Most people believe that another debt deflation is no more likely than an invasion from Mars. And they behave accordingly. The average resident of English-speaking countries is deeply in debt, with the largest part of his assets invested in real estate. This is a gamble on inflation. For most real estate and other tangible assets to hold their 1990 value, let alone appreciate, inflation must rise sharply – as it seemed to be doing during the Kuwait Iraq crisis.

Even a modest deflation would stand inflated real estate, collectibles, and many other assets tumbling, wiping out many individuals, families, and businesses. Yet in spite of the huge investment stake we all have in understanding the dynamics of deflation, most individuals refuse to think about it, relying upon political promises that there will never be another depression.

Deflation More Likely Than People Think

You have heard the reasoning before…. politicians have high speed printing presses. They can make them run as fast as they please. In a choice, they would always want to inflate. Therefore, there can never be deflation. It is a sweet, simple argument. If it were true, it would make your job as an investor incredibly easy. All you would have to do to make a fortune is place a whole hog that on inflation. Just hock every asset you have, run your credit to the limit, buy some gold, and lie back to wait for the silly politicians to float your easy chair down to paradise on a river of red ink.

We don’t think it is that simple. Those who say the government has the power to prevent deflation are right. But they are answering the wrong question. Obviously, the government can print all the money it wants. He can slap any number of zeros on a piece of paper and raise the nominal money supply to a higher power. This has always been true. But it is a mistake to stop your inquiry there, because you have merely answered a misleading question. One could just as well say that the government has the power to prevent you from dying of cancer. It can. By taking you out and shooting at first. But the cure in that case, like the printing press cure for deflation, is worse than the disease.

The key to understanding the danger of deflation is to recognize that the process of deflation is less transparent than the process of inflation. Inflation corresponds to an understandable motive on the part of politicians it is easy to see how they could benefit from printing money. The early stages of inflation are often periods of boom. Easy money makes people feel richer than they are. The inflation euphoria is good for reelection prospects. Politicians tend to prosper when their constituents prosper. So if inflating puts more money in everybody’s pockets, it is clear why politicians are tempted to do it.

Inflation is particularly attractive to politicians in an economy with many organized special interests, what Mancur Olson calls distributional coalitions. These groups obtain special favors for themselves, such as subsidies, price supports, and monopolistic wages that are usually specified in nominal dollars. This means that inflation can devalue the loot that these groups take from society.

A dairy price support, for example, will be less costly to taxpayers and consumers if the dollar loses 10% of its value. A monopolistic wage that is 20% too high for prevailing conditions will cause less unemployment if inflation reduces it in real terms by 10%. For these reasons, modest inflation may in some respects increased real output. It is one of the few ways that we can do governments can loosen the stranglehold of special interests over the economy. They demand more than the economy can afford, perhaps even than the economy produces. If look total of their demands comes to an impossible 110% of output, a weak government can say yes to everyone, and use inflation as a convenient gimmick for devaluing its possible promises.

Of course we don’t pretend that major episodes of inflation in rich countries are solely explained by political expediency. Outside shocks like the OPEC embargo or world war that politicians would sell the court for short-term electoral effect also play a role. But the chronic inflations in the postwar world certainly do seem to fit institutional interests of politicians. Inflations correspond with a political motive that makes sense.

Deflation, on the other hand, doesn’t. Deflation makes many people poor. It reduces real output by tightening the stranglehold of special interests over the economy. Political rigidities and fixed prices that slow economic growth and waste resources when money is losing its value will waste even more when cash is suddenly becomes worth more. A monopolistic wage rate that is 20% too high for prevailing conditions would generate still more unemployment if deflation raised the value of the money. The loss of output due to monopolies and special interests like labor unions and professional lobbies under deflation is much worse than it is with modest inflation.

Making their constituents poor is not a rational act for politicians under most circumstances. Therefore it is difficult for many to understand how deflation could come about. Politicians apparently have no motive to set about to slash the money supply. So why do deflation’s happen? We will get to that in the next part of this series.

We answer that question in our following posts. Just as some stimulants in small doses make those who use them feel giddy, while larger doses are deadly, so there is a point where too much inflation is worse than none at all. As an ironic example, consider the British secret agents were said to have spread Argentine money through the country to undermine the economy during the Falklands war. If printing more money always made things better, governments at war would not counterfeit one others currency as an act of economic sabotage.

We will continue this series regarding the dangers of debt deflation in the modern world as 2010 moves on, and in our next post will be discussing some danger signs of impending deflation. We look forward to seeing you then on OhioLoanFind.com

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