Guest Post: What's So Bad About Deflation?

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Perhaps all the assumptions about inflation being good and deflation being bad miss the key question: cui bono (to whose benefit?)

One of the most widely accepted truisms of our time is that deflation is bad: bad for debtors, bad for the indebted government, and therefore bad for the economy.

What all this overlooks is how wonderful mild deflation is for those who owe no debt but who own the debt and the income streams that flow from debt. What the "deflation is bad" argument ignores is who controls the financial and political systems, and what set of conditions benefits them.

The entire Survival+ critique is based on one simple but revealing question: cui bono--to whose benefit?

The "deflation is bad" view naively assumes the Federal government wants inflation to lower its own debt burden. But since the machinery of governance is directed not at what's good for the government, but at what's good for the financial Elites that influence policy, then the only meaningful question is: what's best for the financial Elites?

Mild inflation won't bother the Elites much as long as their leveraged returns exceed inflation by a substantial measure, but deflation is much more lucrative: why mess around with potentially volatile inflation when deflation works better?

As knowledgeable correspondent James B. recently explained, the financial Elites' are skimming their take regardless of inflation or deflation. (for more on this, see James B.'s commentary in Do the Parasitic Elite Pay Any Taxes? June 13, 2012.)

Deflation makes cash and income streams more valuable as time marches on. At a 1% rate of deflation, our cash buys more goods and services every month. As a result, a 3% yield plus the 1% deflation = 4% real return.

The reason why deflation is considered bad is that wages tend to deflate along with everything else, and so the income debtors need to pay their debts declines, making it more difficult to service the debt.

Governments are presumed to want inflation because it erodes government debt over time and boosts the income of taxpayers and thus of the government. At 5% annual inflation, the adjusted value of $100 debt decreases to $77 in five short years. In 10 years, 5% annual inflation drops the purchasing-power value of $100 debt to $60.

As wages increase with inflation, the number of hours of work needed to service the monthly debt declines. Inflation makes debts easier on the debtor and strips value away owners of the debt.

Nice if you're the debtor, extremely annoying if you own the debt. Once again we must separate the Federal government from the financial Elites who control its policies. If government spending must eventually be curtailed to pay the rising interest on exploding Federal debt, that won't bother those who own the Federal debt (bonds).

Another widely accepted truism is that the Federal government (Central State) can "print its way out of debt" by printing enough money to devalue the dollar. Devaluing the dollar and inflation are two descriptions of the same process: expanding the money supply far faster than the real economy is expanding.

But once again this is naive, as the Federal government doesn't "print money" electronically-- that privilege is held by the Federal Reserve. Does anyone seriously believe the Federal Reserve acts on behalf of the Federal government? For propaganda purposes, the stated "cover" of the Fed is to "preserve price stability" and foster full employment.

The Fed's real function, of course, is to manage monetary policy to benefit the nation's financial sector and its wealthy Elites. What happens to Federal spending and interest payments are of little interest to those setting the Fed agenda. For propaganda purposes, the Fed makes noises about "reining in deficit spending" but this is for show. The most important goal is to maintain real returns for those who own the debt of the Federal government, i.e. the mega-wealthy financial Elites and other Status Quo players.

The critical error made by the "inflation is good" camp is their assumption that wages will rise along with everything else in inflation. Alas, wages for the bottom 90% have stagnated for decades in real terms (i.e. purchasing power), and so "mild" inflation has dramatically decreased their earnings.

In a post-industrial, post-bubble economy, labor is in massive surplus, so wages are flat to down for the vast majority of workers. Inflation is actually terrible for the bottom 90%, as their wages are flat while everything else rises in cost. For those workers with modest debt loads or very low interest loans, deflation actually boosts the purchasing power of their stagnant earnings.

Deflation is a wonderful boost for those who own debt and who receive income streams from interest and principal payments. Every dollar of interest and principal buys more than it did when the loan was originated. Every dollar of cash not only buys more goods and services, it also buys more hard assets as assets tumble in deleveraging.

Some steady writedown of debt is acceptable to those who own the debt. Let's say that 1% of all the debt is written off every year due to defaults, short sales of homes, foreclosures, etc. If the yield is 3% plus 1% deflation for a real return of 4%, then a 1% reduction in principal will still leave a real yield of 3%, which can be leveraged into 10% or even 15% (at 5-to-1 leverage).

The "frog in the pot" syndrome applies. If deflation is modest, on the order of 1%-2% annually, that won't spark insurrection. If the water in the pot is heated slowly, the frog doesn't notice much except a gradual reduction in earnings and government benefits as more government revenue is funneled to debt service.

