Everything We Are Told About Deflation Is A Lie

Tyler Durden's picture

Submitted by Tim Price via The Cobden Center blog,

“The European Central Bank has given its strongest signal yet that it is prepared to embrace quantitative easing to prevent the euro zone from sliding into deflation or even a prolonged period of low inflation.”
- ‘Draghi strengthens QE signal’, Financial Times, April 4, 2014.

Yes, heaven protect Europe’s embattled citizens and savers from a prolonged period of low inflation. How could they possibly survive it ?

If history is any guide, probably quite well. As Chris Casey points out in his essay ‘Deflating the deflation myth’, the American economy during the 19th Century twice experienced deflationary periods of roughly 50 percent:

Source: McCusker, John J. “How Much Is That in Real Money?: A Historical Price Index for Use as a Deflator of Money Values in the Economy of the United States.” Proceedings of the American Antiquarian Society, Volume 101, Part 2, October 1991, pp. 297-373.

This during a period of “sustained and significant economic growth”. But just think of all those poor consumers, having to make the best of constantly falling everyday low prices.

In their research article ‘Deflation and Depression: Is There an Empirical Link?’ of January 2004, Federal Reserve economists Andrew Atkeson and Patrick Kehoe found that “..the only episode in which we find evidence of a link between deflation and depression is the Great Depression (1929-1934). We find virtually no evidence of such a link in any other period.. What is striking is that nearly 90% of the episodes with deflation did not have depression. In a broad historical context, beyond the Great Depression, the notion that deflation and depression are linked virtually disappears.”

In his 2008 essay ‘Deflation and Liberty’, Jörg Guido Hülsmann writes as follows:

“In the present crisis, the citizens of the United States [he could have added: and of the UK, and Europe] have to make an important choice. They can support a policy designed to perpetuate our current fiat money system and the sorry state of banking and of financial markets that it logically entails. Or they can support a policy designed to reintroduce a free market in money and finance. This latter policy requires the government to keep its hands off. It should not produce money, nor should it appoint a special agency to produce money. It should not force the citizens to use fiat money by imposing legal tender laws. It should not regulate banking and should not regulate the financial markets. It should not try to fix the interest rate, the prices of financial titles, or commodity prices.


“Clearly, these measures are radical by present-day standards, and they are not likely to find sufficient support. But they lack support out of ignorance and fear.

“We are told by virtually all the experts on money and finance – the central bankers and most university professors – that the crisis hit us despite the best efforts of the Fed [..and the Bank of England, and the ECB..]; that money, banking and financial markets are not meant to be free, because they end up in disarray despite the massive presence of the government as a financial agent, as a regulator, and as money producer; that our monetary system provides us with great benefits that we would be foolish not to preserve. Those same experts therefore urge us to give the government an even greater presence in the financial markets, to increase its regulatory powers, and to encourage even more money production to be used for bailouts.”

But as Hülsmann goes on to argue, all of these contentions are wrong, and have been proven to be wrong since the times of Adam Smith and David Ricardo. A paper money system is not beneficial “from an overall point of view”. (Nor has any unbacked paper money system ever lasted.) A paper money system does not create real resources on which our welfare depends. “It merely distributes the existing resources in a different manner; some people gain, others lose. It is a system that that makes banks and financial markets vulnerable, because it induces them to economize on the essential safety valves of business: cash and equity.”

The conventional view of deflation is that if it sets in, “the banking industry, the financial markets, and much of the rest of the economy will be wiped out in a bottomless deflationary spiral.” But as Hülsmann goes on to argue, such a spiral would not prove fatal to the lives and welfare of the general population. Rather, it would destroy “essentially those companies and industries that live a parasitical existence at the expense of the rest of the economy, and which owe their existence to our present money system.”

Let us be more explicit. Severe deflation threatens at an existential level bankrupt banks and the bankrupt governments that perpetuate their existence. Deflation is a mortal enemy to the heavily indebted state and its embedded parasites, but it is a friend to the saver and to anyone with a positive net worth. Because it is so dangerous to the debtor, (unelected) central bankers clearly feel they have no option but to incinerate savers at the altar of perpetuating an unsustainably indebted banking and political elite.

