Mar
20
The inflation rate in Indian economy is sharply decreasing since some weeks and now it is around 0.44%. As some economic pundits have predicted, India may face deflation eventually. Obviously, it is an alarming effect of the deep recession India is facing and will have to face.
Is Deflation good or Harmful?
Today’s Economic Times has the screaming article Indian Economy staring at deflation. Is it good news ? in its front page that claims that, deflation is a threat, which must be tackled with.
The most common belief about deflation is that falling prices constitute deflation and thus must be feared and, if possible, prevented.
As Economic Times explains the belief
“If deflation lasts for some time, as seems possible, it would be a new experience for India. Japan went through a decade-long deflation in the 1990s, termed as the “lost decade” for that country. At present, most major economies are witnessing disinflation — a lowering of the inflation rate — and some have also seen deflation kicking in. Japan and China have already reported negative inflation rates in the latest data and there are signs that the US, too, could be heading the same way.
While a fall in prices may sound like good news to most laymen, economists see this as an ominous sign of a collapse in demand in the economy.1 “
While ET demonstrated, deflation as falling prices, deflation is not falling prices but a decrease in the quantity of money or the measure of spending in the economic system.
Deflation actually is fall in demand. Falling prices are an outcome of deflation, not the deflation itself.
If prices fall even though demand remain steady or may increase, than it is prosperity and profit for the consumer and the producer both, and that happens in a free market with enough options of competitions between producers.
On the other hand, if demand decreases, (that is, deflation occurs) the prices falls as a result of decrease in demand.
Deflation is obviously harmful, yet the falling price is not harmful, in fact, falling prices is the actual and only possible cure for the deflation.
Falling prices are that cure to the economy, which is suffering from deflation that makes it possible for the economy to recover from the situation of deflation and start enjoying the economic progress again.
Let me explain this again. Deflation is decrease in Demand, or decrease in willingness to spend, it is a dangerous situation as it causes unemployment and chaos, the solution is Falling prices, that is, the falling prices indicates that the economy is at the path of recovery from deflation, how is it possible?
Let us consider that before any deflation Mr. Ramesh used to go once a week to buy flour from the shop, he could afford to spend Rs20 for the flour per week, at a price of Rs2 per Kg, he used to buy 10 Kgs of flour. Suddenly the economy suffers deflation and victimizes Mr Ramesh too. Now he is not willing to spend Rs20 for flour and at most, he can spend only Rs10.
If the prices will not fall, Mr Ramesh will be able to buy only 5 Kgs of flour, while his weekly need is of 10 kgs, that is, he will suffer a loss of 5 Kgs of flour, and He may starve. On the other hand, if prices fall from Rs 2 per Kg of flour to Rs 1 per Kg of flour, Mr. Ramesh will be able to buy 10 Kgs of flour for a week at his affordable spending of Rs10.
If one look for the situation properly, they will understand that deflation was Mr. Ramesh’s lack of will to spend Rs 20 to buy 10 Kgs of flour, his demand for flour was forcibly reduced, but as the prices fell down, he again bought 10 Kgs of flour, that is, his demand reached the proper need and that is the cure of deflation.
What is Mr Ramesh deny buying a commodity even at reduced prices, will it help economy?
Let us say Mr Ramesh used to buy 2 Litres of milk every day before deflation at a price of Rs8 per Kg, that is, he was ready to spend Rs16 per day for milk before deflation. Due to deflation, that is, due to lack of money, he reduced his demand to 1 litre per day as he wished to spend only Rs 8 for milk per day. To counter the deflation, the prices of milk fell down to Rs 4 per litre, that is, now he can buy 2 litres of milk for Rs 8. Yet, if Mr Ramesh decide not to buy extra milk, which will save his Rs4 from the amount he decided to spend on milk. Obviously, he will be able to spend that extra Rs 4 on some other commodity, say he will buy a packet of Biscuit Parle G. Overall; the fall in prices will help in reducing and eventually completely curing the effect of deflation.
Thus, although deflation is a sickness to an economy and hence it is harmful, yet the falling prices is the only possible solution for deflation and the current scenario in India where the deflation will soon signify its consequences in form of falling prices, the things will better by themselves.
What is the cause of Deflation; can government intervention solve the situation?
India is facing liquidity crunch since last November. Finance ministry and RBI issued three stimulus packages to solve out the credit crisis, yet it provided no betterment in situation, the bail out of economy in form of economic stimulus absolutely failed. It was obvious as any governmental intervention can never help any market, it may cause havoc though. We explained it here and we discussed why economic stimulus is nothing but robbery of common citizen.2
The liquidity crunch in India is because of the bad assets of the government and private banks and the lost money in failed credits. Government and the centralized bank RBI control the repo rates, credit and lending policies in India. In order to increase GDP and profits, government and RBI always try to stimulate government and private banks to lend credit as easily as possible, and that often causes bad assets.
Some times, for the cause of making greater profits, the private banks also make risky adventures and fails miserably, and that all causes credit crunch. As the money in market decreases, the demand starts decreasing and hence the deflation.
The reason for such failure is the obvious monopoly of the government and RBI over currency supply in market, and the flaw in the system is because of the Fiat Currency system. The fiat currency often forces high inflationary rates, which may reach the hyperinflation rates and the forced bad risk dealings in the environment of economic bubbles often leads to a situation causing deflation.
Thus, initially, the fiat currency system, government monopoly and interventionism in market and bad decisions based on fake profits due to economic bubbles causes the cycles of Inflation, hyperinflation and deflation.
As demonstrated earlier, the falling prices cure this sickness of the regulated mixed economies.
The falling prices not only cures the problem of deflation, it also cures the mystery of economic bubbles and provides a clear picture of actual market growth by eliminating almost all the non-productive and non-profitable activities in the market.