Indeed, by many measures, Japan has been in deflation for over 20 years. The slow erosion of wages has been partially offset by a decline in the cost of goods and services. Meanwhile, those who own the debt have a low-risk increase in their wealth and income, year after year. What's not to like?

Before we assume the Federal government needs inflation, we should ask who sets the policy objectives of the government. Since the super-wealthy have captured the regulatory and legislative processes, why would we think the government's actions don't align with their interests?

Since the Federal government can't "print money," it can only borrow it, then it is incapable of creating inflation, even if it wanted to. The interests of the Federal Reserve are served by propaganda about "inflation targeting," but behind the curtain mild deflation is perfectly fine with the financial Elites.

Consider this. In mild deflation, Treasury bonds increase in value as the income streams of interest gain purchasing power every year. When other assets tank--for example, stocks and real estate--the bonds can be sold and the other assets snapped up for cheap from those who have only debt to deleverage and no cash.

Deflation is only bad for those with crushing debts and no ability to borrow more. Since the Federal government (like the government of Japan) can always borrow more, those buying the debt are assured of a low-risk income stream that can then be used to buy other deflating assets.

Everyone assuming the Federal government has the power to create inflation and that inflation is "good" should examine the interests of those who control the government's policies, i.e. those who own the debt.

Put another way: here's what will be scarce: reliable income streams and liquidity.

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SilverTree's picture

Banksters will loose power.

idea_hamster's picture

There has long been a small but growing cadre of economists (smart ones) who propose that the currency should deflate at the real risk-free interest rate.

This would allow savers at all levels to realize the natural market return by holding currency, and require equity to meet or exceed the true risk-adjusted expected return levels.

Carl Spackler's picture

While deflation would benefit my situation, it is completely unrealistic to think that the governing class in the United States of America would allow deflation to take root...until after a revolution or total economic collapse.  If allowed, deflation would become the cause of a national revolution (following waves of credit default at all levels, subsequent collateral seizure and foreclosure, and most Americans left without materiality and without a dream), something in direct opposition to the needs of the governing class.

One of the modus operandi of this nation is an inflationary environment because one goal of government, in practice, is to benefit the governors while making it look like the governor is benefitting the governed.  But all costs have to come at the expense of the governed, because charity is short term only. 

Now, to get into the governing class, one has to engage in quid pro quo schemes (i.e., election promises of benefits to causes via transfers of values), and actual governing requires a status quo appearance and the ability to -here's the kicker- make it look like nothing is lost when facilitating the transfer of current benefits for pet interests (while skimming for the governors' sakes). 

To carry such out, in the normal course of their work, the governors give away the results of other people's hard work and savings to their pet interests, but balance the payment shortfall in the the benefit-for-cost equation through inflation, which very subtlely spreads the burden to every consumer through a day-to-day, invisible hand of decreased purchase power).  Because decreased purchase power robs slowly and is not perceived by the sheeple being governed, it is not a risk to the governors losing their control.

Going off the gold standard to a fiat currency made it easier for the governors to keep the game going.

Anyhow, this nation has been engaged in this modus operandi for so long that it is a part of the entire fabric, and you cannot take out key threads without destroying that whole fabric.  Moreover, the only people with the power to change this fabric are the ones who benefit from it, and they are not going to shoot themselves in the head.

d edwards's picture

Hope I'm not just stating the obvious, but the Great Depression was a deflationary event-and we still had our currency backed by gold and silver then.

Now our money is backed by what? Hot air?

Umh's picture

FWIW. The dollar was pegged to a given amount of gold. The peg was altered during the depression.  In 1933 ( I think) people were forbidden to own gold coins and bullion.

toady's picture

And we definitely don't need any loose power.

TheGardener's picture

Feels like April fool`s day on ZH.

Please have my account deleted or this commie CHS removed from this site. Can`t stand his crap.

francis_sawyer's picture

 "What's So Bad About Deflation?"


No bankster bonuses... aka TEOTWA[they]KI

Buckaroo Banzai's picture

Deflation is BAD for the lending class (i.e. bankers). Here's why.

FIRST. Understand that bankers are PARASITES. Put yourself in the parasite's shoes: what are they good at? what are their goals? Their goal is to own nothing except your obligation to pay them an income stream (i.e. interest) for doing nothing.

