Hong Kong destroys Keynesian deflation myth

[Knighted]

We've all heard of the Keynesian deflationary spiral of doom. It's painted as a horror story, where proponents like Krugman argue that if the central bank doesn't step in to combat deflation during a recession and the government doesn't enact fiscal policy spending, the economy will enter into a never ending death spiral until it finally just croaks. Of course, we have a few hundred years of historical recessions before the Fed came in existence to disprove this notion (otherwise, how would we be where we are today?) but they never seem to buy that.

A similar argument is frequently made that constant, steady inflation of the monetary supply by the central bank is vital to creating economic growth. The argument is that if the money supply was held constant while the economy grew, the ensuing deflation would have a crippling effect on the economy and stifle growth. They say this would occur because people would hold onto their money, expecting perpetual price drops and never spending their cash, thus causing the economy to stagnate. Of course, we have the incredibly successful and booming electronics industry's perpetual deflation to disprove that notion as well, they never seem to buy that either.

Well, fortunately we now have empirical data to put the last nail in the coffin of deflation scare-mongering. Hong Kong over the last decade has demonstrated that economic growth can and will take place in the presence of deflation. Over the last decade, Hong Kong's inflation rate has averaged -0.3%/yr, with a total 3.6% deflation since 1999. In the same time frame, GDP/capita has grown 90% or an annualized rate of 5.5%/yr. This is through two recessions, and is one of the highest GDP/capita growth rates in the world during this time period.

Real GDP/capita (PPP) by year shown at bottom of page:
http://www.indexmundi.com/hong_kong/gdp_per_capita_(ppp).html

Inflation rate by year shown at bottom of page:
http://www.indexmundi.com/hong_kong/inflation_rate_(consumer_prices).html

[cubical]

Technology exposes the deflationary spiral myth. If something is worth the money, consumers will spend the money even if they know they can get it cheaper later.

[ababba]

These are straw men arguments, I don't think economists believe anything close to what you are saying. They don't think that output in the long-run is affected by the rate of inflation, which would be required for everything you say they believe. They do think that a surprise deflation would be bad, a deflation that people weren't anticipating. Then the nominal interest rates on debt contracts would be a lot higher in real terms.

[Seraphim]

But that also means that prices drop, meaning that cash is let over to pay debts - it works both ways.


These are straw men arguments, I don't think economists believe anything close to what you are saying. They don't think that output in the long-run is affected by the rate of inflation, which would be required for everything you say they believe. They do think that a surprise deflation would be bad, a deflation that people weren't anticipating. Then the nominal interest rates on debt contracts would be a lot higher in real terms.

[Steven Douglas]

These are straw men arguments, I don't think economists believe anything close to what you are saying. They don't think that output in the long-run is affected by the rate of inflation, which would be required for everything you say they believe. They do think that a surprise deflation would be bad, a deflation that people weren't anticipating. Then the nominal interest rates on debt contracts would be a lot higher in real terms.

I think it is safe to say that every institution that operates from a Keynesian framework is steadfastly in favor of a slow, steady, perpetual inflation of the money supply, and decidedly opposed to a long term stable money supply, let alone the opposite. And it would be easy to understand - from their limited, self-interested perspectives only - precisely why. So forgetting Krugman and what economists might or might not believe in general - what do you personally think are the primary pitfalls, or negative consequences, of a slow, steady, but perpetual rate of deflation?

[LibForestPaul]

Why must the commodity (fed res notes) that I store continually loose value? Why is this considered good for this one commodity?

[Diurdi]

Why must the commodity (fed res notes) that I store continually loose value? Why is this considered good for this one commodity? Because the budget deficits of governments must be financed somehow. That's the ultimate purpose.

[matt0611]

Yup, deflation is just scaremongering.
Normal growth deflation is totally fine.
Sudden high deflation can be the symptom of a big problem (huge bubble bursting) because of the fractional reserve nature of our monetary system.
Keynesians confuse the symptom for the problem though, which is a allocations of resources and mal-investment caused by the artificial expansion of credit.

A good video to watch if people are interested:


http://www.youtube.com/watch?v=U9w0S9bEXIw

[Steven Douglas]

Because the budget deficits of governments must be financed somehow. That's the ultimate purpose.