As the enforced policies of regulatory government and institutions like RBI causes the cycles of inflation, hyperinflation and deflation in a market by misleadingly regulating the supply of currency in market, we cannot expect further supply of currency by government to solve out the liquidity crisis. That is the reason why the economic stimulus plans of various countries including USA, India and China are actually providing no results.
Will the government interference in form of economic stimulus change the situation?
Government talk of providing economic stimulus to counter the falling prices.
As falling prices are, the solution to deflation, by trying to avoid falling of prices, governments actually increases the tenure of economic crisis. It happens because the stimulus leads people to postpone buying even in situations where they have ability to buy, the consumer prefer to wait for falling of prices. On the other hand, the falling prices stimulate the consumer to buy the commodities.
Thus, whatever interventionism a government adopts to provide economic stimulus, further increases the mess in the economy.
Also, considering the fact that Indian government suffers one of the highest fiscal deficits everyday, we know that Indian government does not have potential to provide any economic stimulus, yet the government already have provided three economic stimulus of amount Rs2000 crores each, and now, the upcoming elections will further cause Rs10,000 crore of spending.
When government is already going in fiscal deficit, how will the government manage these extreme spending?
Government have three ways to support these already provided stimulus packages, the election expenses and further Rs30,000 crores of stimulus government have promised by any of the following ways
1. Higher government taxes
2. More government borrowing
3. More, freshly printed Reserve Bank notes.
Any of these moves will further deteriorate the economy by giving birth to a new cycle of economic boom and burst.
Taxation is a failed measure of revenue projection that is why Indian government always remains in fiscal deficit. Besides, higher tax rates discourage people from saving and investing, especially when such taxes target the rich.
Increasing taxes on middle or poor class makes no sense, and increased tax on rich deprives the economy of the funds necessary to grow production, income, and employment.
Thus, the first option is failure by default.
Indian government already have asked for economic help from World Bank and IMF, thus we can expect that Indian government may take further loans and debts. We know that foreign aids never helps an economy, we discussed how foreign aid actually harms a nation’s economy.3
The government monopoly over the currency is the ill-power, by which government can create money from thin air any time, but printing more currency does not help any body, it causes further extreme problems though which we discussed here.4
Thus, no matter what way government adopts to fight against the falling prices, the way will lead to further deterioration, not only that, countering the falling prices itself means strengthening the deflation.
We have already seen how economic stimulus proved a big failure in USA, Indian government should take lesson from the failure of Obama stimulus packages and should keep away from market, adopting the policy of free market, no interventionism.
- Deflation, is it good news?, Economic Times [↩]
- economic stimulus is not cure, it is venom, Reason for Liberty [↩]
- Foreign Aid Versus Foreign Investment, Reason for Liberty [↩]
- The story of Money, What causes Inflation, Reason for Liberty [↩]
33 Responses to “Falling Prices is the cure of Deflation”
Leave a Reply
GP Says:
March 23rd, 2009 at 9:43 am@Unpretentious Diva
What’s your professional opinion on -
“how to solve credit crunch issue in current economy?”
Please Note : I have read your article thoroughly and only two important points you elaborated -
1)According to you Deflation can be cured through lowering prices of commodities.
2)Government interventionism failed to improve current economy.
But you haven’t mentioned your solution for credit crunch.
(Please don’t give me usual anwer i.e. “free market system” coz I am looking for practical solution which can fit into existing system and “free market system” is still an idea.)
Pradeep T R Says:
March 23rd, 2009 at 10:40 amInformative article….but had a doubt…. falling price is a cure for inflation…agreed…can low price make people buy in the current economic situation. Everyone wants to be cautious at this time….so can falling price really lift the mood of the people?
renegade_division Says:
March 23rd, 2009 at 11:11 am@GP said:
Allow me to answer the question.
Tell me something, how can you solve a hangover?? Sure one way of solving the hangover is to start drink and get drunk again, surely this feeling of hangover will be gone. But then you will get another feeling of hangover.
This is exactly what the perception of current crises is in the world. This crises occurred because of the measures taken to fix the last crises(the IT Bust).
Massive amount of liquidity was poured into the market, the interest rates were kept at 1% for 2 years. This caused so much free money to be flowing that it totally distorted the market.
This is the c0rrection phase of the market, all that distortion is getting corrected. But WAIT! Before that could happen properly, the Federal Reserve again slashed the interest rates to 0%(lower than the last time).
What does that mean? Well it means that though we are getting out of recession in some time, we are gearing up for another bubble, a bigger larger bubble and its going to be an even bigger bust.
So I am sorry I got no solution to fix the “credit crunch”(which is a totally phony term, because there is no credit crunch or liquidity crises as such, but if by that term you mean the current recession then) because the only solution to this whole issue is to NOT do anything and allow markets to be readjusted, but guess what, Markets weren’t allowed to come back to normal, they are being inflated again.
They are being distorted again, and that’s whats happening right now. The current situation is beyond repair. Though the negative effects will not run through before 2015.
Its like the solution of “hangover”, the hangover need not be fixed, hangover is a fix itself of the extra alcohol in your body from last night, but then its too late because you have started to drink already.
Robert Says:
March 23rd, 2009 at 10:54 pmDeflation is not nearly the problem it can be if mishandled by governments. Deflation will work itself out over time. The problem is when governments thrown incredible amounts of money at it to correct it. When all of that money finally reaches the market we go from deflation to massive inflation. These peaks and valleys are artificial and are introduced by government meddling. The markets will always self correct if left to their own devices.
GP Says:
March 24th, 2009 at 9:43 am@renegade_division :
Well, honestly speaking – I think its too optimistic to just wait n watch for market to correct itself without doing anything I mean similar approach was adopted in 1930 and I guess it took a long time for economy o get back to normal..and may be 1945 war helped it to some extend by increasing government spending and utilisation of manpower.
