But Now You Know

The search for truth in human action

Why Deflation is Bad…for You, Private Property, and Capitalism


Politicians and journalists are worried, right now, about a downward spiral of deflation, of the type that normally comes in an economic depression.

They are pointing to two signs we are having bad deflation…first, the falling price of commodities like oil, and the disappearance of money in this economic failure causing demand to plunge. One of those is actually good, the other is very bad.

When prices go down naturally, because of an increase in efficiency or improvement in technology, it is good for everyone. 

For example:

  • Improved efficiency makes the manufacture of computers cheaper, while more advanced computers make the old versions cost less.
  • Food used to take up most of humanity’s effort, therefore most of  a family’s cost of living, but has declined to third or fourth place as technology and efficiency allowed us to grow more with less.

The decline in oil prices, returning to only double their normal level, will cause a good kind of global price decline, because most prices are effected by the cost of the energy required to create and deliver products and services.

But, again, those specific cost reductions are not deflation.

What Are Real Deflation and Inflation?

When money deflates, people choose to just hold onto it, starving the marketplace and causing a spiral of ever more deflation

When money deflates, people choose to just hold onto it, starving the marketplace and causing a spiral of ever more deflation

In real economic terms, inflation and deflation happen when the ratio of money to economic wealth changes. If the amount of money becomes greater, in comparison to the economy, then you get inflation. Because the most common result of this is for prices to increase, we confuse the terms and call general price increases “inflation”, but actually it’s the change in ratio that is inflation.

The eleven trillion-plus dollars of capital that have purportedly vanished in the past few months represent a huge decline in money supply, causing actual deflation. This failure was caused by the inability of central authority to manage money any better in the US than it could provide shoes and food in the Soviet Union.

Prices Can Increase Without Inflation, Too

Prices can actually increase for other reasons, and that’s not really inflation. For example, when oil increased 600% in price, it drove up the cost of production, without regard for the number of dollars in the economy. This general price increase was NOT inflation.

And when prices decrease for other reasons, it’s not deflation.

Inflation is Harmful

We all know that when the ratio of money to wealth increases, causing inflation, it is bad for the economy, and especially for the poor and middle classes. This is because it usually drives up prices, and the poorer you are, the more of your wealth and well-being is in cash.

Poorer people depend on cash they have in a bank, or other savings. They are paid by employers who give them only a set rate, plus raises for special reasons like increased skill.

Wealthier people tend to have more of their wealth in assets like, stocks and real estate, that will simply increase in price, sheltering them from some of the effect if inflation. They get cost of living increases in salary every year, on top of any other raises.

Deflation is Harmful, too

But the opposite kind of damage occurs if you have deflation, and is compounded by a new problem.

First, deflation artificially drives down prices. To a person with no real assets or investments, this sounds good, because “stuff costs less”.

But it comes at a horrible price.

Deflation punishes investments that can raise people from poverty, both personal investments, and business growth

Deflation punishes investments that can raise people from poverty, both personal investments, and business growth

For example, the decline in prices includes wages. Deflation is universal, with a shortage of money everywhere, so that your income will decline, along with the price you pay for things. What good is cheaper stuff, if you also have less money?

So people with fewer assets and no investments will more or less end up breaking even. But they still lose out in the end, because they become blocked from gaining assets, trapping them in relative poverty.

For example:
 

How Deflation Traps the Poor and Middle Class

Imagine you’re buying a house. Not on a sub-prime loan, but one where your income is perfectly fit for the home you’re getting.

It’s probably a thirty year loan. So you’re going to be stuck paying on the original price of your house, for thirty years, at the original size of house payment.

Now remember that your income (in dollars) is getting smaller every year. That’s deflation.

And the price of your house, too. Each year, its is worth fewer dollars, yet your original debt is the same. And so are your payments.

Within just a few years, you are making far less money, but are stuck with the same size house payment you always had.

While you still have to pay the same percentage of of your paycheck income for food, electricity, and so on, your house payment takes up a higher percentage of that money every year.

Soon, your income has shrunken to the point where you cannot make your house payment at all. Not even if you paid your whole check to the bank every week.

And worse, you can’t simply sell his house to get out of it. The price of your house has also declined every year. Selling it now that the payment is too high won’t even pay off your remaining house debt.