Actually, the process is two-fold, greasing both public and private concern palms, which is one reason why the system has been practically immune from political attacks over nearly a hundred years. The Fed was established, with its "lender of last resort" status, as the means by which both the Federal Government and Private Business could freely borrow against the value of all the wealth owned by the American public. But they aren't actually borrowing from the public. The value is only siphoned from the public currency. The Fed and its member banks are the ones who freely take title to the value they siphon through legalized counterfeiting as they lend it out.

The U.S. government provided a paper currency issue monopoly to a privately owned banking cartel which is now known as the The Federal Reserve Bank System. What the privately owned Fed gets out of the entire deal is peanuts compared to what all of the "member banks" get - namely, and essentially, a license to defraud the public by debauching their currency by expanding credit and lending out money which does not exist. This expands (dilutes/artificially inflates) the existing money supply. Every time a bank "expands the money supply" in this way, the "new dollars" that are put into circulation compete with existing dollars, which ultimately (albeit with a delay) drives the value of the entire currency down. In other words, the new money might have been created out of thin air, but the value of that new money did not. That value was siphoned, invisibly but surely, from all the other money in existence, including yours. Prices of everything goes up as a result - not because the value of goods and services increased, but because the value of your currency went down. And if your means of income is fixed, or labor, that usually means that you are the very last to get the memo, the last to realize that your prices/income must increase as a result as well. But since by that time the damage has already been done, you are the one to feel the most pressure, as you are perpetually the biggest loser in the entire process.

That is the private sector big business side of the equation. In exchange for selling the American public (and anyone else who holds or uses U.S. currency) down the economic river, the federal government has first shot at "borrowing" newly created money (on your behalf) from the Fed for itself. It does this by selling Treasury bonds (IOU's from We The People) to the Fed, and is an end around sneak for virtually unlimited revenue generation (and the way Presidents like Bush and Obama could pay for all the wars, economic stimuli, bailout money [to-anyone-but-you] and all the other wonderful goodness that government promises to "provide". Since an increase in taxes would be politically unpopular, or even politically deadly, the Federal Government just tells the Federal Reserve to "put it on your tab" - that you're good for it. That's deficit spending in a nutshell, and the other side of the equation - as you have clowns to the left of you, jokers to the right, and here I am, stuck in the middle with you.

The Fed does not reach into its vault (it's not a real bank, and doesn't have one) to lend money to the U.S. government. The Fed in turn uses the power the government gave the Fed to create money to essentially counterfeit Fed notes at will (electronically, of course). The new money that is deposited into the Treasury and "spent into circulation" also competes with all the other money, including yours - again driving its value down - doubling down on the invisible tax on top of the taxes that you (and your grandchildren down the line, whose economic souls were also sold into slavery) must ultimately pay in order to pay down (or at least service the interest on) all the debt that is owed...to the counterfeiter of first and last resort.

Double whammy? Nah, it's much worse and more complex than that - double, triple, quadruple and then some - but that is the essence of it. The net result is an ever-expanding money supply, and a deliberately perpetual loss in value/purchasing power of your currency. It is because of this government/large banking cartel alliance, and all their fraudulent activities which act in collusion against your personal, private interests, that you will always need more next year than you did this year - absolutely guaranteed, until finally, the currency becomes so diluted, so valueless in everyone's eyes, that it loses virtually all of its purchasing power, as hyperinflation sets in - signalling the death of a currency, the days of which were numbered to begin with, from the instant that it began to be artificially inflated - as if that's just what you do.

[ababba]

I think it is safe to say that every institution that operates from a Keynesian framework is steadfastly in favor of a slow, steady, perpetual inflation of the money supply, and decidedly opposed to a long term stable money supply, let alone the opposite. And it would be easy to understand - from their limited, self-interested perspectives only - precisely why. So forgetting Krugman and what economists might or might not believe in general - what do you personally think are the primary pitfalls, or negative consequences, of a slow, steady, but perpetual rate of deflation?

This is the Friedman rule, which is the optimal rate of price growth if that was the only thing you considered. There are other benefits to higher average inflation like a lower probability of zero nominal interest rates and a reduction in wage stickiness that comes because firms can't cut nominal wages.

[robert68]

There were falling prices with rapid economic growth in the 1880’s. In economic professor George Selgin’s book, “Less Than Zero: The Case for a Falling Price Level in a Growing Economy (http://mises.org/books/less_than_zero_selgin.pdf)”, beginning on page 49, there’s much information on this, and he says Friedman and Schwartz gave a similar account. Murray Rothbard does as well in “A HISTORY OF MONEY AND BANKING IN THE UNITED STATES: THE COLONIAL ERA TO WORLDWAR II", (http://mises.org/books/historyofmoney.pdf)beginning on page 161.