I do understand slashing interest rates,tax cuts to increase demand/ liquidity in market can result into inflation in long term but atleast it can move economy from deflation to some other level and before reaching to extreme high – inflation..I guess govt./reserev banks can always re-evaluate their policies to keep a tab on it.
I think its about changing your plans and policies till experts feel that market is stable.
Unpretentious Diva Says:
March 24th, 2009 at 12:10 pmI mean similar approach was adopted in 1930 and I guess it took a long time for economy o get back to normal..and may be 1945 war helped it to some extend by increasing government spending and utilization of manpower.
Lol the war monger. Try to answer yourself, why is not the war helping Pakistan to improve its economy? Pakistan is going through war with Taliban isn’t it?
Why is war not helping USA? USA is going through war in Iraq, Afghanistan, USA force are still in quwait, Kosovo Japan and many other areas.
Isn’t it providing the utilization of man power?
I know you are a fan of keynes. So you feel that may be Mumbai Bomb Blast helped Indian economy isn’t it?
Now government have more ways to “utilize” man power for non-productive activities.
What you forget is, WAR never helps and can never help because Wars does not produce, they destroys.
You feel that during the depression of 2000-2001, the attack on Pentagon and WTO helped economy?
well GP is a known human hater.
Unpretentious Diva Says:
March 25th, 2009 at 1:50 amis it bcoz his purchasing power reduced? if yes, then what caused the reduction in Mr. Ramesh’s purchasing power?
Yes his ourchasing power got reduced that is why he cannot buy a dozen of eggs at current prices and that is why fall of prices will help him by increasing his power to purchase, and that is how it will help whole economy to revamp.
Now why his purchasing power got reduced?
In the article I mentioned why.
Since Americans lost their purchasing power, the exports got reduced, FDI decreased, NRI support decreased, even traveling and tourism decreased.
Remember in Nov. 2008, before announcing the first stimulus package, Indian Air Lines, Kingfishers airlines and Jet Airlines announced around 45,000 employers to be removed from their work fleet? We had covered that too.
So Mr. Ramesh was an employer of Indian Air Lines (it is government sector, completely controlled by government) Indian airlines told him to remain at leave without any salary. Obviously, since he is not earning, he lost his purchasing power.
Now after some anti-removal campaign and political force, Mr. Ramesh was called back for his job, but Airlines and other companies too adjusted the cringe in travellers and consumers by reducing the salaries of all their pilots, airhostess, and other workers, Mr. Ramesh was one of them.
or may be Mr. Ramesh was an employer of Satyam. He lost his job.
With reduced salary, he has lesser PP.
Also, due to export declines, many indian around some 2-2.5 lakh, lost their daily wages jobs. and many such incidences where people lost their earning routine and hence lost their purchasing power.
Why is this economic meltdown?
Go, get it here
http://www.reasonforliberty.com/reason/economic-meltdown-explained.html
Now look at the question–
what caused the reduction in Mr. Ramesh’s purchasing power?
Purchasing power of Mr Ramesh got reduced because of the Inflation, and then the hyperinflation. Inflation reduces the purchasing power of Rupee (or other currency). Previously, mr. Ramesh had a proper chain of salary income that used to provide him dues because of Inflation too in form of increments. Now, although the purchasing power of Rupee has been increased, but mr. Ramesh have no way to earn, or his salary has been reduced.
Purchasing power of Currency decreased because too much currency and government interventions.
If government again increase supply of currency by printing currency notes through thin air, it will further increase inflation and will decrease the purchasing power of mr. Ramesh more.
In fact, government is looting mr. Ramesh.
renegade_division Says:
March 25th, 2009 at 2:33 am@GP said:
Ok there are a lot of fallacies in the above statement. These are all the mainstream(liberal economics) assumptions propagated by Paul Krugman(NYT writer). The problem with what happened in great depression is that there is no Empirical way of knowing what could have happened or what should have happened if so and so policy was followed.
According to the fans of Govt intervention, the govt did not intervene enough, on the other hand those who don’t believe in govt intervention believe that govt interfered too much.
Now what is the real reason? Did govt intervene too much or too little, there is no empirical way of knowing. Thankfully there is a logical way of knowing that, but mainstream economics does not believe in logical thinking, only empirical thinking(that is unless you experiment it, you cannot tell the outcome of an action). So for mainstream economists there is no way of knowing what really happened in great depression and what should have been the right course of action.
President Herbert Hoover did massive govt intervention and made the recession worse, but nobody really believes that Hoover’s intervention was responsible for the depression, rather what everybody is taught in High Schools in America, that Hoover didn’t do anything while the nation went into chaos.
This was actually the election platform of FDR, that President Hoover is not doing enough to recover the economy, and you would have heard the same thing from Obama had Bush be running for a reelection last nov.
Since FDR won, that means people believed that Hoover didn’t do enough. Its just like since Obama won, therefore everybody is going to write in History that Obama won on a anti-war platform. Irrespective of the fact that Obama may not do anything but to get out of Iraq during the last year of his presidency.
Had FDR faced another adversary who ran on the platform that FDR is not doing enough to fix the economy, he could have easily won. Its like a doctor who for a patient who is sufferring from common fever tells him that he is sufferring from a grave illness, and the only solution is with him and it costs $20,000.
Since the patient is ill, he believes the doctor and considering the heavy price he paid for the cure, he will always look back and consider it a brush with death because of the massive sacrifice he made to get out of that situation.
FDR prolongated the depression, and its demonstrated by the fact that every other previous recession was recovered in no time because Presidents didn’t do anything. They didn’t do anything because even before they could think of doing something the recession was over.
The “Roaring Twenties” on the other hand was caused by the easy credit policy of the Feds, the 20s were the unsustainable credit driven boom, which needed a massive correction, and the correction did take place in 1929, and had the market allowed to recover on its own it would have like all the other previous depressions. But Hoover intervened too much, his biggest criticism was he wasn’t doing enough so he kept on doing more and more and even after that FDR won on the grounds that Hoover didn’t do enough.
