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What’s So Bad About Deflation?

November 20th, 2008

In response to a Christian Science Monitor article on the perils of Deflation, Todd asks:

The whole idea of “deflation” seems mostly nonsense to me. The only way to have true deflation is through a decrease in the money supply (like destroying money). I think when they say “deflation” they usually mean what I would call “net deflation,” taking into account not just the money supply but the supply, quality, and cost-to-make of goods as well. So while a debt-based currency will always be inflating due to new money being created with every new loan, there could be “net deflation” if the prices of products relative to the currency are decreasing.

Does that make sense? Is that a weird interpretation?

I am looking at you David Z. and FSK.

A debt-based currency can certainly deflate as you describe – the Fed could simply retire more notes than it produces in a given timeframe, and voilà: deflation.

They probably don’t mean deflation in the same sense that you do, just like the MSM never properly identifies inflation as an increase in the money supply. In any event, deflation is not per se a bad thing. On the other hand, it’s much more palatable when it’s caused by an increase in valuable production, which we can never really isolate in the absence of a true market economy.

Currently, I speculate that much of the inventory (whether it is houses or cars or widgets) was essentially loaned into existence, it’s not exactly over-investment, but rather malinvestment. The prices for these things have been bid up by phantom money, and in part, people consumed because of disincentives to saving.

At some point, new money stops being created as fast as it had been, or it stops being created altogether. Since it was the continuous creation of new money, day after day and month after month, that drove prices to the heights they’ve reached, in the first place, and only the continued creation of new money which could sustain them, what follows is that prices have to drop in response to the new market conditions.

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no third solution

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