January 30, 2015
By: Claudio Grass, Managing Director at Global Gold Switzerland
The Eurozone has been hovering around a 1% inflation rate, getting closer to zero during 2014, nothing close of the ambitious 2% benchmark set by central banks. Any small downward adjustment in the inflation rate will put it in the negative territory, allowing for prices to spiral downward. The West is genuinely fearful of deflation. Headlines in leading papers were very strong in reflecting this fear, describing deflation as “the world’s biggest economic problem”, or the “nightmare” that stalks Europe that will lead to its “descent” and collapse.
The real question is why do our governments fear deflation? Why do they perceive it as the chronic disease that could infect our economy and why do they go to such great lengths to avoid this “taboo”? The mainstream argument says we should avoid deflation because it causes a drop in overall demand and lower growth (Germany and other European states have been living a slowing recession recently which called for a downgrade in 2014 growth expectations). Also, deflation implies a decline in prices, lower corporate earnings and asset values, particularly real estate.
But the greatest concern to governments is not deflation itself; the real concern is the impact of deflation on the already over-indebted economies of Europe. Seven of the Eurozone countries are projected to have public debt to GDP ratios of over 100% next year! The worry is quite legitimate as Europe is on the verge of a debt-deflation spiral. With deflation, the burden on the already highly indebted governments increases making a default even likelier. So what are policymakers doing to “tackle” this problem?
As always, policymakers opt for the easy way out. Interestingly enough, they expect a turnaround of “fuelled” growth in 2015, driven by ECB President Mario Draghi’s quantitative easing (QE). QE means there will be more money printing that will increase the overall debt even further. Instead of questioning the methodology itself, analysts expect an impact from this policy. The ECB’s current priority is obviously to stimulate growth the American way: facilitate 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 monetary policy is not enough, and believes in further interventionist measures to avoid deflation at all costs. The direction that the ECB has taken throughout this year strongly reflects this – the negative interest rate is one of them. But really how negative will the interest rate go? Mr. Draghi has asserted his commitment to consider all available options to redress threats of deflation, including structural adjustments – but these are too time consuming. The easy way out is more debt and more printing of money.
The delusion that is inflation
Before he was Chairman of the United States Federal Reserve, Ben Bernanke claimed in 2002 that “…sufficient injections of money will ultimately always reverse a deflation”. Unfortunately for Bernanke, the Japanese cannot argue in favor of this opinion. Deflation was not unfamiliar to Bernanke. Japan went through a decade of deflation since the early 1990s and it has been “trapped” there since, not because of deflation itself but rather because it chose to redress deflation mainly by reflating the economy. It even implemented its QE program back in 2001 but with mixed results. It is living proof that monetary easing only perpetuates the “crisis” and does not repair the damage. So why go through that road again?
The Austrians say deflation plays a major part in the inevitable bust
Bernanke himself said that deflation is feared because it increases the real value of debts. Truth is deflation accentuates money, or rather the value of money. We believe that it strips all the excess nominal value added in the price of a product, making it reflect its true value and worth. Therefore we ask why the fear from deflation? In our view and as highlighted by the Austrian School economists: the bust is inevitable. The bust allows for the market to correct itself. Intervention in the economy, particularly through monetary expansion will only prolong the time span until the bubble bursts, and it will be more severe the longer it is delayed. Yes, we see there is a beauty to deflation.
There is no one that could agree more than Austrian School economist Jörg Guido Hülsmann, a senior fellow at the Mises Institute and Professor of Economics at the University of Angers in France. Over the years, Hülsmann has made great contributions on this topic. To Hülsmann, deflation is our savior – this is no exaggeration. As he said: “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 enslavement that was created with the monetary policies in the past 100 years. The unlimited printing of money we’ve seen over the years became an orthodox strategy to avoid deflation. In fact, Hülsmann argues deflation became the scapegoat of 100 years of pro-inflation propaganda!
Austrian economists such as Mises and Rothbard did not show strong opposition against pro-inflation propaganda. 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 may have discussed the topic more so as he argued that deflation has a beneficial role in speeding up the readjustment of the productive structure after a financial crisis. But clearly, deflation plays a great part in the readjustment of the economy to its natural equilibrium. Mises is quoted as saying:
“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 Our Lost Liberty
Hülsmann builds on Rothbard’s work, and his views are strongly and absolutely against inflation mainly due to the intervention of government in the economy. In other words, for deflation to happen means that government has no business in the economy. Anything short of laissez fair, such as structural adjustments or reforms, means the government is still in control. But how did inflation endorse state intervention and thus lead to the loss of our liberties?
- 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 debts making the individual constrained by the burden to repay his loans and financial commitments.
- The debasement of currency and loss of value has led the individual to opt for debt instruments and debt-related financing measures to increase income.
- Inflation has led to unfair and unequal redistribution of wealth. The few that exist in the form of financial and monetary authorities and their acquainted banks and financial institutions get to benefit at the expense of the general public.
- Inflation redirects money into refinancing debt facilities and away from investing in production capacities, making the state (and its citizen) tied into a never-ending spiral of debt.
- We truly believe that the endorsement of deflation goes hand in hand with safeguarding liberty. Does this sound extreme? Dramatic? But it is true. Monetary history shows that in the 19th century individuals were “sovereign”. During the gold standard, individuals were free from debt and enjoyed independence due to what is known as “sound money”.
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 Hülsmann on this. Paper money, inflation, and debt all are ingredients of this political project, only to benefit a certain strata of society or “political entrepreneurs” as Hülsmann calls them, at the expense of individual liberties and independence. In fact they have every right to be afraid. Deflation strips them from the benefits they have reaped at the expense of the rest of society.
We argue that deflation liberates us. Deflation will redistribute wealth by modifying the structure of ownership and thereby ensure distributive justice. The drop in prices and the quantity of money will reinstate the true value of currency and thus true wealth of states and persons. Deflation will put an end to the individual’s dependency on debt structures and therefore promote focus on enhancing production. The determinant of wealth is not found in the quantity of money but the factors that drive it, namely productivity and innovation. We firmly believe that gold and silver are the sole currencies that will safeguard independence and liberty. They reflect true value, a store of wealth and safeguard the sovereignty of nations and individuals!
We do not know what the future entails when our existing monetary and financial systems break down, but we are convinced that gold and silver will offer security (at least) in the transition period. If we look at the gold purchases by the East, it also reveals how emerging markets have set their minds on gold. This further supports our conviction that a form of gold standard might regain a prominent status and take over once again. However, the prevailing monetary experiment called “fiat currency” is likely to persist for some time to come.
This article appeared in the newest Global Gold Outlook Report. Subscribe for future updates on www.globalgold.ch
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By Claudio Grass, a passionate advocate of free-market thinking and libertarian philosophy. Following the teachings of the Austrian School of Economics, Claudio Grass is convinced that sound money and human freedom are inextricably linked to each other. He is currently the Managing Director of Global Gold Switzerland.
One Response
Exceptional article. I have maintained the exact same viewpoint for many years. What is so wrong about deflation?
The only “wrong” is that, as pointed out in the article, is that debtors (i.e.governments and over leveraged consumers) take a large hit as they have to pay debt back in ever more expensive currency. The productive people or businesses (savers) then have the ability to buy goods and services at ever lowering prices (in purchasing power terms). Additionally wage growth appears for everyone and the corresponding increase in purchasing power. No more $15 per hour cries for minimum wage and flipping burgers.
I actually hope that a deflationary environment takes hold as it will reset, as suggested in the article, governments, consumers and businesses on their thinking on managing finances in a rational and logical manner.