The problem is Hoover-FDR screwed up the economy on so many ways that it took 10 years for market to get back to where it was, but in our books its all registered as Hoover didn’t do enough and FDR did enough to get us out of it, or sometimes that FDR-Hoove both didn’t do enough.
What do you really say to Socialists who refuse to believe that Socialism is a failed ideology despite of looking at USSR?? Their belief is that USSR govt did not control the people enough, or they didn’t implement the Socialism properly.
Now you tell me what do you think happened? Do you really think that had USSR been a bit more strict on its people the Socialism might have succeeded??
The problem is there is no upper limit on “not done enough” argument, but there is an upper limit on “don’t do anything” argument. No matter how much is done, if it still screws things up the defense will always be “you didn’t do enough”.
To support my argument of not doing anything, I can quote all the previous recession in American economy before the Great Depression.
On the other hand to support govt intervention you got none, and you will only use “Great Depression” as “not done enough” deal. To counter my argument you will only say “Great depression was an exception and it was a terrible thing and we didn’t do enough and that’s why things became so worse”.
The “not done enough” argument can never fail.
because when you do more than enough, and it screws things over, you can still say “hey you still didn’t do enough”.
So you tell me how can anyone prove that there was too much intervention and that caused all the problems??
War and Broken Window Fallacy
Coming to the issue of whether War got us out of the great depression.
The reason why it is said that War got us out of the great depression is because of the GDP figures(where govt spending is a huge component) become big during a war. The govt seizes the resources from the private industry and uses them to fuel the machinery of war.
Here is the problem, GDP is just a bunch of numbers added togather. It does not represent anything. USSR had a huge GDP but people were miserable under it, how come that much misery was not reflected in the GDP figures of the USSR?
When govt seizes property from private hands, that is added into the GDP, but the property which was gone from the hands of the private individuals and the amount it won’t produce anymore, is not subtracted out of it.
If your Dad takes your bike which you bought from your pocket money savings, and sells it, ges $100 for it, the GDP figure for your house will claim that you are now $100 richer than before.
Similarly, if you buy your wife’s land, sell it back to her, your GDP has just increased by a lot.
How? Because GDP is Consumption+investment+spending+(exp-imp)
That is You bought the land for $1 million
You sold the land for $1 million
Your month’s exp $50,000
That means your total GDP is
$50,000+$1 million+$1 million=$2.05 million
That’s your GDP, on the other hand on most of the months when you don’t perform that action of buying and selling the same piece of land your gdp is onoly $50,000.
On the other hand if you put some money aside for your future say $25,000, your GDP has suddenly fallen down by 50%.
GDP is the indicator which is used to demonstrate that how at each war the figure magically goes up.
But guess what happens when the war stops and the economy has to go back to the way it was, and all the ammunition factory has to be closed down??
The GDP falls significantly. After World War 2, the GDP of America fell by the same amount it rose when the war started. But do you hear about the Great Depression of 1946-47?? I hope not.
gopi Says:
March 25th, 2009 at 3:57 pm@ diva : thanks for ur post and the explanations. i hav a few doubts regarding the last 2 paragraphs in ur previous comment. if i put together all what u hav said till now, can i say ” Govt intervention & Central Bank caused excessive inflation (by printing money out of thin air), which reduced Mr Ramesh’s purchasing power, which in turn reduced his demand for goods (led to deflation), and the solution for this is lowered prices”… if that is indeed the case, we have nothing to worry about, coz the rise in price of commodities due to an inflated currency will be offset automatically by the lowering of prices due to the consequent deflation, right?
Unpretentious Diva Says:
March 25th, 2009 at 7:33 pmThat is why the heading of this article is “Falling prices are the cure of Deflation”. And yes it is indeed the case.
But try to answer yourself again, why should there be inflation? Why should government be allowed to intervene with currency and hence keep everybody its slave?
What do you think, increased prices brings happiness to the common citizen? Does the huge fiscal deficits and unwanted, unwarranted loans and debts on the citizens because of governmental foreign loans, government non-productive spending, and red carpeting, corruption brings any good for individuals of a nation?
So yes Falling prices is the only cure for the inflation and hyperinflation.
Government should avoid itself from intervening in the situation and deny providing any sort of bailout for the failed enterprises and also deny any sort of huge stimulus plan. because that will prove to be venom and nothing else.
Unpretentious Diva Says:
March 25th, 2009 at 8:43 pmThe proof of the fact that falling prices is the cure of deflation…
Purchases of new homes in the U.S. unexpectedly rose in February from a record low as plummeting prices and cheaper mortgage rates lured some buyers.
http://www.bloomberg.com/apps/news?pid=20601068&sid=a0YI6z_ZfAUE&refer=home
gopi Says:
March 25th, 2009 at 11:31 pmso, in short u r saying “inflation causes deflation”..hmm.. interesting.. and i completely agree with all ur arguments. they r perfect. and i can understand ur views on govt intervention coz i’ve read “Economics in One Lesson” (which was a real eye opener). just one more question (and this is what the so called “economists” teach / brainwash in our colleges) – they say “when prices fall, consumers tend to postpone their purchase in the expectation of lower prices in the future (rather than purchasing more like said in the bloomberg report) and this causes lower demand and hence lower production.” what’s wrong with this argument?
Unpretentious Diva Says:
March 26th, 2009 at 12:12 amThe wrong is, its impractical and unsubstantiated explanation.
I have tried to explain that in main article too.
Let’s take the case of the Flour or milk again.
Because of inflation, and his decreasing purchasing power, Mr Ramesh was unable to buy the normal amount of flour he wanted to buy. Against the idea of taking debt or loans and then suffering the burden to pay back, he chooses to cut off his consumption. He cuts off his milk usage too.