So it would seem that the euro zone, under Mario Draghi, is on the verge of outright quantitative easing, and that the ECB is also committed to using “unconventional instruments” in an increasingly desperate attempt to revive the corpse through explicit inflationism, not least by actually buying sovereign debt of dubious underlying value, rather than merely pledging to. The financial markets certainly appear to think so: the yields on Spanish 5-year government paper fell below those of their US equivalents last week. Spanish bonds yielded more than 7% above US paper as recently as 2012. And as Bloomberg pointed out, the yields on Spanish and Italian five year paper, and the yield on 10 year Irish government debt, all fell to record lows last Friday.

Whether in terms of goosed bond markets or inflated stock markets, inflated higher not necessarily by any improvement in corporate prospects but primarily by expectations of more ex nihilo money courtesy of the world’s major central banks, these are false markets. They cannot entirely be trusted – assuming that markets ever can. Fund manager Seth Klarman has written well on the artificiality of today’s markets:

“The Fed and the Treasury openly discuss the aims of their policies: to manipulate financial markets higher and to generate reported economic “growth” and a “wealth effect”. Inside the giant Plexiglas dome of modern capital markets, just about everyone is happy, the few doubters are mocked and jeered, bad news is increasingly ignored… The artificiality of today’s markets is pure Truman Show. According to the Wall Street Journal, the Federal Reserve purchased about 90% of all the eligible mortgage bonds issued in November.”

John Phelan of the Cobden Centre writes well that “the Federal Reserve has become an enabler of the financial havoc it was designed (a century ago) to prevent.”

Messrs Yellen, Draghi et al should be careful what they wish for. Inflation targeting is hardly a precise science. Achieving an entirely arbitrary 2% inflation level is bad enough for savers on fixed incomes when deposit rates are close enough to zero as to make no difference, but markets have a tendency to overshoot. Most government bond markets are clearly overbought – but in a QE world given fresh impetus by the looming arrival of the ECB, overbought markets can become even more overbought. When we don’t claim to understand the underlying dynamics (political) or the final destination (though we have our own fears), it’s much better simply not to play. From an asset allocation perspective, classic, benchmark-unconstrained Benjamin Graham-style ‘deep value’ equity is, we now believe, pretty much the only game in town – and that is where we now focus our attention, almost exclusively.

Meanwhile, we watch in disbelief as market distortions become even more untenable.

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I Write Code's picture

In brief, agree.

The "problem" is that in deflationary environment it may pay to delay purchases.

And can you imagine the government *cutting* social security payments annually according to the CPI?

DoChenRollingBearing's picture

Let me try this again, as I am waiting to see if this might become "the story of the day".  Remarks re falling velocity of money (below Fed chart) are very welcome:


My concern is that this mixed with ZIRP = capital destruction.

knukles's picture

Dats da troof, my man.
Just begin with if it's suggested as reality or fact by da gubamint, it is a destroyer of capital and freedoms.
In other words, just about everything we are told is a lie.


fxrxexexdxoxmx's picture

Hope is not a lie. Change is not a lie. Hope and change as a slogan has always been a lie.

AmCockerSpaniel's picture

It's the State part that's the issue with deflation. Deflation hits taxes. Just take it from there

and see how it feeds on it's self (loss of State jobs).

acetinker's picture

The thing is- that this tightly wound spring (our economy) has to be un-wound slowly to allow the state employed lackeys time to adjust to jobs that pay much less, and require an order of magnitude more skill.

I don't think that's actually gonna happen.  We will see inflation as the bankers flame out in a spectacular supernova.  Ten cents on the dollar will be generous when the dust settles.

ArkansasAngie's picture

The ends do not justify the means.

Save the banksters?  People will be hurt?

Horse manure.

Zirp is theif.  Inflation is theif.  Bailouts are thievery on a grabd scale.

The only arses being saved today are the 1%'ers.

Lets start with redistribution of wealth from the insolvent being kept in business by liquidity.

