In today’s inflationary environment, people have become so accustomed to rising prices that it has clouded their economic thinking. Concepts like profit, wealth, and economic growth have more or less become synonymous with credit expansion.
However, printing money plays no role in creating any of these concepts—it merely redistributes resources. Since monetary inflation affects all markets unevenly, the earlier recipients of newly-created money benefit at the expense of later recipients.
This phenomenon, known as the Cantillon effect, benefits central banks, commercial banks, governments, and asset owners. On the other hand, it hurts ordinary people who live on fixed incomes and save money.
Most often, new money enters the financial and real estate markets first. This is why we typically see the largest price increases there. Increased production and innovation are also factors in some rising stock prices. But when it comes to real estate, a used house would normally depreciate over time, everything else held equal, just as a used car or shirt would.
Typically, average Joes consider rising financial and real asset prices good and healthy, while rising consumer prices are frowned upon. Often, these people use consumer price indexes as guidelines for how much consumer goods should be “allowed to” increase in price. If the price of a consumer good rises more than the CPI, it’s often blamed on greedy capitalists.
Why Not Welcome All Falling Prices?
All people are profit-seeking, whether it’s the investor looking to buy low and sell high or the shopper hunting for bargains. One can easily see that the shopper benefits from falling prices, but what about the investor or the shopkeeper?
Economic growth is the key force behind wealth for the majority of people. When individuals can acquire more valuable goods with less effort, society as a whole benefits. In turn, economic growth is enabled by capital accumulation, as people save and invest to generate higher future returns. However, for everyone to benefit from this growth, sound money is essential.
Monetary deflation would also bring about overall falling prices. And, while shrinking today’s money supply would be an improvement, it would still leave us with fiat money in the hands of the government. This is why we need sound money, like gold and silver, managed by private competing mints and banks.
Consequently, the combination of economic growth and sound money should lead to overall falling prices. Murray Rothbard referred to this as growth deflation, distinguishing it from price deflation, which most often refers to falling prices caused by monetary deflation. Sound money supply could still grow naturally over time and prices would be affected unevenly due to supply and demand. While most prices would fall in the long run, many could still rise and fall in the short term.
Suppose we lived in a world of growth deflation. In such a world, we should generally expect falling prices as long as the supply of goods and services increases faster than the money supply. Additionally, holding cash could almost be seen as an investment since it could buy more goods over time.
The More They Leech, the More They Fear Deflation
In an economy, people normally trade what they produce. Money is only the medium of exchange between these goods and services. Hence, unproductive inflators couldn’t leech off productive people without monetary inflation. This is why elites fear falling prices and sound money.
The Federal Reserve fights falling prices to protect its power and the profits of banks and government cronies, as deflation undermines its ability to manipulate credit and the economy. Regardless of the direction overall prices take, the Fed will use it to justify and increase its intervention. However, prices heading south is their least desirable scenario, as it threatens their inflationary grip on power.
Commercial banks fear falling prices because the demand for loans would decrease, affecting their profits. Furthermore, falling prices lead to lower interest rates. This reduces banks’ net interest margins, as the gap between the interest rates they charge on loans and the rates they pay on deposits narrows.
Another group that fears falling prices is asset owners. This group includes banks, crony capitalists, and ordinary people alike. Obviously, people buy assets expecting a return, so they wouldn’t want their investments to depreciate. However, if overall prices are falling, it means the value of money is rising. In that case, money becomes the better investment.
Last, but certainly not least, we have the most significant beneficiary of inflation—the state. The government dreads losing its fiat currency monopoly, which enables inflation and expands its authority. Deflation under fiat money would strain its finances, but sound money would eliminate its ability to manipulate the money supply altogether.
Falling prices hurt the government in several ways. First, they significantly decrease tax revenues. Let’s say someone bought a home today for $100,000 and sold it for $99,000 ten years later. In such a case, there would be no nominal profit to tax.
Second, governments are heavy debtors. In a world of deflation, their debts would increase in real terms, as the money they repay would be worth more than the money they borrowed. Conversely, when prices are rising, it hurts lenders, as the money they receive can buy less.
Finally, governments cling to the debunked deflation spiral fallacy, ignoring how falling prices—like those of computers—spur consumption and growth in a free market. Instead, they believe falling prices would lead people to postpone consumption, resulting in economic stagnation and crisis.
Conclusion
To sum up, production and capital accumulation drive economic growth. In a sound monetary system and a free market, overall prices would generally fall as the economy grows faster than the money supply, enabling people to purchase more with their money. The only ones who need to fear this scenario are the leeches who profit from the wealth redistribution caused by monetary inflation.