Obviously, he needs them yet he cannot afford, literally speaking, he is starving because he has no job, and prices are going high (even now, the inflation rate is 0.46%, that means prices are increasing irrespective of increasing unemployment).
If prices comes down, first of all, it saves him from starving, to an extent, it saves him from the position of taking loans for which, he has no idea how he will pay back, thirdly, with reduced prices he has more option to spend his savings.
That is, he may very well decide to not to re-increase his milk consumption, yet, will he save that money for buying milk when it goes further cheap? No, he saves that money to invest, or spend in some other more important need he faces. With decreased prices, he has freedom to opt. He may well try to self-employ himself by investing his spending in some work. Currency is not wealth and he sincerely need to create wealth, for that, he can invest his savings.
Let us take the example of houses too.
Lets say mr. Ramesh did not loose his job, yet his salary has been reduced.
He is paying rent to the apartment he currently lives, it is a burden and a non-productive-investment. As soon as prices of houses go down and the level comes where he find that living on rent is not as profitable as buying a new house, he will run to buy the house in order to save the spending he is forced to spend as the rent for the house he is currently living.
Furthermore, as he buys a house, he owns a property, he just cannot deny the opportunity.
if fall of prices is opposed and intervened by government, he will never get a chance where he will observe that spending money as rent for a house is more cumbersome and non-helping than investing his savings to buy and own his house.
Thus, practically, fall of prices only can encourage him to spend, further rise in prices is certainly not going to make him spend more.
renegade_division Says:
March 26th, 2009 at 12:30 am@Gopi Said:
See the dishonesty with the above argument is whomsoever makes it, they always make it look like this:
“When prices rise people buy more stuff because they expect prices to rise in future which raises demand and increases production”
“(But)When prices fall they expect prices to go down even further down which lowers demand and reduces production”
The problem is both the arguments face the same problem which Henry Hazzlitt talks about, it just looks things in one time frame and not all time frames.
What happens when prices continue to rise due to inflation done by the govt??
When prices continue to rise due to inflation people initially postpone their purchases in expectation that prices will come down tomorrow so they will buy it then, but prices continue to rise so now they think before the prices rise too much in future lets buy all the stuff they need in future now and hoard it all.
This causes a massive surge in demand and people just wanna get rid of the currency in hand.
Lets say the govt stops inflating the currency at this point then soon the prices will come down significantly because people will realize that prices aren’t going up anymore, and prices will stabilize then.
What happens when say govt deflates the money supply?
When prices fall initially people delay their consumption thinking that tomorrow prices will fall even more so they will buy the commodities then.
But prices continue to fall so they wanna hoard on money so they sell all the stuff they have before it loses value.
This causes a massive dip in demand and people just wanna get more and more currency before its value rises too much.
Lets say at this point the govt stops deflating the currency then there reaches the point where the prices don’t fall anymore. At this point people now wanna buy all the purchases they have delayed, and the demand of commodities comes back to normal.
Now lemme remind you both these examples are only for the situation where there is fiat currency and govt is continuously manipulating the money supply in one direction.
What happens when there is a physical commodity backed currency? Say Gold standard??
When there is a gold standard, and say for some reason the gold supply isn’t increasing anymore, because of the growth of the economy there will be a general fall in the prices of the commodities(which mainstream economists erroneously term as “deflation”), IF for some reason it does result in a boom of gold prices(what will then be termed as hyper-deflation), the boom will be very short lived because people no individual is fueling this boom, there is no real factor behind this gold boom(a real factor would be like that there is a rust in gold, or some organization is seizing all the gold and hoarding it irrespective of the rest of the world).
Since there is no real factor behind this gold boom and its all because of market expectations that gold boom(or hyper-deflation) will be burst very quickly because sooner or later people will need real goods.
At max a commodity based boom caused by high market expectations lasts over a few months, one example was the Crude Oil boom we saw last year. Similarly, we see vegetable prices boom from time to time in India.
A deflationary cycle in gold standard will last only uptil that much. The reason why in Zimbabwe the inflation is going on and on is because Zimbabwe central bank is not stopping from printing currency.
gopi Says:
March 26th, 2009 at 12:31 amur explanation is right when it comes to essential products like milk/flour/housing… but dont u think that a financially well off person (not Mr. Ramesh who lost his job) wud postpone his purchase of mobile/laptop/car if he see a downward trend in it’s prices? wudnt that be harmful (as explained by the proffesors)?
gopi Says:
March 26th, 2009 at 12:51 amnice post renegade… as far as the question whether ppl buy or sell more when prices go up / down is dependant on human psychology. the risk averse/ risk taking nature of the person concerned and the type of commodity (essential or luxury items?). i don’t think it can be generalized for the mass. if it cud be generalised, u cud make pot lots of money in the stock markets.and yes, i’m aware of the virtues of a gold standard (and how it controls inflation), thanks to “Gold, Peace & Prosperity” by Ron Paul. btw, this site is a nice effort by u guys..i learnt a lot on Austrian economics. keep posting articles and comments..
Unpretentious Diva Says:
March 26th, 2009 at 12:52 amWhen a person who is financially well-off is not ready to buy a mobile even at reduced prices, why will he take it at doubly increased prices?
Can any professor explain it?
What do you check when you go to buy a mobile or laptop?
its price tag or the features and services and model and technique provided by it?
By increasing the prices, you cannot increase the demand. A consumer is not a fool you know, he knows what he want and why he want it.
By increasing such fake prices, you can create a bubble though, a false demand.
because of that bubble, that false demand, the companies making a particular mobile at a present cost and expense may start investing too much in producing that mobile, but when the increase in prices fails to actually increase the consumer demand (because it is impractical) the bubble bursts, and a new economic crisis evolves.
Same happened with USA and India in current depression.
