Sunday, June 19, 2011

Inflation Essential for Transition to Industrial Economy?

Far be it from me to say that I have odd dinner discussions...

Anyway, I hosted a dinner tonight, which I am still reeling from. I made sangria (red wine, brandy, triple sec, blackberries, pomegranate juice, lemon juice, orange juice and club soda). Additionally, one of my guests kindly brought some American whisky as a contribution to my liquor collection. Which I appreciate. The majority of my collection is Scotch (Glenfiddich, Glenmorangie, Laphroig, and another one), though I also have a Rip van Winkle bourbon and a High West rye, courtesy of my friend Jeff.

But to get back to the point, at my dinner tonight, we discussed the essentiality of inflation for a transition from an agrarian to an industrial economy. Which, if you follow this blog, you will not be surprised at the fact that it came up in conversation. But you'll probably be glad that you weren't at the dinner table for it! Though maybe not - the food we had tonight was stuffed tomatoes (panko, tomato pulp, basil, almonds, olive oil, salt, and buffalo mozzarella for the stuffing), tortilla espanola, a grain and zucchini salad, a mango and fruit salad, and espresso. In my opinion, the food may have compensated for the discussion. And if it didn't, I would certainly have provided ample libations to assist in ignoring an argument among economists.

Anyway, why is it that an agrarian economy is fine sans inflation, but an industrial economy requires it? For that was the implicit point that my friend was making when he argued that the Federal Reserve was created to help stabilize the banking system (though, if any of us remember 2008, we have to doubt that it truly stabilized it!). Does anyone realize that computers are deflationary in pricing? You get more computing power each year without paying more, which is deflationary. And yet, the computer industry is not suffering. The computer industry is competing, and competing quite vigorously, aiming to deliver products to us at lower prices than the prior year when considering computing power. As a consumer, this is great! We consider this to be fine!

So why do we consider deflation to be evil? Clearly, price deflation is good for consumers with savings, since their savings increase in purchasing power during that period. Also, during one of the most robust periods in U.S. economic history, where average GDP doubled, the CPI decreased from 138 in 1869 to 93 in 1889 (The period of 1910 to 1914 is 100 here, The Case for Gold, p. 164 and 167). This is price deflation, which is evil according to people like Bernanke. But think for a moment: is it evil that 20 years later, I can buy the basket of essential goods for my survival at 32.6% less? I would think this a blessing. And yet, central bankers today consider deflation, such as this, to be bad. Never mind the fact that the economy grew during this period, proving that price deflation does not equate to economic downfall.

Maybe central bankers consider deflation evil because government debt becomes more expensive during deflation. On the contrary, with inflation, a dollar is debased and is worth less, so the debt burden is lightened. So maybe central bankers are subject to a very primitive bias: "Whose bread I eat, his song I sing."

To circle back to the headline of the blog post, if during the period of 1869 to 1888, when we were certainly experiencing economic growth sans inflation while going towards a more industrial economy, shouldn't that prove that we don't need inflation for an industrial economy? Or, to put it another way, why is it essential that the US dollar inflated to be worth so much less today than in 1913 in order to grow our economy? Why is it essential that people who saved money were penalized by inflation to grow the economy, when in prior periods this was not necessarily the case? If during the late 1800s we grew our economy with price deflation, why can't we grow our economy now with price deflation?

I'm unconvinced of certain people's arguments that inflation, created via the Federal Reserve, is essential for economic growth. To me, it seems essential to avoid a crippling debt burden from bad fiscal policy (inflate our money away, and the debt will not be as much of a burden!). In other words, we are paying for the sins of the politicians via inflation. If we grew our economy via price deflation during 1869 to 1888, then there is no reason why that can't occur now, except for government intervention. The switch from agrarian to industrial does not convince me either. If anything, an industrialist would want to know that the money he receives is sound (since he may be doing contracts from far places), and hence would prefer a money that is not debased in value.

In sum, I am unconvinced of my friend the government economist. Quite frankly, I view it as a case of A) "Whose bread I eat, his song I sing"; and B) mainstream economics thinking, which embraces the "euthanasia of the rentier" and forgets that the rentier is the one who provides the capital that allows new businesses to be created, through bonds he buys, IPOs he participates in, seed capital he provides to startups, deposits that he makes at banks which are lent out to small businesses, and so on. Maybe in government land, inflation is good, but from where I stand, my savings are being degraded each year unless they keep up with inflation, which can be hard in certain years (for example, during a period of hyperinflation, or a year where a stock market bubble bursts and takes down all stocks).
N.B. Sadly, I am convinced that most people don't realize that a primary factor in inflation is the Federal Reserve. "Power tends to corrupt, and absolute power corrupts absolutely."

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