In regards to comments made by Andrew and Dan about the used car market
collapsing, is there anyone here who understands economics to be able to
comment on the article I found below? I have heard a quote from Benjamin
Anderson who said the Great Depression of the '30s "was great in
magnitude and endured because the 'government played God.'"
Craig
P.S. I do not understand economics. When I was in college, the fellow in
the next student house room was an economics major. His faculty
advisor was the prof who taught the economics course I was required
to take and commented to him I was one of the people who should not
be forced to take economics.
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Even If the Fed Keeps Pumping Money,
We May Still See Deflation
It is tempting to assume both money supply inflation and price
inflation will come soon as the central banks pumps new money.
But if banks aren’t lending because the economy is in disarray,
the money supply may actually shrink, and prices may even fall.
So far in March, the data indicates that the yearly growth rate of our
measure for US money supply (as measured by the AMS metric) stood at
10.5 percent against 6.6 percent in February and 1.7 percent in March
last year.
Given that the Fed is busy throwing money at the economy as if there were
no tomorrow, it is tempting to suggest that the momentum of the AMS is
likely to increase further and that consequently runaway inflation could
emerge in no time.
However, in response to the massive decline in real economic activity,
it is possible that banks’ generation of loans out of thin air, i.e.,
through fractional reserve lending, could fall sharply.
For the time being, the annual growth of our measure for this type of
credit -- also known as inflationary credit -- stood in March at 14.1
percent versus 7.4 percent in February and 3.4 percent in March 2019.
If the momentum of inflationary credit were to fall sharply, it would
likely cause the yearly growth rate of money supply to follow suit (see
chart). Consequently, a sharp fall in price inflation could emerge. If
this were to happen, the government and the central bank would intensify
their spending and money pumping to counter the deflation.
Figure-1
A general decline in the prices of goods and services is regarded as bad
news, since it is seen to be associated with major economic slumps such
as the Great Depression of the 1930s.
In July 1932, the yearly growth rate of industrial production stood at
–31 percent while the yearly growth rate of the consumer price index (CPI)
stood at –10.7 percent by September 1932 (see chart).
Figure-2
Is the Fall in Prices Bad News?
Contrary to popular belief, there is nothing wrong with declining prices.
In fact it is the essential characteristic of a free market economy to
select those commodities as money whose purchasing power grows over time.
What characterizes an industrial market economy under a commodity money
such as gold is that the prices of goods follow a declining trend.
According to Joseph Salerno,
In fact, historically, the natural tendency in the industrial
market economy under a commodity money such as gold has been
for general prices to persistently decline as ongoing capital
accumulation and advances in industrial techniques led to a
continual expansion in the supplies of goods. Thus throughout
the nineteenth century and up until the First World War, a mild
deflationary trend prevailed in the industrialized nations as
rapid growth in the supplies of goods outpaced the gradual
growth in the money supply that occurred under the classical
gold standard. For example, in the US from 1880 to 1896, the
wholesale price level fell by about 30 percent, or by 1.75% per
year, while real income rose by about 85 percent, or around 5
percent per year.1
In a free market the rising purchasing power of money, i.e., declining
prices, is the mechanism that makes the great variety of goods produced
accessible to many people. On this Murray Rothbard wrote,
Improved standards of living come to the public from the fruits
of capital investment. Increased productivity tends to lower
prices (and costs) and thereby distribute the fruits of free
enterprise to all the public, raising the standard of living of
all consumers. Forcible propping up of the price level prevents
this spread of higher living standards.2
Most experts argue that a general fall in prices is always “bad news,”
for it postpones people’s buying of goods and services, which in turn
undermines investment in plants and machinery. All this sets in motion an
economic slump. Moreover, as the slump further depresses the prices of
goods, it intensifies the pace of economic decline.
For consumers to postpone their buying of goods because prices are
expected to fall would mean that people have abandoned any desire to live
in the present. But without the maintenance of life in the present no
future life is conceivable.
Should “Bad” Price Deflation Be Fought?
Even if we were to accept that price declines in response to an increase
in the production of goods promotes the well-being of individuals, what
about the case in which a fall in prices is associated with a decline in
economic activity? Surely, this type of deflation is bad news and must be
fought against.
The Problem with Money Creation
Whenever a central bank pumps money into the economy, it benefits various
individuals engaged in activities that sprang up on the back of loose
monetary policy, and it occurs at the expense of wealth generators.
Through loose monetary policy, the central bank gives rise to a class
of people who unwittingly become consumers without first making any
contribution to the pool of real saving. Their consumption is made
possible through the diversion of real savings from wealth producers.
They only take from the pool of real savings and do not contribute
anything in return.
Observe that both consumption and production are equally important in the
fulfillment of people’s ultimate goal, which is the maintenance of life
and well-being. Consumption depends on production, while production
depends on consumption. The loose monetary policy of the central bank
breaks this bond by creating an environment where it appears possible to
consume without producing.
Not only does easy monetary policy push the prices of existing goods up
-- or prevent goods from becoming less expensive -- but the monetary
pumping also gives rise to the production of goods which are demanded by
non–wealth producers. Now, goods that are consumed by wealth producers
are never wasted, for these goods sustain them in the production of goods
and services. This is, however, not so with regard to non–wealth
producers, who only consume and produce nothing in return.
As long as the pool of real savings is growing, various goods and
services that are patronized by non–wealth producers appear to be
profitable. However, once the central bank reverses its loose monetary
stance, the diversion of real savings is arrested. Non–wealth producers’
demand for various goods and services is then undermined, exerting
downward pressure on their prices.
The tighter monetary stance arrests the bleeding of wealth generators as
it undermines bubble activities. The fall in the prices of various goods
and services comes simply in response to the arrest of the impoverishment
of wealth producers and hence signifies the beginning of economic
healing. Obviously, to reverse the monetary stance in order to prevent a
fall in prices amounts to renewing the impoverishment of wealth
generators.
As a rule, what the central bank tries to stabilize is the so-called
price index. The “success” of this policy however, hinges on the state
of the pool of real savings. As long as the pool of real savings is
expanding, the reversal of the tighter stance creates the illusion that
the loose monetary policy is the right remedy. This is because the loose
monetary stance, which renews the flow of real savings to non–wealth
producers, props up their demand for goods and services, thereby
arresting or even reversing price deflation.
Furthermore, since the pool of real savings is still growing, the pace
of economic growth remains positive. Hence the mistaken belief that a
loose monetary stance that reverses a fall in prices is the key in
reviving economic activity.
The illusion that monetary pumping can keep the economy going is
shattered once the pool of real savings begins to decline. Once this
happens, the economy begins its downward plunge. The most aggressive
loosening of monetary policy will not reverse it.
Moreover, the reversal of the tight monetary stance will eat further into
the pool of real savings, deepening the economic slump. Even if loose
monetary policies were to succeed in lifting prices and inflationary
expectations, they could not revive the economy while the pool of real
savings is declining.
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