USA never had that much demand of houses or cars, but government, in order to create false demand, encouraged (actually regulated) the interest rates on home loans and taxes in retail market because of which, the prices of houses increased falsely. When the busted, people suffered. Banks lost huge amounts as bad assets as people failed to pay back the loans.
False demands never helps anybody, they creates the similar kind of havoc US is suffering right now.
yet government worldwide keep experimenting such mad ideas and keep facing cycles of boom and busts.
And when such bubbles busts, government blames the banks for their lack of regulations, and then banks forces bailouts and government punishes consumers again.
The reality is, the government and officers does not suffer the consequences, the common man suffers it.
And that is why free market is citizen friendly. Government should NOT intervene in market.
One thing which I have notices as a difference between mainstream economists and the Austrian economics is, Austrian economics is basically based on principle of Individualism, it is based on the honour and sanctity of the freedom of citizen and his ability to judge for himself. He is not a slave, nor a blind fool needing a leader to teach and order him what to do and what not to.
On the other hand, main stream economist often treats the citizen as braindead or may be certain sort of animals who lead their lives based on certain instincts which these leaders and economist can control and hence rule over the citizens. because of this wrong premise of Keynesian economics, it always fails, because citizens are not fools, they are free individuals, able to make their own decisions based on reason.
gopi Says:
March 26th, 2009 at 9:31 am@diva : i’m sorry, but u completely misunderstood my question. my question is : won’t the financially well off people postpone their buying decision when prices fall because they EXPECT price to fall further and thus hurt production of that particular commodity (mobile, laptop etc). btw, i never said “By increasing prices you can increase demand” – That is outrageous!!!
Unpretentious Diva Says:
March 26th, 2009 at 11:55 amthe financially well off people postpone their buying decision when prices fall because they EXPECT price to fall further and thus hurt production of that particular commodity (mobile, laptop etc).
Well, the answer lies in the “Law of Scarcity”.
One must not forget that a Free Capitalist market is ruled by Consumer’s force.
More consumption is made possible only by more production, but production that is done in line with both the spending and saving patterns of individuals in the economy. If lines of capital are created that are not compatible with saving and spending patterns set by consumers, then the capital is malinvested.
When the structure of production i.e the mixture of capital goods, resources and labor is put in line with the patterns of spending and saving by consumers, the economy grows.
This is not a circular activity in which production is propped up by spending and cheap credit that accrues back to the households. Instead, the act of saving provides a means for producers to obtain capital, and capital goods are then used to produce more goods using fewer resources so that the newly freed resources can be used to produce those things that were unavailable before.
So, even if a person is able to buy two liters of milk a day, or a laptop or a mobile, he can surely save his money, i.e his purchasing power to invest in better option.
Overall, his saving is going to help him and the market and the very string of entrepreneurship and innovation only.
Furthermore, it is the right of the Individual to decide when to spend and at what.
By falsely increasing the prices the situation can not be solved.
The only rational option is to let the patterns of consumer to save and spend decide how the production proceeds.
GP Says:
March 27th, 2009 at 9:37 am@renegade_division Says:
First let me thank you for explaining in detail your views. Now -
The problem is there is no upper limit on “not done enough” argument, but there is an upper limit on “don’t do anything” argument. No matter how much is done, if it still screws things up the defense will always be “you didn’t do enough”.
<<<–ok I got it. But, don’t you think currently govt. is just trying to be empirical by trying to increase liquidity in market
to overcome deflation?( just an experiment ..lets see if it works?..if not ..think something else?)..I do understand your approach of “wait n watch and let market correct itself”
and appreciated too but I guess currently media scrutiny is so much that politicians have to react in such situations ro else they have to face another criticism by media that they are not doing enough..right?
..i mean if u take current example of indian govt. approach i.e. playing a patient diplomacy with pak in Kasab’s case…some ppl call it correct approach
while some call it “helpless poor govt. who cannot dare to finish it off once and for all” ..right?
Its all in mindset of govt! US politicians were always been reactive and aggressive in nature so its quite unlikely that they will play game of patience(wait and watch approach) like indian politicians.
Now you tell me what do you think happened? Do you really think that had USSR been a bit more strict on its people the Socialism might have succeeded??
<<<<<<<<<Yup, I think the answer is “yes” and why?..bcoz if u see china you will surely agree that chinese govt. have demonstrated great control over their citizens(exceptions – few minor things like some blogs in internet,Tibet issue,etc. but you gotta accept that in current globalisation)
and thats the reason why “socialism”(Now we call it “mixed economy” and not the ideal socialism as proposed by Marx…but roots are there)
still exist in china!>>>>>>>>
Now regarding correlation between GDP,WAR and whther its correct indicator of poverty or strength of economy
I would say – Superficially “yes” it is. But, just for showing to external world. and Its not always indicate true health of economy.
Just like – Satyam’s balance sheet [:)]
FYI – I knew and totally understand reasons for 1945-46 post economic depression for other countries except US. and probably thats the reason why – its superpower now!(smart mobve – not to participate too much in war ..isn’t it?
renegade_division Says:
March 27th, 2009 at 12:19 pm@GP Said:
This is not the first time the govt is doing such a thing, this is exactly what govt did when IT Bubble burst. This is exactly what it did in 1970s.
In fact the whole concept of stagflation came in(70s) because govt created too much liquidity in the market, there was no growth in the economy, and that increase in money supply resulted in increase in the general prices. This phenomenon was termed as “Stagflation”.
Here is a simple thing, you believe that we are just empty believers of “Free Market will do everything”, and I acknowledge that it may given an impression from some writings here, but trust me we got a full fledged ideological backing to our beliefs in the form of Austrian Economics. I mean if there is any reason why you are undermining us on the basis of “what do these ideologues know about Economy and big serious things” then you are totally wrong.
This whole problem has been created by the govt, and funny thing is they created this thing last time when they were trying to fix the IT bust.
