Deflation, Easy Money, And The Boom-Bust Cycle

Authored by Frank Shostak via The Mises Institute,

According to the president of the Federal Reserve of St. Louis James Bullard the current level of US prices is noticeably lower than what it would be if the Federal Reserve had delivered on its 2% inflation target, calling the trend “worrisome.” The yearly growth rate of the consumer price index (CPI) eased in April to 2.2% from 2.4% in March. 

Many economists maintain that a fall in prices generates expectations for a further decline in prices. As a result of this, it is held, consumers postpone their buying of goods at present since they expect to buy these goods at lower prices in the future. For most economists and various commentators a decline in the growth rate of the CPI raises the likelihood of an outright general decline in prices, which is labeled deflation and is considered to be a terrible thing.

Consequently, this weakens the overall flow of spending and this in turn weakens the economy. A fall in consumer expenditure subsequently not only weakens overall economic activity but also puts further pressure on prices. Or so it is argued. Note that from this it follows that deflation sets in motion a spiraling decline in economic activity.

But is it true that a fall in prices should always be bad news for the economy? Take for instance a case where a general fall in prices has taken place as a result of an expansion in the production of goods and services. Why should this be classified as bad news? On the contrary, every holder of money can now command a larger quantity of goods and services, i.e., people’s living standard are going up — so what's the problem?

General Declines in Prices and Money Supply

A general fall in prices can also emerge as a result of a fall in the money stock. An important cause for such a fall is a decline in fractional reserve lending. The existence of the central bank and fractional reserve banking permits commercial banks to generate credit which is not backed up by real saving (i.e., credit out of "thin air"). Once the un-backed credit is generated it creates activities that the free market would never approve. That is, these activities consume and do not produce real wealth. As long as the pool of real saving is expanding and banks are eager to expand credit, various false activities continue to prosper.

Whenever the extensive creation of credit out of "thin air" lifts the pace of real-wealth consumption above the pace of real-wealth production, this undermines the pool of real saving. Consequently, the performance of various activities starts to deteriorate and banks' bad loans start to rise. In response to this, banks curtail their loans by not renewing maturing loans and this in turn sets in motion a decline in the money stock.

It must be realized that it is only commercial bank lending that is not backed up by proper savings (fractional reserve banking) that can disappear into “thin air” thus causing the decline in the stock of money. Money, which is fully backed up by savings, once repaid by the borrower to the bank, is passed back to the original lender and therefore cannot disappear unless the original lender decides to physically destroy it. From this we can infer that the greater the percentage of credit out of “thin air” is in relation to overall credit the greater is the risk of a large fall in the money stock once the pool of real savings starts declining.

The point that must be emphasized here is that the fall in the money stock that precedes price deflation and an economic slump is actually triggered by the previous loose monetary policies of the central bank and not the liquidation of debt.

It is loose monetary policy, which provides support for the creation of un-backed credit. (Without this support banks would have difficulty practicing fractional reserve lending). The un-backed credit in turn leads to the reshuffling of real savings from wealth generators to non-wealth generators. This in turn weakens the ability to grow the pool of real savings and in turn weakens economic growth.

Many commentators are of the view that a fall in prices raises the debt burden and causes consumers to repay their debt much faster. (Rather than using the money in their possession to buy goods and services, consumers use a larger portion of their money to repay their debt.)

On this way of thinking a continuous debt liquidation could put severe pressure on the money stock and in turn on households demand for goods and services. All this, it is held, could lead to a prolonged decline in the price level. A fall in the price level in turn raises the debt burden and leads to a strengthening in the process of debt liquidation. Hence to prevent this downward spiral aggressive monetary pumping by the central bank is recommended.

Again the debt liquidation and emerging price deflation are not the causes of the economic slump but the necessary outcome of the previous loose monetary policies of the Fed that have weakened the pool of real savings. Also note that it is not a fall in prices as such that raises the debt burden and intensifies price deflation but the declining pool of real savings. The declining pool weakens the process of real wealth generation and in turn weakens borrowers’ ability to serve the debt.