Rising productivity causes prices to decline because, as Selgin puts it in his article “America's Deflation Hysteria”: (http://www.cato.org/pub_display.php?pub_id=5979)


Rising productivity means declining unit costs of production. A given amount of labor, capital, and natural resources yields more output than before.

When unit production costs fall, businesses can pass the lower costs on to consumers in the form of lower prices without sacrificing profits.

[Che]

well, then why is Japanese Yen making new highs? because of QE perpetuated by BOJ?

[nobody's_hero]

well, then why is Japanese Yen making new highs? because of QE perpetuated by BOJ?

What are they comparing the yen to?

[Knighted]

This is the Friedman rule, which is the optimal rate of price growth if that was the only thing you considered. There are other benefits to higher average inflation like a lower probability of zero nominal interest rates and a reduction in wage stickiness that comes because firms can't cut nominal wages.

You argue that there are some benefits to inflation. But you ignore the disadvantages. Inflation encourages spending and discourages investment - if a person believes the value of their money will go up in smoke, they will spend it as quickly as possible. And inflation rewards borrowers at the expense of lenders, making debt accumulation more attractive, both for consumers and for government. The role this has played in our current crisis is hard to put an exact number on, but it definitely has played one. In addition, savings and investment are the true drivers of economic growth, and without investment, it's a proven fact that growth will stagnate. To whatever role inflation has played in encouraging spending and debt accumulation, it has fundamentally lowered future economic growth by diverting money away from investment.

Inflation caused by increasing the money supply also affects people differently depending on what stage they receive the newly printed money. Those who receive and can spend the money first can get the most benefit out of it before the increased dollars chasing the same number of goods raises prices (creating price inflation), while those who receive and spend the money last must do so after prices have already risen. In other words, those who receive the money last receive dollars that have much less buying power than those who receive it first. It's possible that this is a prime contributor to wage stagnation at the consumer level.

[Seraphim]

A lot of the Yen appreciation has to do with people purchasing the Yen as they see it as a more stable environment at the moment then most other currencies.

As those Yen flee Japan and get taken out of circulation, the remaining Yen appreciate in value and it drives up the cost to purchase Japanese goods. Huge portions of the Japanese tech sector rely on exports.

In an attempt to subsidize these industries, the BoJ has been massively intervening in their currency markets to make their goods competitive (price wise) on the global market.


well, then why is Japanese Yen making new highs? because of QE perpetuated by BOJ?

[ababba]

You argue that there are some benefits to inflation. But you ignore the disadvantages. Inflation encourages spending and discourages investment - if a person believes the value of their money will go up in smoke, they will spend it as quickly as possible. And inflation rewards borrowers at the expense of lenders, making debt accumulation more attractive, both for consumers and for government. The role this has played in our current crisis is hard to put an exact number on, but it definitely has played one. In addition, savings and investment are the true drivers of economic growth, and without investment, it's a proven fact that growth will stagnate. To whatever role inflation has played in encouraging spending and debt accumulation, it has fundamentally lowered future economic growth by diverting money away from investment.

Inflation caused by increasing the money supply also affects people differently depending on what stage they receive the newly printed money. Those who receive and can spend the money first can get the most benefit out of it before the increased dollars chasing the same number of goods raises prices (creating price inflation), while those who receive and spend the money last must do so after prices have already risen. In other words, those who receive the money last receive dollars that have much less buying power than those who receive it first. It's possible that this is a prime contributor to wage stagnation at the consumer level.

Having said that deflation is the optimal Friedman rule rate of inflation, how exactly did I ignore the disadvantages? LOL. The stuff you are talking about are disadvantages of unexpected high inflation not fully anticipated inflation. If inflation is fully anticipated nominal interest rates increase and real interest rates are not affected.

The whole received the money first argument doesn't make any sense. The money isn't given away. It is exchanged for bonds which are retired.

[Knighted]

The whole received the money first argument doesn't make any sense. The money isn't given away. It is exchanged for bonds which are retired.

You miss the point. When new money enters the system, regardless of how the Fed accomplishes that, certain parties will receive that money first. In the case of the Fed purchasing government bonds to inject money into the system, that money first enters circulation through the hands of former bond owners which are primarily banks. Once that occurs, the new money branches out through various channels into the economy, but the point is that it reaches different sections of the economy at different points in time. Those with access to that money first are able to use it whenever it still has the most buying power. Those with access to that money last can only use it after it has already been devalued by circulating through the economy. The money is devalued (less purchasing power) because a larger number of dollars are chasing the same amount of goods, causing price inflation.