Of course people would quickly learn this, and that they simply cannot buy houses, unless they are so incredibly wealthy that they can save up enough to pay cash. 

But even those wealthy people who can pay cash for a house now face the situation where buying a house is a horrible investment, because the house’s value will decline, in dollars.

It would actually be better to leave the money in a vault, and rent monthly, even for a billionaire, because the money’s value increases, while the house’s price declines. One thousand dollars will be worth more next year, if you simply stick it in your mattress, than one thousand dollars worth of house will be worth in that same year.

In fact, owning land becomes a losing proposition. With even the wealthy better-off renting, who’s going to actually be the landlord?

Deflation Attacks Economic Freedom

In fact, ALL property ownership becomes punished!

With deflation, anything you buy does not just depreciate with use and age, but declines in value every year with prices, compared to if you’d simply kept the money.

Today, you could buy that console game, or car, or collectible, and then sell it on eBay a few years from now and recoup part of the cost. But with deflation, the price you recoup is even farther from if you’d kept the cash in the first place.

Deflation Destroys Capitalism

Deflation punishes investment and property ownership, attacking capitalism at its roots

Deflation punishes investment and property ownership, attacking capitalism at its roots

In fact (and this is where the entire economy implodes from deflation), simply holding on to your money is rewarded versus ANY investment, in a deflationary economy. If you put your money in a big ol’ vault, removing it from the economy entirely, it grows in value every year. But if, instead, you buy stocks, or invest in commodities, then your money is gone, replaced with an asset that becomes worth less every year, in dollar terms.

The growth of every business, in fact, would be undone by the rate of deflation. Now from the company’s standpoint, that is fine, because its expenses decline every year by the same amount.

But from an investor’s standpoint, a company growing at 2% per year during 3% deflation would mean you lose 1% over just stuffing your money in a safe. And yet you also risk, when investing money.

Why bother investing even in a company you think might grow at 5%, when you could have a 100% safe 3% investment in a vault under your mattress? So, really, the company facing deflation is NOT fine, because it discovers that it’s far harder to get investors. In fact, the entrepreneur who would have started that company is 3% punished each year for the effort, making him that much less likely to even bother.

With investors discouraged because of deflation, it becomes harder to create wealth. Capitalism, in fact, becomes almost impossible:

  • An entrepreneur can’t get investors for his new project.
  • There’s less reason to buy stocks, so companies can’t raise capital.
  • You can’t get a loan to start a business, because your company’s income would decline every year, yet the loan payment would stay as large as ever.

With deflation, the very engines of capitalism all die out.

Speculation Defines Capitalism

It is the uncertain investment on the wild new idea that makes capitalism superior to central planning. Anyone can decide to invest in a “sure thing”: if that were good enough, socialism would work, because a government bureaucrat could declare money for the obvious solution. It’s diverse people choosing to risk money on many different wild ideas that lets the best solutions rise to the top.

But that very kind of capital investment, in a deflationary economy, is punished, because you get such a good deal by not investing in anything at all, but holding your money in a vault.

All of this, by the way, is aside from the additional destruction caused by the lack of downward price elasticity on many commodities and time-based investments. That’s much more arcane, but a key source of economic depression, that I’ll get into some other time.

For now, it’s enough to realize that prices being FORCED downward by deflation includes your pay, and the value of any investments you make, so that private property ownership, borrowing, and investing, in fact all capitalism, is crippled under deflation.

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December 16, 2008 - Posted by | Economy | , , , , , , , , , , , ,

10 Comments »

  1. There is no such primal right to own land needed by others !Primal refers to the natural;since capatalism depends upon many unnatural ,man-made factors,we should not even speak of capatalism and primal rights in the same breath.Again money is not part of nature!

    Comment by James | April 10, 2010 | Reply

    • In fact, there IS a primal right to own ANYTHING that has scarcity.

      Previously, you tried to claim that land and air are both a form of commons.

      But land is, in a broad practical sense, limitless. Land is not. ALL things that have scarcity MUST be demarcated by private property rights, or else you cannot determine its distribution and use.

      It’s just that simple.

      Comment by kazvorpal | April 16, 2010 | Reply

  2. The American slaves had a right to ”earn” their freedom ! I suppose then,that according to conservitive capatalist thought,slavery is really freedom !?

