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There Is One Key Argument for Inevitable Deflation, and One Key Argument Against It. Choose Sides Now.

Gary North
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Sept. 17, 2009

First, the latest data. The report from the Cleveland Federal Reserve Bank on August reveals that the Median CPI moved up less than the CPI in August.

The reason I prefer the Median CPI is that it is less volatile. This has surely been the case this year.

The CPI was pushed up by food and energy. These are primary commodities. We all use them all the time. But oil is volatile, so energy is volatile. Food looks like a steady climber to me.

Look at the CPI, year to year. It is down 1.5%. Take out energy and food, and it's up 1.4%.

I prefer to look at the trend. Volatility confuses the trend.

We keep hearing about the coming price deflation -- not down a percent or two for a year or two, but something systemic and disrupting. Yet if we look at the prices facing manufacturing, there is no deflation. This was reported by the Institute for Supply Management. Prices paid rose by 10 percentage points, or 18% in one month.

I do not believe in cost-push price inflation. The Austrian School began in opposition to this idea back in 1871. Consumers set prices by bidding against each other with the money they possess.

I do believe that producers bid against each other for scarce resources. They have decided that consumer demand will will rise, and they are buying resources. They bought at very depressed prices. I do not see a wave of price inflation on the horizon.

Second, you are being subjected to warnings about imminent deflation. Keynesians are always fearful about deflation. They are all advocates of government deficits. They don't care if the FED buys the T-bills. They prefer price inflation to recession. This is universally true.

There are also non-economists who have been crying wolf every year since 1968 (J. Irving Weiss, Martin Weiss). Most of them pitch some variation of John Exter's inverted pyramid of credit.

It has yet to take place.

Robert Prechter has predicted price deflation for 25 years. Rick Ackerman has predicted it for 20 years. The rest of the deflationists are late-comers.

They all make the same mistake. They think that a credit collapse that drives down certain highly leveraged investment asset prices leads inevitably to non-leveraged consumer price deflation even though the money supply does not shrink. They see a collapse of credit ahead.

They know the FED can create money. They know the FDIC can keep bank runs from taking place. Yet they invoke deflation as if it were 1930, when the FDIC did not exist. They ignore the fact that collapsing banks did shrink the money supply, 1930-33, which is why there was price deflation.

Inflationists argue that the Federal Reserve can and will intervene and issue credit to banks. The FED did that a year ago, just as we predicted.

The deflationists say that this cannot stop deflation next time. But there has never been a first time since the FDIC was set up in 1934. They do not explain their position in clear logic, with references to banking after 1934. But they use rhetoric that exudes confidence -- a confidence based on 76 years of incorrect forecasts.

Some of my readers hear these arguments and warnings, yet do not understand the logic of the deflationist position. They need constant reinforcement from me that the deflationists are wrong. They don't understand my reasons, either. They just want to hear the old songs.

The next time you hear any of these non-economists with no theory of money and banking pitch deflation, outline his arguments on a piece of paper. Can you follow them? Do they match the "bank credit collapse leads to massively lower consumer prices" argument? If so, ask yourself this: "If everyone has the same amount of spendable money in his bank account, why will consumer prices collapse?"

There really is only one argument for the deflationists: a collapse of credit can take place despite mass inflation by the central bank.

There is really only one argument for the inflationists: the central bank has, can, and will create fiat money which will prevent mass price deflation.

Take your pick. But remember: consumer prices have not collapsed in the USA since 1933.

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