This is a response I just made to a private email, that I thought was worth posting here. Everyone understands why inflation is bad. But I'm very often asked what's so bad about deflation ("wouldn't I be happy if bread cost five cents a loaf, like in 1933?")
No. No, you wouldn't. Because where inflation destroys savings, deflation destroys society.
I'm going to just whisper this because it's not yet clear how far we're going with it. But the thing about deflationary times is that they produce social change, which is sometimes radical change.
Deflationary worlds always produce fewer goods and services (consumables and tradables) than is possible. (The economists would say that the economy is performing below its capacity.) If deflation gets bad enough, the aggregate production of goods and services can fall below what is needed to sustain ordinary survival and basic health for all members of the population. Over time, populations respond to this by getting smaller. In the near term, they can respond by confiscating stores of wealth that are held in private hands.
The latter can happen in hard ways (the French Revolution), semi-hard ways (the New Deal and trade unionism), or soft ways (whatever is going to happen in America over the next five years). The point is that there is stored wealth in private hands, at all times. The social friction arises because privately-held wealth is withheld in times of deflation. People who control wealth are in a position to weather the storm, but people without wealth aren't. If things get bad enough, people without wealth can be relied on to rebel.
Wealth isn't money, which has no reality to begin with. Wealth is assets that can produce goods, like farms, quarries, factories, and the softer assets (such as business relationships) that are needed to produce services. Over time, deflation causes wealth to become socialized. That's where we're going,but no one yet knows how far.
No. No, you wouldn't. Because where inflation destroys savings, deflation destroys society.
I'm going to just whisper this because it's not yet clear how far we're going with it. But the thing about deflationary times is that they produce social change, which is sometimes radical change.
Deflationary worlds always produce fewer goods and services (consumables and tradables) than is possible. (The economists would say that the economy is performing below its capacity.) If deflation gets bad enough, the aggregate production of goods and services can fall below what is needed to sustain ordinary survival and basic health for all members of the population. Over time, populations respond to this by getting smaller. In the near term, they can respond by confiscating stores of wealth that are held in private hands.
The latter can happen in hard ways (the French Revolution), semi-hard ways (the New Deal and trade unionism), or soft ways (whatever is going to happen in America over the next five years). The point is that there is stored wealth in private hands, at all times. The social friction arises because privately-held wealth is withheld in times of deflation. People who control wealth are in a position to weather the storm, but people without wealth aren't. If things get bad enough, people without wealth can be relied on to rebel.
Wealth isn't money, which has no reality to begin with. Wealth is assets that can produce goods, like farms, quarries, factories, and the softer assets (such as business relationships) that are needed to produce services. Over time, deflation causes wealth to become socialized. That's where we're going,but no one yet knows how far.
Hi Mr Cianfrocca, I'm a fan from Redstate. Very nice looking site you have here.
I read this piece and your inflation v deflation piece from yesterday which were very informative.
The best description I've heard of the perils of deflation is probably the basic scenario that you introduce the subject with: If you buy a house and get into a $300k mortgage or whatever during a deflation period, then within a matter of days or weeks the house will be worth a lower number of dollars (due to deflation) and you will owe more than your asset is worth. Thus the incentive is always to wait another few weeks for prices to come down, which in essence totally turns off the flow of consumer spending.
One interesting comment you made was that one possible means of dealing with deflation and loss of consumption would be to engineer a transition to a smaller US economy. Of course this solution seems ugly and would be a hit to our national pride and prosperity, but do you think that this could be the natural course that social demographics are putting us on which a huge chunk of the workforce reaching retirement age?
Forgive the wikipedia link, here is what I assume to be a reasonably accurate chart from the 2000 Census (which means everyone is about 10 years older now).
http://en.wikipedia.org/wiki/File:Uspop.svg
It appears that we have passed the peak generation, and the only things keeping our population growing are longer lifespans (more % of the population are seniors) and immigration. When population growth begins to decelerate (and WORKING AGE population growth has already begun to decelerate) is it natural for the economy and GDP to stagnate?