You talk about liquidity, do you not see what this is all about?? If your bank balance runs to zero, is solution of all your problems “take more Loan to fill up the bank balance”, or filing a bankruptcy, cleaning up the slate and starting over to a new page?
Lets just for a moment assume that you are right, by govt introducing the liquidity in the market it will be stimulating the economy, but then the question arrives, from where does the Govt generate that liquidity??
Govt’s balance sheet shows that its spending more money than it gets from tax payers in terms of taxes.
That means govt is not just opening its treasury and taking its savings of last 4-5 years and giving it to people. Then??
The govt is simply creating more currency out of thin air and pushing in it in the market. But does that action has no consequences? NO, the truth is, every dollar govt prints and pushes it, in takes that much share away from people’s existing capital.
Lemme give you an example:
Abby – $1
Baker -$1
Charlie -$1
Now if Abby somehow prints another dollar out of thin air, and pushes it in their economy, then the purchasing power of every dollar would be reduced, from 3/3=$1 to 3/4=$0.75
Because there is no wealth generation in the society, so the wealth is still worth $3, but there are $4 worth currencies. So the money Abby has is basically pulled out from both Charlie and Baker.
That means every dollar govt prints is basically taken away from the people first. How can you create more prosperity by taking money from this part of the society and putting it on the other?
Its like taking a bucket, taking and pouring water from one end of the pool to the other part of the pool thinking that it will increase the level of water in the pool. Only govt can make people believe that it can pull these kinds of miracles.
Why don’t you understand a simple thing, there is no solution to make-believe prosperity. We are not that rich as we thought we were in 2006, now making pathetic attempts to maintain those levels only delay and worsen the incoming disaster.
The govt is trying real hard to maintain the high prices of houses, there are so many ridiculous attempts like “give citizenship to the immigrants who buy houses in America”. The whole point of the above article is, people will start buying houses when the price falls down, but trying to artificially keep prices high and somehow magically push for more house sales are just a recipe of disaster.
Ok, I am not going to dignify this ridiculous claim. There is usually an upper limit of twisting the facts, but this one crosses them all.
Good bye dude! Come back for a DECENT discussion where your sole intention is not to somehow BRUTE FORCE a winning argument.
Just in case you don’t know what just happened here, you juts quoted China as an example of Socialism, and success of govt tyranny.
I do argue logic, but I am not going to argue facts. If you keep on repeating the fact that USA is socialist and S in USA stands for Socialist, there is no argument possible because its a factual argument not a logical argument. I won’t push a bogus factual comment through the comment section sorry.
You don’t know what you are talking about here. You don’t wanna leave the ground here so trying to find a middle ground.
You KNEW AND UNDERSTOOD reasons for 1945-46 post-war depression???
WOW!!!!! THERE WAS NO DEPRESSION IN 1945-46, that’s the whole point. The GDP shows that there was a massive dip in economic conditions and for all the records there must be a massive depression, but the truth is there was NO DEPRESSION in 1945-46.
French Says:
March 27th, 2009 at 9:13 pmDeflation is a bad thing for the common person and for the economy as a whole. I recently heard about the situation in Iceland where there has been significant home deflation. People who had 40%+ equity now owe more than the house is worth.
GP Says:
March 30th, 2009 at 6:37 pm@renegade_division
.
THERE WAS NO DEPRESSION IN 1945-46, that’s the whole point. The GDP shows that there was a massive dip in economic conditions and for all the records there must be a massive depression, but the truth is there was NO DEPRESSION in 1945-46.
<<<<<<<Yup you are right there was no depression after 1945-46 and my apologies if you misunderstood my statement.
Just to clarify – My sole point was to emphasize that- post 1945-46 the economies of other countries were largely affected due to their direct involvement in war
as compared to US. >>>>>>
Ok, I am not going to dignify this ridiculous claim. There is usually an upper limit of twisting the facts, but this one crosses them all.
Good bye dude! Come back for a DECENT discussion where your sole intention is not to somehow BRUTE FORCE a winning argument.
Just in case you don’t know what just happened here, you juts quoted China as an example of Socialism, and success of govt tyranny.
<<<<<<<I think you forget the part where I mentioned that China is not socialist i.e. “(Now we call it “mixed economy” and not the ideal socialism as proposed by Marx…but roots are there”
Now regarding part of your statement “China is symbol of successful govt. Tyranny” –> I would say I never said that – I just said “chinese govt. have demonstrated great control over their citizens” which do not mean they are autocratic
and I really don’t know how you measure success of autocracy and personally I don’t think they are autocratic in nature they are just non-democratic
Please Note – I just replied to your query “Do you really think that had USSR been a bit more strict on its people the Socialism might have succeeded??”
the logic was simple – identify the countries which have socialist roots and having greater control over the public and I think China fits in very well to that category. I mentioned it. Simple!
Now if u want to call it autocratic so be it..no probs. But what’s point in getting sentimental about it and expressing anguish by saying its “ridiculous claim”(by the way – it wasn’t a claim. It was just an observation.)
also when did I argue or said USA is socialistic? cmmmmmon mate be cool and forget about reading between the lines .
Just read the lines and interpret them as it is! I always prefer not to get emotional about any issue and
keep discussion decent and this is also not an exception.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
mean if there is any reason why you are undermining us on the basis of “what do these ideologues know about Economy and big serious things” then you are totally wrong.
<<<<<<<<Nope I have not thought on those lines and trust me its completely unbiased approach from my side before commenting on any posts on your site.
The only thing I believe currently is -
1) There is no better substitude for govt. to offer in free market economy. In fact, I would say its too optimistic to believe “Free Market will do everything”
2)You may call me skeptical empiricist but as per my understanding no country in world so far adopted “Free Market economy”
so unless and untill we have experiential proofs of its success implementation, its preety difficult to digest it.
