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Chapter 20: Deflation Reconsidered

This is an aspect of thinking which has been called “thinking the unthinkable,” deflation having had an extremely bad press everywhere. I want to reconsider the concept of deflation even though it is now un­thinkable. After all, five to ten years ago the concept of default in New York was also unthinkable, and yet it has at least partially happened and hopefully will continue to intensify in the future.

If default was previously unthinkable and is now thinkable, not only for New York City but for cities and states across the country, then perhaps deflation is also thinkable. I am going to define deflation for the purposes of discussion in the normal manner as falling prices and, despite Professor Mundell’s talk today, falling prices in dollar terms even though I probably have at least as little regard for dollars as he has, maybe even less. But we are sort of stuck with dollars right now so I am going to continue to be dollar-centric even though I don’t like it. In the first place, of all the various facets of deflation, we can consider one of its aspects as that of a secular long-term trend. Now there used to be, back in the good old days of the 1910s and 1920s, intense discussion between economists as to whether or not the price level should be falling or whether it should be constant over time. And even though the falling price level economists won out in theory, of course in practice they didn’t. But I would like to return to that discussion for a moment, and say that as far as I am concerned the trend of an unhampered free market economy will usually be a falling price level. In other words, as productivity increases, as capital investment increases, as technology improves, prices will tend to fall, thereby spreading increasing real income to all consumers. Indeed, over the nineteenth century, generally prices fell and money wages remained approxi­mately constant so that real wages kept going up. We can see even now, in many specific cases, the glorious effects of falling prices in those particular situations where productivity and the mass market has zoomed into the picture, permitting falling prices even in the face of our general inflationary trend.

For example, TV sets on which in 1948 it was almost impossible to see the image, then cost something like $2,000. And now they are infinitely better in quality and cost about $100.00. So that if you look at the price per unit quality of TV sets and think of that in contrast to the general price level, there is a tremendous and magnificent deflation—if you want to use that term for TV sets. I think this deflation is a great thing. This is the way real income increases and should increase. The same thing happened to penicillin, which started out when first discovered with its price so high that it was only available to extremely wealthy people. Now, of course, it is used for almost every nosebleed. And the same is true for electronic calculators, pocket calculators, which are now down to $20.00. So this is the sort of economy I would like to see across the board, not just for TV sets and pocket calculators. This is what would happen if we had a sound monetary system.

In contrast to the Fisher-Chicago idea of a stable price level somehow being divinely providential and being the goal which should be sought, as far as I am concerned, a falling price level should be the desideratum. As far as I can see, the original idea of the Fisher-Friedman view (the original idea of Fisher), of why there should be a constant price level is because he believed that money is supposed to be a measure of values. Since we now know, or at least should know, that values are subjective and unmeasurable, I think that the philosophical groundwork for the idea of the stable price level is no longer valid. And yet it still carries on, trailing clouds of glory behind it without anyone really reconsidering why a stable price level should be particularly desirable. Of course a stable price level is better than the rising price level we have now, but still we are talking about what goal we should set for ourselves. So as far as the secular trend goes, I think we should advocate the falling price level which would occur without monetary inflation.

How about other aspects of deflation? How about the shorter­-run aspects? For example, there is the concept of hoarding. The idea being that a short-run fall in prices is brought about because people’s desire for hoarding increases. Hoarding, of course, is a smear term. It is a loaded, value-laden term conjuring up the image of a miserly hoarder rifling through his gold coins or his paper money in the closet, cackling as the world falls around him. I do not think that is a fair image. I think the so-called hoarder is the person who wants to increase the real value of his cash balances for one reason or another. And, I see nothing wrong with that aspiration. I see no reason why the market should not fulfill it as it fulfills most aspirations if let alone. The usual way in which the aspiration for an increase in real cash balances is fulfilled, given a constant money supply, is that prices fall. Of course, as prices fall the real value of one’s cash balances increases. That however, has fallen in to disfavor among the authorities, pundits, and the establishment in general so that now the alternative way of fulfilling increasing real cash balances is to inflate the money supply. This, of course, is the method we are using now. Inflating the money supply, in addition to causing all sorts of other ill-effects, brings about redistribution of wealth, destruction of the rational calculation system of prices, the confiscation of wealth and income of one set of producers for another set of nonproducers, and so on. In addition to the usual bad effects of inflation which most people acknowledge, there is the Austrian insight of generating the business cycle and causing the eventual breakdown of the currency through hyperinflation.

