Fear Not Deflation

By Jon Matonis
Forbes
Sunday, December 23, 2012

http://www.forbes.com/sites/jonmatonis/2012/12/23/fear-not-deflation/

We should not be afraid of deflation. We should love it as much as our liberties.  --Jörg Guido Hülsmann

Deflation in the context of bitcoin has been cited frequently in the popular press as a detriment to its widespread adoption. For example, famed Keynesian economist Paul Krugman ridiculed the bitcoin cryptocurrency saying "it reinforces the case against anything like a new gold standard – because it shows just how vulnerable such a standard would be to money-hoarding, deflation, and depression."

Krugman could not be more wrong. Deflation is not a problem in the traditional monetary system and it will not be a problem in the bitcoin economy.

As over 99% of bitcoin's possible 21 million coins will be mined by 2031, the fixed mild inflation will effectively cease and a period of non-inflation will commence. Although the supply of cryptographic money will be relatively static with the exception of attrition through permanently lost coins, I will refer to the monetary phenomenon as deflation because as bitcoin's asset value increases compared to political numéraires, its effect on price expression will be seen as deflationary.

Contrary to the central banking and political class insistence that deflation must be prevented at all costs, an economy with a monetary unit that increases in value over time provides significant economic benefits such as near zero interest rates and increasing demand through lower prices. Let's look at some remarks from leading thinkers on deflation.

In responding to an article in The Economist, Doug Casey points out that "in a free-market economy, without central banks and without fractional reserve banking, both inflation and deflation as chronic events are really not possible." Casey states:

"Deflation is actually a good thing, because in a deflation prices drop and money becomes more valuable, so deflation encourages people to save money. Deflation rewards the prudent saver and punishes the profligate borrower. The way a society, like an individual, becomes wealthy is by producing more than it consumes. In other words, by saving, not borrowing. And during a deflation, when money becomes more valuable, everybody wants money. They want to save. Whereas during an inflation, you want to get rid of the money. You want to consume. You want to spend. But you don’t become wealthy by spending and consuming; you become wealthy by producing and saving."

Jörg Guido Hülsmann is a German economist and author of Deflation and Liberty, an important monograph that demolishes the myth of monetary intervention to prevent the cleansing effects of deflation. Hülsmann writes:

"Deflation is not inherently bad, and that it is therefore far from being obvious that a wise monetary policy should seek to prevent it, or dampen its effects, at any price. Deflation creates a great number of losers, and many of these losers are perfectly innocent people who have just not been wise enough to anticipate the event. But deflation also creates many winners, and it also punishes many 'political entrepreneurs' who had thrived on their intimate connections to those who control the production of fiat money.

Deflation puts a break--at the very least a temporary break--on the further concentration and consolidation of power in the hands of the federal government and in particular in the executive branch. It dampens the growth of the welfare state, if it does not lead to its outright implosion. In short, deflation is at least potentially a great liberating force. It not only brings the inflated monetary system back to rock bottom, it brings the entire society back in touch with the real world, because it destroys the economic basis of the social engineers, spin doctors, and brain washers."

Former president of the Mises Institute, Doug French, writes in the essay In Defense of Deflation:

"Lower prices increase demand; they do not reduce or delay it. That's why more and more people own flat-screen TVs, cellular telephones, and laptop computers: the prices of these goods have fallen, and people with lower incomes can afford them. And there are more low-income people than high-income people."

In A Plea for (Mild) Deflation, George Selgin rightly distinguishes between malign demand-driven deflation which is an unfortunate secondary effect of a central bank-manipulated, inflationary malinvestment phase and benign deflation which is the result of an increase in productivity:

"The Great Depression dealt a near-fatal blow to such common-sense thinking about prices and the price level. A new generation of economists became so obsessed with avoiding the bad kind of deflation that they all but forgot about the good kind. Followers of Keynes advocated inflationary policies, which have been the norm ever since. Having paid penance for the Great Depression by suffering through six decades of inflation, it is time for us to revive old-fashioned logic concerning the potential benefits of deflation.

Recognition of the possibility of benign deflation should have a salutary effect on the thinking of the world’s central bankers. By helping them to overcome their fear of falling prices, it will encourage them to deal a deathblow to the worldwide scourge of inflation. But that is only the beginning. Once the possibility of benign deflation is fully appreciated, zero inflation itself will come to be recognized as an overly expansionary policy—that is, as a mere steppingstone on the way to something even better."

Fear not deflation. Ultimately, the market will reach an equilibrium between investment and savings because in the absence of an equilibrium the benefits of a savings-only strategy would evaporate. Proper economic growth through sound investments will lead to a productivity-driven deflation.