Similarly, it is not increases in real interest rates, as suggested by many commentators, but a shrinking pool of real savings that undermine real economic growth. On the contrary, increases in real interest rates put things in proper perspective and arrests the wastage of scarce real savings thereby helping the real economy.

Now if the pool of real savings is falling then even if the Fed were to be successful in dramatically increasing the money supply and increasing the price level, i.e., countering deflation, the economy will follow the declining pool of real savings.

Contrary to the popular view, in this situation the more money the Fed pushes into the economy the worse the economic conditions become. The reason for this is that more money only weakens the wealth generating process by stimulating non-productive consumption (consumption that is not preceded by the production of real wealth).



J S Bach Looney Tue, 06/06/2017 - 18:52 Permalink

If money were issued debt-free to stabilize its "value" (increasing during periods of growth/decreasing during periods of decline), then theoretically, it would maintain a balance with very little inflation or deflation.  It is the albotross of interest owed to unelected usurers that is the cancer which eats at our economy.  Take them out of the equation and a natural stasus would ensue.  Also, without the bottomless money-pit of borrowability, the politicians would be reined in from funding endless bloated government programs to buy votes.  Ah, the ideal world.Zzzzzzzzz.  Well, a man's entitled to dream, isn't he?

In reply to by Looney

gm_general J S Bach Wed, 06/07/2017 - 12:47 Permalink

I thought about this subject at length, but one thing is interest when it is sufficient acts as a deterrant against taking out irresponsible loans. Look at all of the irresposible behavior of late. So what to do? I thought maybe we don't punish the responsible, and have loans with no interest, BUT if you don't pay on time, you get some hefty fine, or other suitable punishment like public tarring and feathering.

In reply to by J S Bach

jaxville Looney Wed, 06/07/2017 - 06:26 Permalink

No mention of the relationship between overall debt and the script issued by the Fed?  Fed doesn't "push" new dough into the system.  They lend it into existence.  Ive read Human Action but I am beginning to wonder about the Mises Institute and its' perspective on fractional reserve banking.  I am beginning to think they are OK with debt slavery if the "victim" chooses that path.   I know the essays I read here are the opinion of individual authors/economists but I always see Mises Institute in the attribution. 

In reply to by Looney

Arnold chunga Tue, 06/06/2017 - 19:53 Permalink

Small business generation sucks.……

"Over 85% of Small Business owner cannot quantitatively prove that social media marketing is helping them grow their business. This means that your efforts are being wasted and you don’t even know it."

In reply to by chunga

learnofjesuits Tue, 06/06/2017 - 18:36 Permalink

Vatican masonic order of jesuits Illuminati rule the world for centuries, they are building theirs New World Order - one government, one religion, global socialism-technocracy, depopulation(because overpopulation destroying biosphere) - check Georgia Guidestones also who has funded it, "order out of chaos"- they create a crisis and than they resolve it towards NWO.Important people in a society works for them, they are giving careers for obedience, we are living in a social pyramid system managed by jesuit masonic order.Just learn why jesuits were suppressed for 200 years in western countries and were allowed to return only a few decades ago - also in USA (there is a pattern easy to recognize). They escaped to Russia and Columbia and created in an underground Illuminati masonic sect.Society of Jesus was the most powerful intelligence agency - of Vatican - and they still are, all national intelligence agencies are controlled by jesuits, rest is a theater and actors.First Rothschild Nathan was rescued by jesuits from a camp and they made him theirs banker, he was not a smart Jew that become extremely rich, but he was just working for most powerful intelligence agency, also Soros is Christian Knight of Malta same as Rothschilds, Rockefeller, Brzezinski..., and Bush and Clinton are Skull and Bones - it is also an jesuit organisation and jesuit symbol, deceased Rockefeller read Bible every day.Templars were bankers and later jesuits took that buisness, it is that simple.Jesuit masonic order works by an undercover organisatios in order to hide.