Let's make it incredibly easy to understand by using a very simple example to illustrate. Suppose the economy consists of only three people: a banker, a blacksmith, and a farmer. If the Fed injects a significant sum of money into this economy by buying gov bonds from the banker, suppose the banker uses that new money to buy a large amount of corn from the farmer. The farmer, seeing this surge in demand outstripping his supply, raises the price of his corn. The farmer then uses all of the banker's money to purchase a new plow from the blacksmith. The blacksmith now has the farmer's money, but suppose he wants to buy some corn with it. The blacksmith has the same amount of money as the banker originally paid for his corn with, but due to the price increase in corn caused by the increased number of dollars in the system chasing the same number of goods, the blacksmith's money will buy less corn than the banker's money, even though they both had the same dollar amounts.

Moral of the story? The banker, with access to the new money first, (and at a lesser extent the farmer) was able to spend his money before the inflationary effects rippled through the economy. The blacksmith, being the last to receive that money, was not. If you want to make it even simpler, just consider the effects of increasing the money supply on people with fixed incomes. Rather than receive the new money as it trickles through the economy later or last, they in many cases don't receive it at all. As the prices of goods around them rise due to inflation, their money buys less and less of what it could before.

[Henry Rogue]

I thought about starting a thread on a Mises.org article about the Keynesian deflation spiral. I found a couple of old RPF threads on the subject and picked this one to post in. I would like to post the whole article , but will settle for posting the end of it and providing a link. https://mises.org/daily/6362/

Conclusion

The deflation death spiral is a theoretical description of a situation but it does not describe the reality of human action, for any number of reasons:

1. There is in reality always a diversity of expectations among the public. While some people will expect prices to continue in the same direction, others will form the opposite view. Everyone’s expectations will change not only in response to changes in the data, but taking into account their entire life experience, their own ideas, and their situation.

2. Expectations are not entirely driven by prices. A broad range of things influences our expectations about price.

3. Lower prices are not always sufficient motivation to delay purchases because everyone prefers to have what they want now, rather than later.

4. Expectations of buyers tend to be met by sellers, if not at first, then fairly soon. In some cases, buyers can hold onto their cash for a bit longer, but most businesses have no choice but to sell their inventories at what the buyer will pay. In other cases, buyers may not be able to delay purchases, or may not wish to, and will pay what they must in order to buy.

5. Everyone—buyers and sellers (and every one of us acts in both of these roles at different times)—has expectations not only about consumer prices, but about wages, employment prospects, even asset prices, the economy in general, the progress of our own life, and the future of our family. A coherent plan of saving and spending takes all of these things into account.

6. Expectations can be met. Buyers have a buying price. Even if not known in advance, they know it when they see it posted. Even if they do not know what they plan to buy in the future, a bargain price will be met by buyers.

7. People only need so much cash. Beyond that, they start to look around for either consumption goods, or investments.

Here is a link to the other RPF thread on the subject. http://www.ronpaulforums.com/showthread.php?256692-Am-I-getting-this-right-Inflation-vs-Deflation

There was actually an article today on Mises --

http://mises.org/daily/4602

Rothbard & The Deflation Bogey

[LibForestPaul]

A lot of the Yen appreciation has to do with people purchasing the Yen as they see it as a more stable environment at the moment then most other currencies.

As those Yen flee Japan and get taken out of circulation, the remaining Yen appreciate in value and it drives up the cost to purchase Japanese goods. Huge portions of the Japanese tech sector rely on exports.

In an attempt to subsidize these industries, the BoJ has been massively intervening in their currency markets to make their goods competitive (price wise) on the global market.

Wonder how they could intervene otherwise. If the Yen Currency commodity is so valuable, people want it and heard it, driving ups it value. So when purchasing a product from Japan, more dollars, or Eurors, are needed, since these commodities are not as valuable at that particular point in time. Wouldn't this mean deflation of a particular currency will result in a rush to acquire said currency?

[Henry Rogue]

The notion of a self perpetuating deflation spiral seems ludicrous.

[Madison320]

The notion of a self perpetuating deflation spiral seems ludicrous.

Plus has it ever happened in history? Especially with unbacked currencies?