting that we will be entering a period of deflation.
To read his free report on on Why we are headed for Deflation
Click Here.
Also see
Elliotwave article
Do You Know how to Preserve Your Wealth? for more
information on investing for safety.
Olivier
Garret, CEO of
The Casey Report
on the other hand believes that all of this massive inflation in
the money supply will result in a hyperinflation. See
Why the Bailout Will Result in Hyperinflation.
For more information see:
The Primary Precondition of Deflation --What
must happen for Deflation to take over.
What Causes Deflation?
Has this article been helpful? We
appreciate your feedback.
Subscribe
to our FREE monthly E-zine
and we will keep you up-to-date on what is
happening in the area of inflation, interest
rates and market trends.
Main Article List
Back to top
|