Leave no incumbant in office.


Soul Glow's picture

Hope is the laziest word in the English dictionary.

Colonel Walter E Kurtz's picture

My velocity (and probably most here at ZH) is at stall speed in order to prepare. If the politicians would be honest, I see radically rising taxes in the near future, ...but much more likely, I forecast bail-ins! Get out of debt and be stealthily liquid is the prescription for that which comes.

samsara's picture

Convert liquid financial assets to ones you physically possess. Food systems, living area, tools, Au/Ag, maybe 308's or 45's, energy systems, etc.

Get out of the "System".

If you don't have it in your physical possession, you don't own it.

dirtscratcher's picture

Convert liquid financial assets to ones you physically possess. Food systems, living area, tools, Au/Ag, maybe 308's or 45's, energy systems, etc.

Get out of the "System".

If you don't have it in your physical possession, you don't own it.---Samsara


Heard it a million times-and I still like it.


Stares straight ahead's picture

Zirp, in theory, would cause increased velocity.
Since the opposite is happening, sumtin' else is afoot.

Debt pay down is a possibility?
Can get less than 4% on some commercial loans. We are paying off principal as much as possible and buying meat on sale, for example.

It's all broken....

Beam Me Up Scotty's picture

Meat's on sale?? Where??

Alpo maybe...

Deathrips's picture

Oh Oh...my currency's too valuable to buy anything with.


Gimme a fucking break.



socalbeach's picture

Hussman has written several commentaries on the "liquidity preference" curves.  The "liquidity preference" is just the inverse of the velocity, but he uses the velocity of the monetary base vs the velocity of M2.  The bottom line is that if short term interest rates rise, either the Fed has to drain reserves or we're going to get unacceptable price inflation.


bugs_'s picture

Here in the Deflationists Lounge we note that by using fradulent CPI calculations the federal government has been cutting real social security checks for years!  When THE DEFLATION begins in earnest expect the federal government to continue to calculate a bogus CPI - then to understate actual deflation instead of understating actual inflation.  An odd juxtaposition - responsible for the tide and fighting the tide.

daveO's picture

'When'? There will be no 'when' until the government collapses, like the USSR. That's the kind of system we're stuck in(a rigged one). There are too many parasites. The host will not survive. Instead of deflation, watch out for Hyper-Youknowwhat. They must feed the freeloaders (at all levels) until the dollar becomes worthless.

Buckaroo Banzai's picture

"The "problem" is that in deflationary environment it may pay to delay purchases."

Um, yeah. The computer industry seemed to do OK even though their products, on a price/performance basis, dropped in price dramatically every single year.

OpenThePodBayDoorHAL's picture

So all of the companies, from Walmart to Amazon, who are desperately trying to provide lower cost goods, should stop what they're doing, because their clients will buy LESS from them as things become cheaper? Lower prices will REDUCE demand?

daveO's picture

Da, Comrade. You understand ones patriotic duty!

TheReplacement's picture

Not to worry.  igadgets will be cheaper.  They will be so cheap they will become a right.  So riteous shall they become that they will be compulsory.  Yay!

zeroheckler's picture

'The "problem" is that in deflationary environment it may pay to delay purchases.'

Sure, we'll delay uptake of food for a week at a time; no gasoline for my car for a while - walking 20 miles roundtrip to work. Oh yes, and surgery can wait for a year or two until it is cheaper.

Troy Ounce's picture


Time to burn down the castle and start over with fresh ideas and new people.


prains's picture

Yes....the entire idea of "bank" needs to be reset along with the reset...and maybe we could just quieltly remove ALL the oligarchs...to a pasture, with flowers and a swing

booboo's picture

I would gladly let my yellow go to 50 dollars (hell zero for that matter) an oz for the trade off of burning the chaff of deadbeat parasites off the ass of this dog. Anyone wishing for a hyper inflationary blow off needs to be in a rubber room and will be if that is the way out of this shit storm.

daveO's picture

I don't wish for it, but I can see it's headlights. There's almost no way out. The Repugnants in Congress would rather collapse the dollar than be called racists for shutting down the government. Vote for either party, and buy gold before, during, and after the election.

daveO's picture

I don't wish for it, but I can see it's headlights. There's almost no way out. The Repugnants in Congress would rather collapse the dollar than be called racists for shutting down the government. Vote for either party, and buy gold before, during, and after the election.

debtor of last resort's picture

There are no savers anymore. So let's hit it.