3)Some of the points proposed by free market economy such as “private judiciary” , “private security” (Here I am talking about substitude for National Armies and not personel bodyguards.)
still not have satisfactory answers to my queries which I put forth in some of your earlier posts.
Look mate – I am not biased or prejudiced just bcoz you are proposing something new or you are hater of govt. policies or I would say politicians ?
All I care is – How your solution/theory/model can be implemented in practical world ?
If you want to know more then plz go through http://arthakranti.org/htm/proposed_system/proposal.htm
Now the biggest flaw in your “free market economy” is – you guys totally reject presence of govt. in your system so naturally 1st question will eb asked “Ok fine!…But how you are planning to discard govt. out of peoples lives? any revolution?..coz blogs can impact only certain readers to certain extent and not more that that..right?
No offence but, I don’t think you have practical answer to this question! Do you?
But yeah , Like i said earlier – I always read your posts with eager mind as they are really informative and present both sides of the coins most of the times.
But not necessarily, I will agree to everything you proposed.>>>>>>>>>
prashanthguevara Says:
April 7th, 2009 at 1:09 pmDeflation is often viewed as bad because people have got themselves so much familar with inflation these days, so much that economics texts even claim that moderate inflation is good for the economy. The funny thing is, none of the mainstream doctrines that claim to “explain” inflation (that is price rise) make any sense. The only theory that can explain rising prices is the Quantity Theory of Money. The sad thing is that it has been abandoned almost completely today.
Coming to the point of deflation (that is price fall), it happens because all checking deposits, which are nothing but magic money, have got washed out. They are no more in circulation, so demand in the economy goes down. Is that so bad, really? Not really, since it’s just the process of the market reasserting itself to standard money spitting off all fake money in the process.
So why does the market hate the fake money (checking deposits)? It’s because the fake money distorted market signals to cause the depression. So the market obviously spits it out!
It’s so much fun to see people speaking of the inability of the market, when it’s the market which reasserts itself to show governments so often what happens when it is distorted with.
Cow Tse Tung Sound System Says:
April 12th, 2009 at 10:57 pma) In your previous post, you claim extreme diligence on the part of Indian banks in regard to extending credit. Now, you contradict yourself and claim private banks are undertaking risky ventures. What side of the fence do you sit on? Also, by “private banks”, I can only assume you refer to “privatized banks”, and “private banks” in the Swiss context, which brings me to BASEL II risk mitigation requirements – an avenue you might want to explore.
b) Deficit financing can be funded via issuance of bonds, and a deficit is not always a bad thing. Also note that the very Keynesian policies you slam without a reasonable basis could be the answer to a multitude of current problems. eg: infrastructure spending, that could have a multiplier effect on the economy.
c) Foreign aid can be an effective tool if the currency of the lending nation is expected to fall in value in relation to the currency of the borrowing nation. I digress here – forex treasury operations and hedging strategies to reduce governmental debt is another matter for another day.
d) If not via fiscal stimulus, how else do you propose to ease access to credit in light of continually worsening business conditions, whereby banks are reluctant to lend to businesses?
e) Your statement about the RBI determining inflation and its variants is highly misleading. I’d suggest a visit to the RBI website to see what a Central Bank actually does.
Unpretentious Diva Says:
April 13th, 2009 at 2:53 am@a) I will prefer not wasting my time on this.
b) As a matter of fact, Keynesianism is simply anti-reason and I am saying it with proper reason. About infrastructure spending, the Hoover Dam and the Zipingpu dam are great examples of results of infrastructural spending.
Collectivism often leads to situations like that http://www.reasonforliberty.com/reason/china-communism-corruption-and-earthquakes.html Simple thing is, every Individual have a right to decide how to invest his money. Government spendings simply loots that individual right. and it is enough reason to denounce government spending.
c) I wrote a whole lot of discussion over foreign aid. http://www.reasonforliberty.com/reason/foreign-aid-or-foreign-investment.html Apart from that, when a government decides to take foreign aid (loan, debt whatever) the individual citizen is forced to bear that debt irrespective of his agreement to it or his disagreement, it is simply against individual right and that is the reason it is illogical. Anyways, the aforementioned article discusses other reasons why foreign aid is negative idea.
d) Why will I propose to keep the dead cells intact? Fiscal stimulus is nothing but a try to keep the dead cells ( or non-productive activities) intact at the cost of price rise and loot of common man.
e) this point from you clarifies that you are misleaded about inflation. try to clear out your confusions.
gopi Says:
April 13th, 2009 at 6:07 pm@ cow tse tung :
a) Excessive extension and retention of money by banks (determined by interest rates that r determined by Central Banks) cause the boom bust cycles. Wouldnt it be better if the rate of savings and demand for loan determine the interest rates?
b) Deficit financing by issuing bonds/debentures is not bad as long as a firm has a viable project or avenues of expansion to ensure cash flow (ie. as long as it is a capital expenditure). However, if a country runs up huge deficits continously and consumes too much instead of investing it (like US), it eventually runs into economic difficulties.
c) Whether the Govt uses hedging strategies like currency swaps effectively is questionable since the risk is borne by the individuals of the country. And it is a risk that the individuals may not want to bear. They are forced into it by the Govt.
d) I do not propose to take resources from the productive sector (via tax) and printing money (inflating) to put it in firms that are inefficient. Let them fail. New firms would spring up in their place whose policies and judgement are sound.
e) A Central Bank prints money, thus devaluing the currency resulting in higher prices. It fixes the price of capital (interest rate) resulting in malinvestments by big businesses, which in turn cause bubbles that eventually burst resulting in recessions. If u can come up with anything else they do, plz post it here.
hmemcpy Says:
May 14th, 2009 at 10:59 pmAdditional reading:
Deflation Fears: Could Falling Prices Let the Air Out of a Recovery?
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2235
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July 26th, 2011 at 3:10 amd or prejudiced just bcoz you are proposing something new or you are hater of govt. policies or I would say politicians ?