learnofjesuits learnofjesuits Tue, 06/06/2017 - 18:36 Permalink

Bill Hughes, "The Secret Terrorists and The Enemy Unmasked"The Rothschilds were Jesuits who used their Jewish background as cover their sinister activities.The Jesuits, hands Rothschilds and financier Nicholas Biddle, sought to take control over the banking system of the United States. " Napoleon Bonaparte; 1769-1821; emperor of the Frence“The Jesuits are a MILITARY organization, not a religious order. Their chief is a general of an army, not the mere father abbot of a monastery. And the aim of this organization is power – power in its most despotic exercise – absolute power, universal power, power to control the world by the volition of a single man [i.e., the Black Pope, the Superior General of the Jesuits]. Jesuitism is the most absolute of despotisms [sic] – and at the same time the greatest and most enormous of abuses…” Abraham Lincoln (1809-1865; 16th President of the United States“The war [i.e., the American Civil War of 1861-1865] would never have been possible without the sinister influence of the Jesuits.” Marquis de LaFayette (1757-1834; French statesman and general. He served in the American Continental Army under the command of General George Washington during the American Revolutionary War.)“It is my opinion that if the liberties of this country – the United States of America – are destroyed, it will be by the subtlety of the Roman Catholic Jesuit priests, for they are the most crafty, dangerous enemies to civil and religious liberty. They have instigated MOST of the wars of Europe.” Edmond Paris (Author of the book The Secret History of the Jesuits)“The public is practically unaware of the overwhelming responsibility carried by the Vatican and its Jesuits in the starting of the two world wars – a situation which may be explained in part by the gigantic finances at the disposition of the Vatican and its Jesuits, giving them power in so many spheres, especially since the last conflict.” R. W. Thompson (Ex-Secretary, American Navy)“[The Jesuits] are the deadly enemies of civil and religious liberty. Fyodor Dostoyevsky (1821-1881; famous Russian novelist)“The Jesuits…are simply the Romish army for the earthly sovereignty of the world in the future, with the Pontiff of Rome for emperor…that’s their ideal. …It is simple lust of power, of filthy earthly gain, of domination – something like a universal serfdom with them [i.e., the Jesuits] as masters – that’s all they stand for. They don’t even believe in God perhaps.” "The Jesuit Order, therefore, stands before us as the embodiment of a system which aims at temporal political domination through temporal political means, embellished by religion, which assigns to the head of the Catholic religion - the Roman Pope - the role of a temporal overlord, and under shelter of the Pope-King, and using him as an instrument, desires itself to attain the dominion over the whole world."Count von Hoensbroech, 1911, German Noble and ex-Jesuit Pope Clement XIV (Who had “forever” abolished the Jesuit Order in 1773)“Alas, I knew they [i.e., the Jesuits] would poison me; but I did not expect to die in so slow and cruel a manner.” (1774) “Above all I have learned from the Jesuits. And so did Lenin too, as far as I recall. The world has never known anything quite so splendid as the hierarchical structure of the [Roman] Catholic Church. There were quite a few things I simply appropriated from the Jesuits for the use of the [Nazi] Party.Adolph Hitler (1889-1945; Nazi leader and chancellor of Germany from 1933-1945) "The Fuhrer had come to power, thanks to the votes of the Catholic Zentrum, only five years before, but most of the objectives cynically revealed in 'Mein Kampf were already realized; this book, an insolent challenge to the western democracies, was written by the Jesuit Father Staempfle and signed by Hitler. For—as so many ignore the fact—it was the Society of Jesus which perfected the famous Pan-German programme as laid out in this book, and the Fuhrer endorsed it."Edmond Paris, 1965 French Historian The Secret History of the Jesuits. Page 138 “The Jesuits wrote the first 25 rites of Scottish Freemasonry in then College de Clermont in Paris in 1754”The True origin of Scottish Rite Freemasonry According to the Masonic Quiz Book: Ask Me Another, Brother by William PetersonásObedience to RomeAfter receiving a message from Pope Benedict asking the Society of Jesus to affirm its fidelity to the magisterium and the Holy See, the Congregation presided over by Nicolás responded, "The Society of Jesus was born within the Church, we live in the Church, we were approved by the Church and we serve the Church. This is our vocation... [Unity with the pope] is the symbol of our union with Christ. It also is the guarantee that our mission will not be a 'small mission,' a project just of the Jesuits, but that our mission is the mission of the Church."