Doom and Dust's picture

Creditors profit from deflation while debtors suffer. Ergo, the rich get ultra-rich and the poor go ever deeper in debt. What's not to hate?


booboo's picture

You mean the responsible folk get a sausage up the ass and told to walk it off and debt monkeys get a pass. If you think they are going to let the proles make $10,000 a week to pay off your college, car, rent a room, gambling and general fuck off debt guess again. The connected survive under any scenario, at least you and your offspring got a fighting chance under deflation.

Solarman's picture

No they don't, the poor in debt default.  While those not in debt have more disposable income.

csmith's picture

Bingo. The Fed is all about preventing default EX POST, which simply cements the power of the banks and the bureaucrats. A well functioning economy avoids excessive risk NOT thru this sort of BS, but adequate cash and equity levels throughout the system.

Sean7k's picture

You really fail to understand this very basic concept. One, it rewards savers. This implies that people will change their habits from consumption to saving and investment (read: more production, employment, etc). Two, it INITIALLY rewards creditors, only because people have become so accustomed to spending their earnings, both present and future, rather than keeping debt levels manageable.Three, you assume the rich have no debt, when the reverse is true. Like most people, some have more debt than others. Four, lower prices benefits the common worker. People on pensions and SS are not poleaxed by fake CPI numbers.

Finally, it is also associated with real interest rates (remember those?) which allows people to price currency correctly and time investments to create profitable production. Deflation is the best thing that can happen.

Doom and Dust's picture

Not to put too fine a point on it because I hate our centrally managed world of ponzi finance as much as the next guy, but historically inflation has acted as the great equalizer.

I just finished Pikketty's book and his data leave no doubt that it was the inflation caused by two successive world wars that depleted the fortunes of the 1% - or rather, 0,1% - and created a level playing field for the emergence of the middle class.

The rich - i.e. the top 1 percent and especially the top 0.1% - get most to all of their income out of capital gains. They profit the most from deflation. And no, rich people, real rich people, don't have net debts. By definition.

Even the small time savers most of you seem to be referring to don't profit as much from deflation as they might think, given the ultra low interest rates that accompany it.

css1971's picture

Capital gains are inflation.

You're simply wrong.

NakedEconomics's picture

I'm not clear that deflation rewards the rich.  If anything, deflation rewards those who have savings, and those living hand to mouth (assuming they can still find work during a defationary environment). Basically anyone who isn't leveraged to the max.  This could be 0.1%, but it also could be middle or lower class living within their means.


Inflation steals from those who have cash, and not hard assets, as well as those living at or below the poverty line.  Isnt' that far more likely to be the poor than the rich?


If I understand your point about the top 0.1%, their wealth lies in hard assets.  Hard assets do well in inflation and deflation, since they will always be worth a relative amount of value.  So this class of individual isn't affected in either case.  They still own a massive amount of the "pie" regardless of the total size of the pie. ;)



Sean7k's picture

If that is true, why didn't wealth concentration start until 1980? What happened from 1950 to 1970? Why was the period durin WWII a time of minimal waelth disparity? (Their charts). No, it was dollar inflation caused by the destruction of the gold standard in 1970, that paved the way for an out of control money supply, increased leverage and gamblng by the only class capable to really take advantage of it- and then they were bailed out when it did collapse.

Capital gains, as in stocks and bonds? Deflation kills stocks. Let's see how well they do if the market crashes to 2009 levels... oh yeah: Bailouts! Ultra low interest rates? Really? What do we have now- HISTORICALLY low interest rates. 

You must have some great filters on in your world...

