There is no greater propaganda victory in economics today than the complete vilification of deflation (and the relative acceptance of inflation). As far as economists and politicians are concerned, deflation, which is defined as the overall decline of prices over time, is the economic equivalent of the bubonic plague. At the slightest whiff of deflation, governments will typically enact policies to push prices back up.
But what’s wrong with falling prices? Habituated as we have become to steadily rising prices, it would shock just about everyone to know that prices in the United States fell steadily for almost 150 years…from the late 1700s all the way to 1913! But during that time we experienced some of the fastest economic growth in the history of the planet… When combined with a stable supply of money (as existed in the United States until the establishment of the Federal Reserve), efficiency will push prices down.
The vastly increased productivity of the industrial revolution made it possible for working-class people to afford all kinds of goods, like upholstered furniture, tailored clothing, plumbing, and wheeled transportation, that were previously available only to the rich. Deflation meant that $100 saved in 1850 could buy many more goods and services in 1880.
Why is this not a good thing? While modern grandparents habitually point out how much cheaper stuff was when they were kids, their own grandparents likely told stories to them about how much more expensive things were in their youth. Yet despite the obvious benefits of lower prices, we still fear deflation. We are told that if prices were to fall, people would stop buying, companies would stop spending, workers would lose their jobs, and we would all return to the economic dark ages.
But we all see time and time again how falling prices do not deter particular industries. In the early twentieth century, Henry Ford made a fortune, and his workers became the best paid in the industry, by steadily bringing down the price of cars. More recently the computer industry has made bundles of money despite the fact that its products constantly experience significant price deflation. Yet despite plunging prices the computer revolution continues unabated. As a result of this efficiency in design and manufacture, millions and millions of people each year spend less and less to experience the marvels of digitization.
Despite this, most people assume that deflation is okay if it’s confined to just one industry. Why would that be? Modern economists mistakenly assume that spending drives growth, and that when deflation is present, people tend to defer purchases (to allow prices to fall); and when they do spend, the diminished price makes less of an economic impact. This is absurd. As we’ve said before, it’s not the spending that means anything. It’s the production that counts! People do not need to be persuaded to spend. Given that human demand is essentially endless, if people don’t want something there is likely a good reason. Either the product is no good or the consumer simply cannot afford to buy it.
Either way, the act of deferring a purchase, or saving instead of spending, is made for rational reasons and tends to benefit the economy as a whole. In fact, if consumers are not spending, the best way to spur demand is to allow prices to fall to more affordable levels. Sam Walton made billions with this simple concept.
Despite all the exculpatory evidence, deflation remains economic enemy number one. This is because inflation (the opposite of deflation), is every politician’s best friend…