    Comment by James | April 10, 2010 | Reply

    • Are you referring to something that was said, somewhere, or are you just posting random thoughts you had?

      Comment by kazvorpal | April 16, 2010 | Reply

  3. You are very wrong Kazvorpal ! Most of the world is in fact capatalist,not socialist nor heaven forbid, communist.
    Why on earth should humans be forced to earn their rightfull place on this planet ? Because ceartain capatalists such as your self think they should ? Man did not create this planet,therefore no one has an inherint right to claim ownership over it !
    It was the enclosure movements in Europe which partialy led to capatalism ! You should be aware of that considering your education.I am sure you are aware of that,however you arew determinend to defend capatalism regardless of the truth.I can only guess why.The elites who stole the land from the pheasants then in many cases proceded to sell those lands to their cronies,this marked the beginning of the treatment of land as a commodity.The people whom they stole the lands from were not capatalist who had bought those lands ! The lands stolen from them were shared commons! Not to horribly long ago land,was treated like the air is today,it was a natural commons,not a commodity to be owned privately nor bought and sold ! This is a fact that arguing against is futile !

    Comment by James | April 10, 2010 | Reply

    • > Why on earth should humans be forced to earn their rightfull place on this planet ?
      > Because ceartain capatalists such as your self think they should ?
      > Man did not create this planet,therefore no one has an inherint right to claim ownership over it

      …and yet that’s what YOU seem to be saying should happen.

      You asked why people should be forced to earn their rightful place, and yet that nobody has an inherent (or inherint) right to claim ownership over it.

      These seem oxymoronic.

      > Most of the world is in fact capatalist,not socialist nor heaven forbid, communist.

      Only if you don’t know what those words mean.

      And you apparently do not, if you are going to imply that being communist might not be so bad as people think.

      The world is largely comprised of places where a central government controls people’s economic decisions. There is really no way around that…and that is not only the very definition of socialism, but is antithetical to the core requirement of capitalism…that there be a free market.

      > It was the enclosure movements in Europe which partialy led to capatalism !
      > You should be aware of that considering your education.I am sure you are
      > aware of that,however you arew determinend to defend capatalism regardless
      > of the truth.I can only guess why

      Are you claiming that I should be against economic freedom based simply upon the fact that one of many things that led to its increase was an iteration of the enclosure movement? But those resisting the enclosure movements are the badguys…greedy people who think they are entitled to have free access to random stuff that they haven’t earned. It’s one thing to take advantage of random cattle roaming unowned lands, it’s another to think that people somehow owe you access to the land and cattle they actually own, themselves.

      > .The elites who stole the land from the pheasants then in many cases proceded
      > to sell those lands to their cronies,this marked the beginning of the treatment of
      > land as a commodity.

      I think it’s outrageous that anyone would steal land from pheasants, but I have to admit that game fowl should not have property rights in a well-organized society, because they are not competent to function as fully autonomous members of that society. Not pheasants, nor turkeys, and especially not quail.

      On the other hand, if peasants owned some land, their private property rights over that land should have been protected. That’s separate from people simply putting up fences or enforcing boundary lines around property that had been in their family for generations, or even what had been public property but was now being privatized.

      Those last to scenarios are legitimate.

      > Not to horribly long ago land,was treated like the air is today,
      > it was a natural commons,not a commodity to be owned privately
      > nor bought and sold ! This is a fact that arguing against is futile !

      Not too horribly long ago, people put oval-shaped yokes around the necks of oxen, in order to try to plough land.

      This is a fact, and arguing against it would be futile.

      But, unlike your statement, mine is actually relevant to the discussion, as it shows how YOUR statement is committing the fallacy of argumentum ad antiquitatem, claiming that because things were a certain way, they should BE that way…when, in fact, people struggled to grow enough food to survive, under both ox farming and lack of private property rights.

      Comment by kazvorpal | April 16, 2010 | Reply

  4. […] But it couldn’t keep that up, because deflation destroys a market economy. […]

    Pingback by Where’s the Hyperinflation? « But Now You Know | July 25, 2009 | Reply

  5. Below is the typical capitalist attitude as to freedom of speach.If what is being said streaghtens or at least seems to streaghthen the capitalist position then it is published,if not it is kept from the public for fear of ? In fact to the capitalists nearly all freadoms are reduced to privalidges,privalidges of wealth that is-no money,no freedom,as if money were part of nature.