Finally, there is another problem related to the idea of fulfilling the desire to increase real cash balances by increasing the money supply, namely, that in the long run it does not work. In other words, as new money is pumped into the system people’s desire for cash begins to fall as they anticipate rising prices. We then begin the spiral upward to accelerating hyperinflation. In other words, after a certain period of time as inflation continues and the public anticipates further inflation, they begin to lower their demand for cash balances. Then prices go up faster than the money supply, and then when the government monetary authorities try to raise real cash balances by expanding the money supply, prices continue to go up faster than the money supply, and real cash balances fall. When they try to raise real cash balances by pumping in more money, there begins the spiral upward toward disaster. Now there is the famous statement by the head of the German Reichsbank in 1923 when the German hyper-inflation was accelerating, namely, to put it into folksy terms, “Don’t worry folks. There is a shortage of money, we realize that (a shortage of money in the sense of a drop in real cash balances). We will offset this shortage, we will compensate for this by turning on the printing presses twenty-four hours a day.”

This alleviates the money shortage, in other words, raising real cash balances back up to the preinflation level. Of course that did not work and one would think that looking back on 1923 with our superior wisdom, that the monetary authorities and pundits would not make the same mistake again. However, they are in the process of doing so, because in 1973, I forget exactly what months, when inflation was rapidly accelerating in contrast to the money supply, Walter Heller wrote an article saying, in effect, “It is not true that the increase in money supply is causing the inflation. On the contrary, there is a fall in real cash balances because prices are going up faster than the money supply. Therefore, it is the job of the monetary authorities to pump in more money so that real cash balances will go back up to the preinflation level.” So even though we may think we have learned something since Rudolph Havenstein of the German Reichsbank in 1923, it looks like we have not done so.

What I advocate then is allowing the desire for increasing real cash balances to be satisfied through a fall in the price level, not through the disastrous and finally self-defeating process of inflationary monetary expansion.

Another point about deflation which I think is admirable, and which very few people talk about, is that if there is deflation, it is inevitably a postinflationary deflation. As a matter of fact, it is almost impossible to have deflation without a previous inflation. Under a pure gold standard of course, it would be impossible—period. After our long process of inflation, a deflation would mean that the fixed-income groups or the relatively fixed-income groups—academics for one, the traditional widows and orphans, people on pensions, creditors—would finally get a little bit of their own back. I see nothing wrong with that. It seems to me that after decades of the compulsory redistribution of wealth from the fixed-income groups to the other groups, there is nothing wrong with a little bit of restitution. A little bit of “reparations” on behalf of those of us on more of a fixed-income level. So I think that there is a good in itself too—the prospect of a little bit of compensatory deflation.

There is another point which I cannot demonstrate here be­cause it involves the Austrian theory of the business cycle which has been talked about this morning—a view of mine which is heretical even within the Austrian camp, which is small enough. Namely, that a deflation coming in the form of a credit contraction would speed up the necessary process of readjustment toward a healthy economic situation. It would speed up the liquidation of unsound investments and thereby spur the recovery process. Since we have had inflationary credit expansion over many years and since the current recession or depression has not succeeded in finishing the entire cleansing work of readjustment, this would facilitate the recovery process. So that is another argument for deflation. In other words, the business cycle argument that deflation would speed up the recovery in liquidating the unsound investments of the boom period.

Another thing about deflation which is extremely important has been generally overlooked—namely, that deflation sugarcoats the pill of recession. From the ordinary person’s point of view, the average consumer’s point of view, there is only one really good thing about a depression, even the depression of 1929 and the 1930s—namely, that at least the cost of living went down. Therefore, if you were employed in the 1930s, you were in pretty good shape. Many people overlook that. It’s true that there was a severe unemployment rate in the 1930s of about 25 percent, but that still meant that 75 percent of the labor force was employed. Those people who were employed were, after all, in pretty good shape since the prices of furniture, food and other consumer goods fell to a nice low level so that their real income increased. My family, for example, bought all their furniture during the depression. My father was among the 75 percent of those who were employed. They never had it so good before or since. As a result of fine tuning and the Keynesian policies or Keynesian-Friedmanite policies which we have been pursuing for a long time, after forty years of being promised full employment and prosperity, we have now wound up with both inflation and recession at the same time. This is the great achievement of the Nixon-Democratic program. What I am saying is that by doing this we have at last eliminated the fall in the cost of living which used to sugarcoat the recession pill. So that now we have the recession adjustments, we have the liquidation of inventory and all the rest that goes along with an Austrian recession adjustment. But along with that we now have inflation and a rise in the cost of living. So the consumer doesn’t even get that consolation from the fact of recession. What I am saying is that consolation was a good thing; it is a good thing to have the cost of living fall and therefore there should be deflation from that point of view too.

