"INFLATION VS. DEFLATION," REVISITED
Gary North
One question that keeps coming from readers is this
one: Are we heading for deflation or inflation?
If you are concerned about how well your investments
will perform over the next year or even decade, you had
better come to an answer and then act in terms of it.
Therefore, it is time, once again, for me to deal with
this one. I have been dealing with it in print for over 40
years. (For the record, this was in a 1964 pamphlet,
"Inflation: The Economic of Addiction." I republished it
as a chapter in my book, "An Introduction to Christian
Economics, 1973.)
To answer this question accurately, we must first
define our terms. "Inflation" is an increase in the money
supply. "Deflation" is a decrease in the money supply.
Monetary inflation produces price inflation. Monetary
deflation produces price deflation.
The most important money supply charts are found here.
I implore you: click this link.
snipurl.com
Click the first three links on the page.
If you refuse to do this, then you are not really
interested in the inflation vs. deflation debate.
Where is there any evidence of monetary deflation in
the United States . . . or anywhere else?
For the evidence of either looming inflation or
deflation, I use the Median CPI, published by the Federal
Reserve Bank of Cleveland. Here are the latest figures for
the Median CPI and the regular CPI.
snipurl.com
Every time you hear an argument for deflation, come
back to these charts: the money supply and the price
indexes. They will help refresh your memory.
MY PREDICTION
We are heading for more price inflation.
I have been predicting this since 1963. I have been
right every year since 1963.
I bought my first silver coins in July, 1963, with my
first paycheck from the Center for American Studies. I was
a summer intern. I went to the local bank and started
buying. I was earning $500 a month. By the end of the
summer, I had bought over $1,000 in silver coins. I sold
this to my parents. I used the money for graduate school.
In September, 1963, the silver coin shortage began.
Toll booths in the New Jersey area started running out of
change. Toll booth employees were sent out to churches
every Sunday evening to buy coins.
I had known the silver coin shortage was likely ever
since the summer of 1962, when Professor Hans Sennholz
predicted it at a two-week seminary attended by college
students at Santa Clara College. He was buying silver
dollars. He said that Gresham's law would soon come into
play: "Bad money drives good money out of circulation."
This law really means: "Artificially overvalued money
drives artificially undervalued money out of circulation."
In June, 1963, the U.S. government ceased producing
silver certificates, which were convertible into silver
coins. Silver was approaching $1.27 per ounce, the price
at which a silver coin would be worth its face value. If
silver went above $1.27, Gresham's law would take over.
This took place in the summer of 1963, just as
Sennholz had predicted.
He is still writing. He is still predicting
inflation.
sennholz.com
So, I have been correct every year since 1963.
Consider this when considering the arguments of anyone who
predicts deflation. How many years has he been predicting
this? He has been wrong for that number of years.
The main arguments on each side of the debate never
change. Only the believers change.
Believe no one -- I mean NO ONE -- who predicts
deflation until he supplies you with information about when
he first began predicting deflation.
He won't supply this information unless you ask. It
is just too embarrassing.
Those forecasters who predict deflation do so year
after year, attracting a new crop of subscribers from the
general population.
Why do they keep doing this, if they are wrong, year
after year? Because it is their chosen niche in the
newsletter market. They supply a counter prediction in
order to get new subscribers. There are always newcomers
who know nothing about investing who are happy to send in
money. They keep sending money for a few years. Then they
finally quit, having heard the same inaccurate song for
several years. New subscribers replace them.
Why abandon a marketing strategy that keeps working,
decade after decade?
Also, these poor souls really believe their own
advertising copy. I know most of them. One of them is a
second-generation promoter of the "deflation is coming
soon" prediction. He is rich, yet he and his late father
have been predicting deflation every year since 1967. I
debated the man on Joe Bradley's subscription tape service
in 1982.
Using the Bureau of Labor Statistics Inflation
Calculator, which understates inflation, we learn that it
would take $2,047 today to buy $1,000 worth of goods in
1982. Yet this man has created a newsletter publishing
empire based on predicting deflation.
www.bls.gov
THE CASE FOR DEFLATION
The debate between deflationists and inflationists
surfaced in 1973. The best-known deflationists were John
Exter and C. Vern Myers. Myers is dead. I don't know
about Exter.
Exter's argument was coherent. Myers's wasn't.
Exter argued that gold would go up in price even though
fractional reserve banking would collapse because of a lack
of secure collateral. Gold is the ultimate collateral, he
argued. The inverted pyramid of debt at some point will no
longer be sustainable. There will be a flight to
liquidity. The fractional reserve banking system will
implode. Consumer prices will fall. But not gold's price.