    If capitalism is the best economic systyem possible then why is it that the majority of the worlds population lives in poverty,while a tiny minority own the vast majority of wealth ? The awnswer is simple,capitalism is great only for the most competitive of people,who become smaller in number as time progresses,and resources are depleted.It is a fact that when people compete some of those people must loose.So tell me what is so great about a system based upon compitition”forced at that”which garuntees that certain people”including children ”must expereance some degree of economic hardship ? Also,tell me if capitalism is such a liberating economic system,then why is it then that in the capitalist system the average person must in effect not just earn a living,but earn even the right to earn a living !

    In our modern capitalist system,the right to land is not a right at all,”that is unless you inherit land”but a privalidge of wealth. I argue that this is capitalism’s greatest and least justifiable flaw.In our country,”and many others”there are people who by virtue of blood relation inherit thousands of acers of land while others spend the better part of their healthy years struggling to legaly maintain minimal living space ! If you believe such a system is just,then you have a very strange concept of justice indeed.

    I could rail on forever as to the injustices inherent in the capitalist socioeconomic system,but what is the use conversing with someone who believes that it is possible to know freedom but yet have to pay another person just for the right to exist upon the planet!?

    Comment by James | February 2, 2009 | Reply

    • > If capitalism is the best economic systyem possible then why is it
      > that the majority of the worlds population lives in poverty,while a
      > tiny minority own the vast majority of wealth ?

      Because the majority of the world’s population lives in socialist economies, while a tiny minority live in something vaguely closer to free market capitalism.

      Your question actually reinforces the fact that capitalism/freedom is the source of wealth and prosperity.

      > It is a fact that when people compete some of those people must loose.

      This is patently untrue. Competition is good for everyone, even if some lazy people are afraid of it. Imagine two societies, one living on an island whose environment is only conducive to producing meat, the other only producing fruit. Capitalist trade between the two societies brings wild profits and benefits to both sides, although either thinks they are fleecing the other. Meat is worth a fortune on Fruit Island and fruit is a time a dozen…so they sell nearly worthless fruit, and get insanely valuable meat…but the opposite conditions are true on Meat Island, who thinks they’re getting valuable fruit for worthless meat.

      Free market competition allows all to compete to contribute the most to society, and everyone wins.

      > Also,tell me if capitalism is such a liberating economic system,
      > then why is it then that in the capitalist system the average
      > person must in effect not just earn a living,but earn even the
      > right to earn a living !

      How do you arrive at this conclusion? In fact, a free market is the only system where people have their natural right to earn a living protected from the outset. In socialism, you have more limits on what you’re allowed to do, generally having to get active permission for any wealth-creating efforts you’d make.

      > In our modern capitalist system,the right to land is not a right at all,
      > ”that is unless you inherit land”but a privalidge of wealth.

      RIGHT to land? No, you have a right to earn, not a right to have. You aren’t entitled to land unless you earn it, or the wealth you trade for it, or someone else earns those things and chooses to transfer them to you.

      You should NOT have a “right” to own land granted…that sort of thing helped create the situation we’re now in. Big Brotherment forced lenders to finance home ownership among people who did not deserve it.

      > In our country,”and many others”there are people who by virtue of
      > blood relation inherit thousands of acers of land while others spend
      > the better part of their healthy years struggling to legaly maintain
      > minimal living space !

      If you live in Europe, then perhaps you mean the land owned by heirs of royalty, who stole the land from others, obtained it via coercion, some time in the past. That is illegitimate, the opposite of capitalism.

      But people who earn wealth, and buy land with it, have a right to retain ownership of what they earned. That includes the right to sell it, or give it away. Obviously, the right to give their property to their own family is as integral a part of that as anything. So someone inheriting legitimately earned property is absolutely necessary, a primal example of your natural rights.

      Comment by kazvorpal | March 9, 2009 | Reply

  6. Nice writing style. Looking forward to reading more from you.

    Chris Moran

    Comment by Chris Moran | December 16, 2008 | Reply


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