Deflation: What is it good for?

TAKE a look at these recent headlines: “ECB paralyzed by split as irreversible deflation trap draw”; “Central banks battling deflation at any cost”; “Global deflationary pressures are mounting.”

What is this “deflation” that prompted all these very worrisome headlines—and the stories behind them—to appear? Deflation is the opposite of inflation. It is defined as the reduction of the general level of prices in an economy.

If deflation means that prices are going lower, wouldn’t you think that that is something we, as consumers, would want to see happen?

Prices are usually determined by supply and demand. If everyone wants to buy pork, and the supply of pork is constant, then demand would push prices higher.

But, apparently, the central banks and governments do not want to see prices fall and, in fact, want them to go higher. What could be the reason for that?

One hundred years ago, when the United States Federal Reserve (the Fed) system was created, this is what happened: The government and the Fed made this deal with the people: Salaries and income were promised to rise about 5 percent a year. No citizen in his or her right mind would turn down that deal. The catch was that prices would always rise by 5 percent, too. But that seems fair enough, where there is no loss and no particular gain. Why not go with this?

And so that is what has been happening for the last 100 years. So why is the world—the Western economies, in particular—in so much pain and trouble?

In truth, the wage gains over the last 100 years have not kept up with the price increases. But the bankers and the government have offset this inequity with all the goodies that were promised at the beginning and, in fact, have increased the global standard of living. We have, for example, electricity, cars, telephones and computers, which would not have been available as quickly as possible without the
system of continuously rising prices and more debt.

Inflation has served the world well, in that more money has been made available to finance all the technological advances that make the world modern. But the cost has rested on the shoulders of the same people who benefited from those technological advances, for the inflationary policies created 100 years ago have finally caught up with the global financial system.

Remember when pork was priced at P40 per kilo, and the minimum wage was less than P100 a day? Both pork and the minimum wage have increased about 400 percent since then. So it is a zero-sum game, where there are no real winners and no real losers.

Actually, in every game, there is always a winner, especially when the bankers and the governments are involved.

Had you borrowed P1 million when pork was P40 a kilo, you could now pay back that loan for only P250,000 in today’s money. That is why loans always charge enough interest to cover the decreasing purchasing power caused by price inflation.

The borrower of that P1 million had gained if the interest rate was less than the increase of inflation. Governments and banks usually borrow at an interest rate lower than inflation, because there is the lower risk of default on the loan.

The loser, though, is the consumer,
the average person who has seen prices of ordinary goods go up faster than wages.

“Just as a bad cold leads to pneumonia, so overindebtedness leads to deflation,” American economist Irving Fisher wrote in 1933. And note this well: Economists generally believe that deflation is a problem in a modern economy, because it increases the “real value” of debt. So the “real problem” of deflation is for the big borrower, not to
you and me.

The economists will completely disagree and say deflation is a very bad situation. Government and central-bank inflation, on the other hand, is good. Looking at historical records of the United Kingdom 200 years ago, there was no inflation and they never invented the iPhone.

Modern inflation is a creation of modern central banks and governments. Like Frankenstein’s monster, it may come back to kill them.

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ON a personal note, a very Happy Birthday to my best friend, Adaline, who is also my wife and the mother of my sons.