Is this scenario plausible? Not then, not now.
Is it possible? Yes. The problem will most likely
come from the leveraged futures markets -- specifically, the
derivatives market. If there is a major default in this
$300 trillion market, inter-bank payments could cease.
Bank A would not settle its daily payments with bank B
until bank C pays bank A. Greenspan has called this
scenario cascading cross defaults.
If it ever comes, the international division of labor
would collapse. If credit ever creases, then the modern
world ceases. It would be like a nuclear World War III.
No one could settle digital money accounts, including
gasoline stations. How would you buy gasoline? How would
the local station pay the regional distributor?
The modern world is like millions of long,
interrelated rows of dominoes. Nobody can see where the
rows are. If they topple, everyone will suffer.
At that point, only well-armed Amish farmers would
survive. Problem: they are unarmed.
This is not a case for deflation. This is a case for
the collapse of civilization.
Short of a bank gridlock, what is the case for
deflation? If you cannot easily jot down the case for
deflation, don't subscribe to anyone's letter until you
can. If you don't understand the theory, don't invest in
terms of it.
There is one thing that governments can do: order
their central banks to buy more government debt. When the
central bank buys debt -- or any asset -- it creates new
money. The government then spends this money. That money
will be spent: by the politicians, by the defense
contractors, by the welfare recipients, by everyone who
receives a government check.
Here is why there is no logical case for 2% or 5% or
20% price deflation. It relies on a totally implausible
theory: governments will not spend money. Governments will
ALWAYS spend money -- more than they receive through
taxation.
The case for PRICE deflation is the case for MONETARY
deflation. The case rests on the theory that people will
not borrow money at some rate of interest above zero. But
they will. The modern world is addicted to debt.
There can be some markets that experience deflation.
Housing is one of them. But general deflation? No.
General deflation that central banks cannot thwart by
buying up the actual assets that are falling in price? No.
If a frightened owner of an asset that is falling in
price is offered a check from the central bank to buy his
asset, he will sell. The central bank is allowed to buy
anything as a reserve asset. It can create new money at
any time, using the purchased asset as a legal reserve.
The deflationary scenario assumes that central banks
cannot overcome falling prices by creating money. Until
you understand why a central bank cannot buy falling
assets, don't take seriously anyone who predicts deflation.
Dr. Ben Bernanke, the newly named future Chairman of
the Federal Reserve System, has made a prediction in 2002.
Pay close attention.
Of course, in lieu of tax cuts or increases in
transfers the government could increase spending
on current goods and services or even acquire
existing real or financial assets. If the
Treasury issued debt to purchase private assets
and the Fed then purchased an equal amount of
Treasury debt with newly created money, the whole
operation would be the economic equivalent of
direct open-market operations in private assets.
snipurl.com
In short, the U.S. Treasury could buy up every asset
on earth by selling the FED its debt. This is socialism on
the cheap. The government would own the capital of the
world.
Why won't this happen? Because the world would at
some point stop selling assets to the Treasury for fiat
money because of mass inflation -- the collapse of value of
the dollar. This is the opposite argument: the inflation
argument, not the deflation argument.
THE CASE FOR INFLATION
Let us start with a fundamental economic principle,
one which I have been using since 1963:
It is cheaper for a fractional reserve bank to
create unbacked fiat money than it is for
individuals to create wealth.
Computerization has made money creation a lot easier
than it was in 1963.
There is also a fundamental political principle:
Incumbents will accept "a little inflation"
rather than be defeated at the next election
because of a recession.
Are there any doubts about these two principles on
your part?
You don't need any further theoretical arguments for
further inflation. These two are sufficient.
For as long as the central banks of the world are
allowed to monetize assets without political restraint,
deflation is not a threat.
A complete bank payments gridlock is a terrible but
inherently unpredictable threat, but that's not what
deflationists are predicting. A bank payments gridlock
would mean that no one could subscribe to newsletters.
That would bankrupt all publishers. This would mean that
existing subscribers would not be sent the promised
newsletters. No deflationist dares to put that in his
subscription offer!
There has not been price deflation in the United
States since 1933. The money supply keeps growing. Prices
keep rising.
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CONCLUSION
Deflationists argue, "Next year, in America!" They
have been wrong every year since 1933.
Inflationists argue, "Next year, in America!" They
have been correct every year since 1933.
Gentlemen, place your bets!
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