Deflation has an annoying side effect: it causes debtors to default. This means that the lender now has to go to all kinds of trouble: foreclosing the loan, seizing the collateral, and disposing of it. So much annoying work! Parasites don't WORK, they FEED.

Mild inflation, on the other hand, is ideal. Keeps the debtors on the treadmill. Yes the value of the debt you own is inflated away slightly, but that's the price you are willing to pay to DO NOTHING EXCEPT FEED.

This is one of the key reasons the Federal Reserve System was set up: to create and administrate an elastic money supply that will prevent deflation and annoying debt defaults.


0z's picture

Deflation of Legal Tender is bad, because it keep the Legal Tender around for longer, and prevents the emergence of free(d) money.

People's opinion on deflation/inflation of a free monetary system is irrelevant; it simly will be what it will be.

That would have been a lot easier to write than the article.

TheGardener's picture

To be fair, he is not a commie but a youngster trying to sell us out on his readings of Marx. Him actually not so
young and at all the more persistent monger on this site makes him dangerous non the less.

Bananamerican's picture

I think the Viet Cong must have kept you in that Tiger cage a little too long....

War's day you learn to write pretty....

TheGardener's picture

Thanks for all those junks, you are appreciated.

I happen to bet against all odds , for this your system
to go up in flames, all you socialists, whether red brown green to burn in hell. I did so before and won .

And this time it is an easy call.

And those who just junked me for my intolerance,
next time welcome back.

Bananamerican's picture

easy no good to try an read this making colors of a hutch hutch hutch....STARSKYYYYYY!!!!!

HardAssets's picture

My bets are more heavily weighted to inflation - - - or at least high inflation or even hyperinflation followed by a deflationary collapse.

But, personally, I want to hear as many well presented views on this as possible. If youre around a big crowd all in the inflation camp (and in the precious metals), its important to get a counterview.

I have to do some more contemplation on the article, but please keep ones like this coming.

BlandJoe24's picture

In a deflation the financial super-elite actually gain enormous power.  This is because:

1.  In a deflation, cash becomes scarce, and he/she with cash is "King".  The elites currently have historically high cash reserves, the real world value of which will grow tremendously in a deflation.  On the other hand the rest of the 99.99% have very low to zero cash reserves, and will be starving for cash in a deflation.   The power imbalance and between the super wealthy and the rest of everyone else will tend to be much, much more than it already is.


2.  The banksters/elites are, generally, creditors,  they are owed cash.  As as cash becomes scarcer (deflation) they gain more power over debtors who simply won't have the cash to repay .   The creditor are loan sharks.  What goes on with loan sharks as their "client's" have trouble paying?  Their power will increase tremendously:  power to demand nastier terms, or change the terms, or repossess hard assets, or control the debtors (debt slavery, debtor's prison, etc.). 


Most people haven't realized that - from a standpoint of pure greed - the financial elites have a lot to gain (financially and in terms of power) from deflation.  And we all know elites have great sway (total domination?) over global financial policy (including the Fed's)...


This hasn't been talked through enough.  I'm thankful to Charles for his clarifying writings.

francis_sawyer's picture

No No No ~ Wrong Wrong Wrong


The 'financial elites', on balance, gain the most when the system which they have established continues on... I do not dispute that they will be 'ALL RIGHT' in a deflationary collapse, but when that happens, their LEVERAGED POWER & CONTROL infrastructure dissipates...

DEFLATION (or INFLATION, for that matter), naturally creates a broader BLACK MARKET for trading of goods & services... That is exactly what 'the elite' don't want... Their whole power remains with the ability to make tax slaves out of people & by creating unnecessary layers to siphon off &/or get their slimy mitts into private transactions... When the slaves have belief in that system (for convenience, or whatever reason), they are WILLING slaves... As that 'faith' dissolves, so does the revenue stream of TPTB (& it actually happens in multiples because of their [the financial elites] ability to LEVER, which the man at the bottom doesn't have)...

BlandJoe24's picture

"The 'financial elites', on balance, gain the most when the system which they have established continues on..."

The system they have established cannot go on, it is irreversibly collapsing.  It is a ponzi scheme, and ponzi schemes necessarily, inevitably, end.   The "winning" exit is to have already have the "takings" ie cash, with cash reserves (already done) AND be increasingly owed cash by others (already done) AND have cash become more and more scarce/valuable (accomplished by deflation).

The big mistake in my post is that I didn't say that I think many, many established financial elites will utterly go bankrupt in a collapse and only some will expontentially grow in power/wealth. 

francis_sawyer's picture

Look ~ I don't think we're on two completely separate pages here...

