The euro zone’s consumer price inflation rate declined below 1% in early 2014, getting closer to zero during 2014, nowhere near the ambitious 2% benchmark set by central banks. A further small downward adjustment in the inflation rate has put it into negative territory, so harmonized euro area consumer prices are now declining. Western monetary authorities and economists appear genuinely fearful of deflation. Headlines in leading papers reflect this fear very strongly, describing deflation as “the world’s biggest economic problem”, or a “nightmare that stalks Europe” that could lead to its “demise and collapse”.
Photo credit: Yuya Shino / Reuters
The real question is though, why do our governments fear deflation? Why do they perceive it as a chronic disease that could infect the economy and why do they go to such great lengths to avoid this “taboo” event? The mainstream argument is that we should avoid deflation because it causes a drop in overall demand and hence lowers economic growth (Germany and other European countries have experienced a slowdown recently which has resulted in a downgrade of 2014 and 2015 growth expectations). Also, deflation implies lower corporate earnings and asset prices, particularly real estate prices.
The euro area’s harmonized index of consumer prices has recently dipped slightly into negative territory, which is excellent news for European consumers – click to enlarge.
But the greatest concern to governments is not deflation itself; the real concern is the impact of deflation on the already over-indebted governments of Europe. Seven euro zone countries are projected to have public debt to GDP ratios of over 100% next year! The worry is quite legitimate from the perspective of indebted governments. With deflation, the burden of debt increases, making defaults more likely. So what are policymakers doing to tackle this problem?
2-year inflation expectations (derived from the spread between nominal and inflation-indexed government bond yields), US, euro area and UK – click to enlarge.
As usual, policymakers are opting for the easy way out. Interestingly enough, they expect a turnaround in economic growth in 2015, driven by ECB President Mario Draghi’s quantitative easing (QE) policy. Instead of questioning this policy, analysts expect it to have a positive impact. The ECB’s current priority is obviously to stimulate growth the American way by engaging in bond purchases with newly created money.
On its website, the ECB states:
“In a deflationary environment monetary policy may thus not be able to sufficiently stimulate aggregate demand by using its interest rate instrument. This makes it more difficult for monetary policy to fight deflation than to fight inflation.”
Unfortunately, all this means is that the ECB is convinced that standard monetary policy is not enough, and believes in implementing further interventionist measures to avoid deflation at all costs. The direction that the ECB has taken throughout last year strongly reflects this – negative interest rates on its deposit facility are just one symptom. But how much further into negative territory can interest rates go? Mr. Draghi has asserted his commitment to consider all available options to redress the alleged threat of deflation, including structural adjustments – but these are too time consuming. The easy way out is more debt and more money printing.
The Delusion that is Inflation
Before he became chairman of the Federal Reserve, Ben Bernanke claimed in 2002 that “…sufficient injections of money will ultimately always reverse deflation”. Unfortunately for Bernanke, the Japanese cannot confirm this assessment. Japan has gone through intermittent bouts of concumer price deflation since the early 1990s and it has been “trapped” there up until recently, when its authorities once again chose to attempt to “reflate” rather than reform the economy. The BoJ has implemented several QE programs over time, to no avail. It is living proof that monetary easing only perpetuates the crisis and does nothing to repair the damage. So why would anyone want to go down that path again?
In our view and as highlighted by Austrian School economists, a bust is inevitable once an inflationary boom has run its course. The bust allows the market to correct the maladjustments of the boom; deflation is simply a normal feature of the bust phase of the business cycle. Intervention in the economy, particularly through monetary expansion, will only prolong the time span until the bubble bursts, and the bust will be more severe the longer it is delayed.
Austrian School economist Jörg Guido Hülsmann, a senior fellow at the Mises Institute and Professor of Economics at the University of Angers in France has made great contributions on this topic over the years. Hülsmann argues that deflation souldn’t be feared and could actually be our savior. As he puts it:
“We should not be afraid of deflation. We should love it as much as our liberties.”
Deflation goes hand in hand with releasing the individual from the debt enslavement that was created with the monetary policies of the past 100 years. Nigh unlimited printing of money has become the orthodox strategy to avoid deflation. Hülsmann points out that deflation was made the scapegoat for all sorts of economic ills in a century of pro-inflation propaganda.
Austrian economists such as Mises and Rothbard did not take as strong a pro-deflation stance as Hülsmann. According to Hülsmann, Mises and Rothbard “championed deflation only to the extent it accelerated the readjustment of the economy in a bust that followed a period of inflationary boom.” Rothbard pointed out that deflation has a beneficial role in speeding up the readjustment of the economy’s production structure during an economic crisis. Clearly, deflation plays an important part in the readjustment of the economy to its natural “equilibrium”. As Mises famously said in this context:
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
Deflation Reinstates Lost Liberty
Hülsmann is strongly opposed to inflation and government intervention in the economy. For deflation to happen government interference in money and the economy needs to stop. Anything short of instituting laissez faire, such as structural adjustments or reforms, means the government will remain in control. However, what is the connection between inflationary policy and state intervention and the loss of our liberties? Here is a brief list:
- Unlimited printing of money to support the welfare state created a sense of dependency of the individual on state services.
- The expansionary monetary policy led to an exponential increase in public and private debt, constraining individuals by the burden of having to service their debts and financial commitments.
- The debasement of currency has led individuals to opt for debt instruments and debt-related financing measures to maintain their standard of living.
- Inflation has led to unfair and unequal redistribution of wealth. The few who have first dibs on newly created money get to benefit at the expense of the general public. First and foremost these are monetary authorities and the banking cartels and financial institutions attached to them.
- Inflation redirects money into refinancing debt facilities and away from investing in production, tying the state (and its citizens) to a never-ending spiral of debt.
The endorsement of deflation goes hand in hand with safeguarding liberty. Does this sound extreme or overly dramatic? Perhaps, but it is true. Monetary history shows that compared to today, individuals were truly “sovereign” in the 19th century. During the era of the gold standard, people were largely free of debt and enjoyed far greater independence.
Precious Metals Safeguard Independence and Liberty
“Paper money has become the technical foundation for the totalitarian menace of our days.” We can’t but agree with Guido Hülsmann on this. Paper money, inflation, and debt all are ingredients of a political project that benefits only certain strata of society, “political entrepreneurs” as Hülsmann calls them, at the expense of individual liberties and independence. These political entrepreneurs have every reason to be afraid of deflation. Deflation would strip them of many of the benefits they have reaped at the expense of the rest of society.
Deflation would liberate us, as it would redistribute wealth by modifying the structure of ownership, thereby restoring distributive justice. The drop in prices and the quantity of money would reinstate the true value of currency and consequently the true wealth of states and persons. Deflation would put an end to the individual’s dependency on debt structures and promote a focus on enhancing production. Wealth is not determined by the quantity of money, but by factors such as productivity and innovation.
We firmly believe that gold and silver are the sole currencies that can safeguard independence and liberty. While we do not know what the future entails when our existing monetary and financial systems break down, we are convinced that gold and silver will (at the very least) offer security in the transition period. If we look at the growing gold purchases by the East, they certainly show that people in many emerging markets have set their minds on gold. This supports our conviction that some form of gold standard could be reinstated one day, although the prevailing monetary experiment in fiat currency is likely to persist for some time to come.
Economist and prolific author Guido Hülsmann – an unorthodox champion of deflation