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What’s wrong with falling consumer prices?

What’s wrong with falling consumer prices?

Greenspan, Wall Street, and the financial media seem obsessed with the idea
that falling consumer prices (incorrectly referred to as deflation) are the
worst possible fate that could befall a free market economy. In reality the
opposite is true: A consistent fall in the general level of consumer prices
is the natural and beneficial result of rising productivity inherent in a free
market economy.

For the 120-year period which spanned from 1790 to 1913, U.S. consumer prices
fell. The brief exception was during the Civil War, when for the first time
the United States government issued paper money (Greenbacks) to finance the
war. This expansion of the money supply (inflation) resulted in rising consumer
prices. When the war ended, the government discontinued the issuance of Greenbacks,
and over the years they were gradually removed from circulation. Prices resumed
their downward trend, which remained intact until 1913, with the introduction
of the Federal Reserve. It was the continuous expansionary monetary policy
(inflation) of the Federal Reserve that reversed the downward trend in consumer
prices which had prevailed since the birth of the republic.

Rather than being a problem, falling consumer prices result in real increases
in the value of wages and savings, and therefore produce a rising standard
of living.

As far as I can tell, there are four basic arguments advanced for why falling
consumer prices are a bad.

1. Consumers will defer spending in anticipation of lower prices. This argument
is ridiculous on its face. First of all, most purchases such as food or energy
cannot be put off. After all, consumers cannot refrain from eating while waiting
for lower food prices. Other purchases, such as televisions, VCR’s, DVD players,
digital watches, personal computers, or cells phones, can be postponed. However,
since prices for all of these items have been falling for years on increasing
sales, our real-world example of the way consumers respond to falling prices
disproves this argument.

2. Business will have their profits squeezed because of falling prices for
their goods. This argument ignores the basic fact that costs are themselves
prices. If a business’ costs are falling in line with its prices, its profit
margins are not effected.

3. The United States had falling prices during the 1930’s, and Japan has falling
prices now, therefore falling prices must be bad. This is basically false logic,
because a causal relationship is assumed between two unrelated elements. The
argument goes as follows. The economy in Japan is bad. Japan has falling prices.
Therefore falling prices must be bad for the economy. This is a false conclusion.
During the Industrial revolution, which saw the most rapid economic growth
in American history, consumer prices fell consistently.

4. Falling prices hurt debtors by increasing the real burden of their debts.
This is the one argument that has some merit. Falling prices benefit creditors
while rising prices benefit debtors. Since the United States is now a nation
where debtors far outnumber creditors, with the Federal Government itself the
biggest debtor of them all, there is certainly a powerful lobby for inflation.
However, since savings make possible the capital formation vital for true economic
growth, a monetary policy designed to discourage savings cannot possibly by
considered beneficial for an economy.

P.S.

Some comments on Greenspan’s testimony today.

Again, when asked about the value of the U.S. dollar, Alan Greenspan replied
that only the Secretary of the Treasury was allowed to speak about the value
of the dollar. This is ridiculous. Maintaining the value of the dollar is the
principle mission of the Federal Reserve. It is the Fed, not the Treasury that
conducts monetary policy. Greenspan spoke for hours about issues having nothing
to do with the Fed, such as tax policy, the labor market, energy, foreign policy,
housing, and the federal budget, yet refused to comment on the one issue over
which he has direct influence: the value of the dollar.

Further, when asked if he thought the resolution of America’s enormous current
account deficit would be like “falling of the edge of a cliff” he
replied with words to the effect “No, because of the enormity of the dollar
debt in foreign hands, creditors will be unable to sell because they would
not want to cause a crash.” The gravity of this statement, and the arrogance
implied in making it, speaks for itself and should be of grave concern to America’s
creditors, who Greenspan believes will be trapped in depreciating dollar assets.

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