YES ~ "The system they have established cannot go on, it is irreversibly collapsing. It is a ponzi scheme, and ponzi schemes necessarily, inevitably, end."

But then... THINK FOR A MOMENT... If one 'creates' a system, isn't it logical to assume that they are most invested in a system that they created (versus the 'hedge' they have if their perverse system collapses)?... Therein lies the rub... They will come out, mostly, unscathed in either sense, but the larger picture is that they want the poinzi to continue...

Nobody (who initiates a PONZI) wishes it to end...

The bottom rung have zero bearing on this matter... I wouldn't exactly label them as 'VICTIMS' (because people are only victims by their own ignorance & sloth)... While I empathize with their plight, if it came down between a fight between me & them, I'd slit their throats... Whereas, the corrupt fucks who use power & influence to apply unnecessary human toil... I'D FUCKING CRUCIFY...


In any case, the (more minor) premise of the argument ~ vis a vis DEFLATION, & 'who' it penalizes more... is largely irrelevant... & to that end, I'd say that folks who are neither IGNORANT, nor SLOTHS, are capabable of emerging BETTER (based on individual milestones), than any of the nominees on the board...

LawsofPhysics's picture

You better define what you mean by "cash" first.  FYI- the "elites" always have a lot to gain/lose no matter what.   This isn't about money, it's about power and control. What about savers?  What about real consequences for bad behavior?  I call bullshit.

francis_sawyer's picture

+1 LOP... I call 'bullshit too...

(read my comment above, as well)...

BlandJoe24's picture

I mean "real" cash in hand/in the bank/in US Treasuries not all the rehypothecated empty promises which will evaporate as this thing implodes.  Millions in a severe depression can be richer in real terms than billions in the present.

And yes it's about power and control.

Just look at the great depression.  Whomever had cash, or was owed cash, had power and control.  Whoever didn't, you were a serf (financially speaking).

I'm not saying I want this to happen.  Just pointing out what the logic of greed may drool over.

Herd Redirection Committee's picture

Deflation is good if you have little debt, and steady earnings.  Cash on hand is also a boon.  But... Here's the thing.  The mega-elites have many cronies.  If the Mega-Elite are the 0.1% then their cronies are the top 1-2%.   Now the thing is... These cronies have been brought on board with the use of future promises (a cushy job down the line, gov't contracts), by being offered a 'club membership' ("You are one of us now")  and....  cheap liquidity. 


The top 1-2% (who aren't IMO mega-wealthy) are the most leveraged members of society, due to their connections and 'the deal' they have made.   So on the one hand the mega-elite can benefit from deflation, but they are also 'breaking the promise' to their cronies, who will over the fullness of time, become very upset, if not go straight bankrupt.

So the mega-elite can either decide to plunder their 'allies' and take them for everything, but risk making some powerful enemies, or they can allow copious amounts of inflation, which will empower their allies, at the risk of weakening the mega-elite.

The key here is to understand that much (if not all) of the nouveau-rich (i.e. the lackies, cronies of the mega-elite) are rich because of connections, and because of tremendous leverage.

BlandJoe24's picture

Yes, in a continuing collapse of the present financial ponzi/bubble and corresponding deflation, many of the now rich, the top 1-2%, and some of the super-rich, who'se wealth depends on that ponzi, will go utterly bankrupt. 


DavidC's picture

I've argued this for ages, much to the ridicule of people I've spoken with about it.


dwayne elizando's picture

Man I wish we'd have deflation!

cynicalskeptic's picture

We're getting deflation - in the prices of things we DON'T need or HAVE to own (cars, big screen TV's and other 'stuff') bit we're seeing inflation in the cost of the basics we DO need - like food and energy.


As for housing - it's cheap where there are no jobs, expensive where there ARE jobs and rents are rising faster than the price of owning (but lots of luck trying to get a mortgage now).  And as for the price of 'stuff' - just wait until the $US starts to implode and you'll see the price of all the imported crap shoot up as well.  I'm already seeing the price of high end Japanese camera gear much higher than it was a few years back.

I need more cowbell's picture

There is nothing wrong with "mild" deflation, just like "mild" inflation. Too bad it doesn't work that way.

agent default's picture

There is nothing wrong with deflation as long as you are not in insane debt.  If you are in debt deflation is effectively an increase of the real interest rate of the debt. 

MachoMan's picture

Right...  but isn't one of the perplexing characteristics of modern americans (as well as our government) that we have incredibly large debt levels?  The author says that deflation is good for everyone but those in large amounts of debt, but who isn't? 

