In part 1, we saw that there is no necessary link between deflation and depression. The deflation that appeared in the Great Depression seems to be an abberation rather than a rule. So, why the near hysterical reaction by our leaders to stop deflation?
We can rule out a couple of reasons; the reverence for FDR among Democrats. Many on the right side of the political divide fear deflation as well. We can also rule out any interpretation of Keynesian Theory. Keynes not only strtessed the idea that governments should borrow heavily during recession, he also emphasisized that governments should withdraw from the market and save money during boom years. There are very few true Keynesians in government.
The most important things to realize about deflation and the reaction to it is that the value, or buying power, of money increases, and that profits on a balance sheet are measured in quantity, not quality.
Deflation Losers
Most public companies, like those on Wall St., hate deflation. With deflation, the quantity of money decreases. With lower prices, companies must sell more to stay even. Deflation requires more output for the same amount of money. It’s much easier to show a profit during inflationary times.
Ordinarily one might think that banks would like deflation; the advantage is with the lender. However, most banks are public companies subject to the same disadvantages stated above. With falling prices, the amount needed for a loan decreases, further cutting into the bank’s profit.
Governments also lose with deflation. They neither make anything nor sell anything and have no need to show a profit. With governments, it is a strict borrower/lender situation. When a government borrows during a deflation episode, the money it paysd back is worth more than the money it borrowed. It’s much better for them to run up inflation after they borrow.
Deflation Winners
It should go without saying, but consumers love deflation. What shopper doesn’t like lower prices? Case closed.
Savers benefit from deflation. The elderly, disabled, and retirees make money simply by holding on to it. As the value of their money grows, their buying power increases even when their incomes stay the same.
Wage earners are helped by a deflation episode. Even if wages themselves hold steady, real waged rise once deflation is factored in. Any raise a wage earner recieves gets an added boost from the lower consumer prices.
Sincew the end of WW II, it has been the policy of our government, acting through the Federal Reserve to try to maintain a 3% inflation rate.
The advantage goes to the banks, corporations, and against the wage earning, consuming savers. Government feels free to borrow as much as they like, knowing that the dollars they borrow will be paid back with less valueable dollars. All of which leaves this wage earning saver sounding a bit like Oliver Twist, “Please Sir, may I have some more deflation?”