In reply to by learnofjesuits

perkunas Tue, 06/06/2017 - 18:45 Permalink

Nope money printing is not the problem, its the system itself. When a private bank prints the money, and charges us compound interest on it. Then gives it to their billionaire friends, that gambles it in the market, while offshoring our jobs, its a bad thing. In the past we would print the money interest free, and build things like Rail Roads, that built the Nation. 

gold rubeberg perkunas Tue, 06/06/2017 - 23:27 Permalink

Manipulating interest rates is nothing more than price fixing in the credit market, a practice that would be scandalous if engaged in by oil companies or computer software makers. Let a banking cartel do it and for some reason it's acceptable? It's no wonder our economy is on life support and drowning in debt.

In reply to by perkunas

Tiwin Tue, 06/06/2017 - 18:57 Permalink

It is really time to abandon our conditioning and political correctnews.Nothing is going to get better in this country until we expel the Jews. All of them.OUT of our country. Its either kick out the Jews or they will destroy what is left of America.

Salmo trutta Tue, 06/06/2017 - 19:33 Permalink

All savings originate within the payment's system. And saver-holders never transfer their savings outside of the payment's system (unless they hoard currency or convert to other national currencies). However, savings are never activated (put back to work), unless their owners spend or invest, directly or indirectly, via non-bank conduits. It's simple accounting. You get higher and firmer *real* rates of interest by forcing the commercial banks out of the savings business (the opposite of the political/economic instruction since the late 50s, hiking then eliminating caps on commercial bank deposit classifications). You also get lower loss from bad debt. This increases the ROA and ROE for the commercial banks. It also increases NIMs for the non-banks. I.e., the profitability of the DFIs is dependent upon the profitability of the NBFIs (where the size of the DFI system is not synonymous with the system’s and individual bank’s overall profitability) Commercial banks pay for their new earning assets (from a system's standpoint), with new money (not existing deposits). And since time deposits originate within the banking system, there cannot be an “inflow” of time deposits and the growth of time deposits cannot per se increase the size of the banking system. If you tally the principle “outside” factors that affect the money stock, e.g., reserve bank credit (+), expansion in bank capital accounts (-), etc., you will find that collectively, these factors are peripheral to any alteration in bank deposit growth (the money stock). It is a fact that the capacity of the commercial banking system to lend, and its aggregate size, is determined by monetary policy (not the savings practices of the non-bank public). From the standpoint of the system, the monetary savings practices of the public are reflected in the velocity of their deposits and not in their volume. Whether the public saves, dis-saves, chooses to hold their savings in the commercial banks or to transfer them to a non-bank will not, per se, alter the total assets or liabilities of the commercial banks, nor alter the forms of these assets and liabilities. The commercial banks could continue to lend even if the non-bank public ceased to save altogether.

gold rubeberg Tue, 06/06/2017 - 23:20 Permalink

Where did this 2% inflation target come from? The Constitution? Congress? Do they have any idea how to measure inflation anyway?

This kind of crap is as good a reason as any to end the Fed.

King of Ruperts Land Wed, 06/07/2017 - 02:05 Permalink

Central bank induced perpetual la la land does not work. The economy needs to go on the ropes once in a while. There has to be some deflation sometimes. Failures have to be liquidated. The business cycle serves a purpose like the ebb and flow of the waves on the beach.

ElTerco Wed, 06/07/2017 - 02:56 Permalink

"Similarly, it is not increases in real interest rates, as suggested by many commentators, but a shrinking pool of real savings that undermine real economic growth."

So if 50% of all savings/capital is owned by retired people, and they are continuously, albeit very slowly, spending down real savings, what is the right course of action to maintain a healthy economy? In the minds of Central Bankers, QE. We will be using fictitious QE tranches until the economy collapses. Japan will likely go first, although China is creating debt so quickly, they may win the race to the bottom.