and Deflation is Self-Correcting!
by Jas Jain
December 16, 2005

My reply to the assertion that �deflation is worse than inflation� (see appended excerpts) got quite a few responses. There are at least four persons named George on my private list and I heard from two of them.

One George, an e-friend for many years, thinks that we may have hyper-deflation (�banks get scared �they stop lending�). There is no such animal, George B., and the world, especially, the US, can use some scared bankers. The second George, with whom I have the pleasure of having frequent dinner conversations, is a pilot (he just finished building his own plane likes of which I have never seen) and one day we were just talking what if there are too many drunken pilots. His response was quick and brief: The problem is self-correcting. What he meant, as he elaborated, was that over time enough of drunken pilots will be dead and we wouldn�t have the problem of having too many drunken pilots. George I., a clear thinker, can drink, but he is a very sober pilot.

Just like the problem of too many drunken pilots is self-correcting, so is the problem of deflation, i.e., when deflation becomes economically injurious it will get killed and thinned. We can all agree that it is lot easier to reduce or kill production, and thus limit the supply, than to increase production, or supply. The clearest case in point is crude oil as well as refined gasoline and heating oil, where it is very difficult to increase supply over a relatively short period of time, or even over a longer period for that matter. As prices fall to the point that the production is not profitable there are two ways that business people, including farmers, have dealt with the problem � limit the production, or destroy part of the production (both these were used in Brazil when the coffee production was so high that one would lose money by selling coffee beans at the market price). I have never read a case of hyper-deflation.

We all know areas of the economy where we have incessant deflation, e.g., computers, but it is not economically injurious to anyone except those businesses that can�t compete. The problem of excess supply, e.g., memory chips, gets corrected by normal market forces, but the problem is never the falling prices, which is the norm. Therefore, deflation by itself is never a problem and where deflation leads to economic problems it gets corrected one way or another over a reasonable period of time. People would refuse to produce and sell below a certain level of profitability and so the prices cannot fall, or keep falling, below a certain level that allows some minimal profits for all involved, including labor. Yes, there would be some period of pain while the adjustments take place but it will not go on for too long, or get out-of-control, as the term hyper-deflation is meant to suggest.

Long periods of �price stability,� Greenspan�s favorite term, necessitate some years of deflation to counter some years of inflation. In that sense deflation, even when it is injurious to the economy over short-term, as sustained inflation certainly is, is a part of corrective mechanism and nothing to fear, or fight. To fight deflation at all costs is idiotic because it disables a very important economic function, one of adjustment.

It is like disabling the brakes in a vehicle.

Inflated egos of central bankers are self-reinforcing!



Henry: Deflation is worse than inflation, but nothing is worse than hyper-inflation�

Jas: History must be irrelevant to you, Henry, or do you claim that we are in a New Era? Here is what history has to say: THE GREATEST ECONOMIC PROGRESS IN ENGLAND AND LATER IN AMERICA WAS MADE DURING A PERIOD WHEN DEFLATION WAS AS COMMON, OR MORE COMMON, THAN INFLATION. During 1871-1914, the annual inflation rate in the US was minus 0.77% (yes, prices were lot lower in 1914 than in 1870!); there were more years of deflation then there were years of inflation; and the GDP growth rate was never exceeded before or after as best as one can judge from available records. Real returns on stocks were fantastic during the deflation years! Smart Americans of those years demanded dividends and what could be better than getting 5% dividend when things cost less and less every year? The Roaring Twenties (1920s) were deflationary even when the stocks were booming (YoY inflation rate was negative during Jul�26-Jun�29)...

© 2005 Jas Jain
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Jas Jain

Tehachapi, CA USA

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