Doom and Dust's picture

What destroyed the gold standard and Bretton Woods was US financial incontinence, due to politicians sucking balls left (Great Society) and right (Vietnam)

The US government was already trying to print its way out of debt at the time, running inflation rates >5%. But then foreign countries came demanding gold for green and they had to close the gold window.


Sean7k's picture

The question wasn't what destroyed the gold standard, which was a political decision to stop the outflow of US gold reserves, the question concerned your inability to read a chart and make assumptions regarding effects. Exactly what is "financial incontinence"? New economic term?

The US government has been printing money for debt since 1913, however, it really took off in 1971 as the CHART SHOWS. If you are going to appeal to an economist's argument, you need to understand the material enough to defend it. 

Now, that being said, I haven't read the author's book, nor do I plan to. Anyone silly enough to not understand why disparities exist in wealth levels or attempting to create an explanation is merely another academic attempting to hide the obvious: to wit, they run the show. It is the confluence of State coercion and corporate malfeasance denominated in debt notes of no real value defended in a compliant media that creates wealth disparities. 

None of which speaks to deflation, which is a godsend to savers, retirees and workers.

daveO's picture

The first Texas Instruments calculator, I remember, cost $400, forty years ago! Productivity matters most. Ours has been shipped to Asia since those world wars. That author doesn't seem to know what he's talking about. Let me guess, he's an Ivy League shill. The rich people, today, are more likely New York parasites who profit from offshoring. Not many Henry Fords around.

NickVegas's picture

That's what I was thinking exactly. Henry Ford claimed 1000 thousand new customers for every $100 drop in price. Based on our understanding of Ford's history, it was an accurate account of the business mechanics. Ah, but who cares, some Yalie wants you to fear saving so you are consumed by the beast. Debt is freedom, ignorance is war, and death is strength.

BidnessMan's picture

Not so. The same families in Germany that owned all the big industrial companies in 1914 still owned them in 1949. Paper comes and goes, but ownership of assets is what counts.

The middle class saver and pensioners who "followed the rules" are who got wiped out.

TheReplacement's picture

Sure but how can you deny that we aren't going to have massive inflation first?  Deflation means a stronger dollar.  Inflation is what is happening - currency printing and typing.  It depends on if inflation takes us over the edge or if another reason kills the dollar. 

Who can possibly know for sure what will happen?  I'm certain that Obama thinks one thing, Yellen another, and guys like Putin another and so on and so forth.  Everyone has a part to play.  In a way this is like the one world government race to the bottom to find out who ends up on top.

Unknown Poster's picture

You assume the rich are not debtors. With current extended margin debt levels on financial instruments and high end real estate bought with borrowed money, I am not so sure.

Doom and Dust's picture

Again, of course the real rich don't have net debts. They wouldn't count as rich if they did. Also, I'm talking about the richest centile and especially the top 0,1% - still more than 300.000 people in the US. They inherit wealth and live off it. They are the new aristocracy, and they will become worse and more oppressive than the Old World's after prolonged deflation. That's what's at stake.

Unknown Poster's picture

Agreed that deflation hurts debtors, but no net debt doesn't imply no debt. The ultra wealthy will attempt to shed debt, but if a signicant portion is in shares of debt laden companies can they roll that off easily.

daveO's picture

I wonder if they own any gold? The old aristocrats did. If not, they'll be more like USSR Communist party honchos in 1992. Turn to crime or be left out.

css1971's picture

Deflation benefits those who deal in cash and penalises those in assets. The rich do not get richer in a deflationary environment. Which is why it's so rare. The people who benefit the most are the poor and those on fixed incomes ; retirees.

See Japan. CEO salary multiples vs the average employee : 16x average. In the US: 75x average. That's deflation for you.

NakedEconomics's picture

I might clarify, "penalises those who are leveraged", not those in "assets", if you define assets as "hard assets". 


If you own your apartment building outright, or a hord of gold, deflation would change the value of those assets relative to paper currency, but they still have the same intrinsic value.  You are still worth the same, relatively.


Agreed - those living within their means or on fixed incomes, will benefit in deflationary times.