Deflation, at this juncture, would basically be the final culling of the "have nots" and "wannabes"...  allowing the fire sale to be paid for with spoils from the run-up...  spoils that often times have questionable origins.

Of course, this process is inevitable...  however I think it's fairly disingenuous to claim that deflation is some magic cure all...  our predicament is vastly more complicated.

Anusocracy's picture

Government is a high time preference entity run buy those who wish to entrap the sheeple in a high time preference world based on debt.

It works as planned.


Snakeeyes's picture

Think of Great Depression when Ag Sec Wallace ordered the slaughter of millions of hogs to ... increase prices.

Producers stop producing. That is why.

asteroids's picture

There's absolutely nothing wrong with deflation. It happens all the time. The banksters view is unnatural and perverse.

BooMushroom's picture

And if everyone knew that there would be deflation, and not inflation, it would be fine. Most people have noticed that there has been massive inflation for the last 100 years (FED) and logically discount the future. If we had natural deflation for the last century, then it would be natural to discount the present, work hard, save, build assets, store goods, etc.

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered...I believe that banking institutions are more dangerous to our liberties than standing armies... The issuing power should be taken from the banks and restored to the people, to whom it properly belongs." -Jefferson

MachoMan's picture

First, you need to check our sources for the quote.

Second, accepting the misquote of Jefferson's logic as true, we've already had the run-up inflation...  now you're actually advocating the second part of "their" plan...  please explain... 

Buckaroo Banzai's picture

Snopes? Really? Those lying, left-wing, sacks of shit?

Here's what Snopes is good for: if Snopes "debunks" it, you know it's probably true.

Herd Redirection Committee's picture

Like amateur 'MythBusters'.  Or like how Julian Assange, the all-knowing gov't critic and 'hacker', who once said people who think there is "more to 9/11 are wasting their time".  LOL, ok there Assange, keep collecting that paycheck you 'useful idiot'.

HardAssets's picture

Well, I'm a great admirer of Jefferson and have read many books on that fine American.

The quote does appear to be bogus (as checked from many sources). The terms 'inflation' and 'deflation' were not used in reference to economic matters in Jeffersons time.

Even so, Jefferson expressed the attitudes given in that statement. One could consider it a kind of paraphrase of how he felt on the subject.

MachoMan's picture

I concur...  as does snopes...

BooMushroom's picture

Saying that it would be okay if everyone knew about it from past experience, is a far cry from saying it is okay now.

Deflation would be fine if it were not for the past hundred years of intentional inflation.

PoliticalRefugeefromCalif.'s picture

At my point in life it is sort of the lesser of evils, but then I am retired and fixed income with only a mortgage payment as debt..

I pity my grandchildren and kids that have to live in diminished expectations for most of their lives.

Canadian Dirtlump's picture

Theory seems to be increasingly getting relegated to college round table pontification these days since every scenario has the average joe jumping into the barrel, and the powers that be lining up with a bottle of astroglide.

Hype Alert's picture

Yes, it's true.  We've been lied to.  Again.

Jason T's picture

Deflation would act like a forest fire and clear out all the dead wood and the too many trees that were planted in the credit boom.  Would be a hell of a fire, but good for the long term health of the forest, economy.


MachoMan's picture

playing with fire is a dangerous endeavor...

I think the correct answer is that we're in a pickle and there isn't an answer...  however, I do agree with the premise that if you're lucky enough to survive the fire, there is the possibility life will be better for you post charring.

LawsofPhysics's picture

Correct, real consequences for bad behavior - good for savers and those who lived within their means.  I call bullshit on the garbage, but then again none this is about money, it is about power and control.  Daflation means banks and financial houses LOSE,  can't have that now can we?

sschu's picture

I can barely stand to read CHS anymore.  What level is his audience, 8th graders?

The PTB want whatever keeps the game going.  The do not want "a lot" of inflation as that dilutes their debt holdings, likewise too much deflation insures their debtors will not be able to pay because they are ruined. 

Their problem today is the game as it stands is failing, and the people are waking up to this fact.  The thing that the PTB fear most is a rerun of Paris in the 1790s.




bagehot99's picture

And that is what they SHOULD fear most.

I have long believed that the logical outcome here will include large numbers of our 'leaders' and their financiers hanging from lampposts. They have been stealing from us, and people have started to notice. If the average Joe knew about things like HFT and the other scams being perpetrated by these people it would already be happening.