Another great thing about deflation and this, of course, I cannot demonstrate today, but can only indicate my present position,—is that without the interference of the Federal Deposit Insurance Corporation, deflation could finally and at long last smash the fractional reserve banking system. It has deserved this fate for many decades. Once the public recognized the fraudulence and innate bankruptcy of the fractional reserve banking system, because it is bankrupt, let’s face it—they have not got the money they say they have to pay on demand. When the public cottoned onto this in 1931, 1932, and 1933 and the banking system was in the process of being smashed in every state of the Union, that was a great and glorious day for those of us who are hard-money people (and in favor of the cause of truth and honesty). We were in the process of smashing the banking system, and then the various governors, and Hoover and Roosevelt came in with the bank holidays and the Federal Deposit Insurance Corporation which bailed the banks out. If not for that bail-out, there was a golden opportunity to eliminate fractional reserve banking forevermore. There wouldn’t even have been the problem of a transition period because we were in a transition, it was just a matter of leaving the thing alone for a few more months and the deed would have been done. Deflation would have helped in this process of smashing the fractional reserve banking system. Why it should have been smashed is that that system has been a constant threat and source of inflation and special privilege, the business cycle, and a whole raft of other evils.

The one problem which emerges from such deflation is the objection that wage rates are rigid downward and that there would be severe unemployment. Well, it’s true that wage rates are rigid downward, and again the Keynesian way of solving that, a tricky end run around rigid wage rates, was of course to cure the situation by lowering real-wage rates through inflationary monetary expansion and price increases. Being fairly sure that wages are going to lag behind prices, you can make an end run around unions and minimum wage laws, and unemployment insurance, and all the other rigid wage producing measures, and lower real wages and reduce unemployment through that kind of tricky, deceptive method. Well, it worked for a while, but now I think everyone has got onto the game. Unions have economists too and they understand about the cost of living index and all of that. As a result, I think this policy has become less and less viable; this idea of fooling the working class through lowering real wages through inflation.

Therefore, finally and at long last we will have to tackle the problem of rigid wage rates downward, honestly and directly. Tackling it directly would be politically difficult, there is no question about that, but so is hyperinflation politically difficult. I think the choice is basically that between run-away hyperinflation on the one hand, and smashing rigid wage rates downward on the other. And the way you smash rigid wage rates downward is fairly simple, conceptually simple, although politically difficult—namely, by repealing minimum wage laws, repealing special privileges to unions (notably the Wagner Act and the Norris-­LaGuardia Act), and removing unemployment insurance and welfare payments, etc., so that wage rates would at long last be flexible downward. I think if you are going to have any kind of free price system at all this will have to he tackled sooner or later and therefore the sooner the better, because once again accelerated inflation is on the horizon now, and it’s not just a theoretical problem.

Finally, I was moved by Professor Lerner’s statement today about trusting human beings. We have in this country a Bill of Rights. The First Amendment is a notable achievement, it seems to me, which very simply does not trust human beings, in other words it does not trust human beings in the government, in charge of the state apparatus. It doesn’t trust them one bit, because the general tendency on the part of the state apparatus throughout history is to censor, to oppress, to put people in jail without due process of law.

The First Amendment and the Bill of Rights in general were designed to check government and to show that we do not really trust the government and are putting in these severe limitations on government action. Now perhaps Professor Lerner wants to repeal the Bill of Rights, which is his privilege, but if he does he should say so. It seems to me we also cannot trust government in the monetary sphere. There are good reasons for this too. And I think one particularly good reason is that the state is inherently an inflationary instrument. The reason is that the state has acquired over the centuries a legal monopoly on the business or the function of counterfeiting. In other words, the state has arrogated to itself a compulsory monopoly of the counterfeiting business; a business of printing money, creating new money. I submit that any group of people, if handed the power of compulsory monopoly of the money supply, of the counterfeiting business, will use it. I don’t care how “good” they are. I do not consider the state as being particularly good even in general. Even I, handed the legal monopoly of the money supply, might be tempted strongly to start using it. First you pay off some debts, then you buy yourself a new house, etc., and pretty soon the temptation feeds upon itself and you’re off to the races.

What I want to do then, the reason why I want to go back to gold or forward to gold, is to eliminate the state’s compulsory monopoly of the printing press; to eliminate the counterfeiting power altogether, which I consider antisocial, parasitic, anti­productive, destructive, etc. And I recognize again that to do this, to have a free price system in the first place, and secondly to induce the state to give up its compulsory monopoly power, is not an easy task. It requires a political movement, a mass movement from below, if you will, to do it. But again, I think this has to be done.

[Originally appeared as “Deflation Reconsidered,” in Georgraphical Aspects of Inflationary Processes, Peter Corbin and Murray Sabrin, eds. (Pleasantville, N.Y.: Redgrave Publishing, 1976), vol. 1.]
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