Sunday, January 30, 2011

So what's so bad about deflation?

Some thoughts on the Federal Reserve, inflation, and deflation.  Please let me know if you find things that don't seem to make a lot of sense or there are things for which you want evidence. (I just don't want to go into too much detail because I could turn this into a small book.)

The theory explaining why  deflation is worse than inflation goes something like this:
  • The price of goods and services will be less tomorrow than it will be today.
  • Therefore the consumer will put off today's purchases until tomorrow because he'll get a better price then he can today.
  • Since this will be the case every day, consumers will never buy anything, and the economy will tank.
The problems with this:
  • It assumes that the only value of a consumer purchase is contained in the price paid.  This is obviously in error as a purchase is made to utilise.  Take computers as a concrete example of this.  The computer I buy today, I can be certain I will be able to purchase next month for less, and the month after that for even less.  Yet I still make the purchase because I buy it to use it.
  • It also ignores a distinct counter example of this: the United states in the late 19th century.  During this period the purchasing power of the dollar was increasing and the economy was booming.

The most widely cited example used to back up the "deflation is bad" argument is the disastrous results of the Federal Reserve's monetary contraction policy during the Great Depression.
  • The significant point here is that the deflation in this case was artificially introduced by government action, not by natural market forces.
  • To understand why governmental meddling with the money supply is harmful to an economy, one must understand how the meddling takes place.
    • If, for example, one day the government dropped a trillion dollars from helicopters, or mailed $300 checks to every person in the US, or magically added a zero to every dollar amount in the country, not much would happen - it would be a fairly meaningless gesture because the economy would be able to instantly adjust to the pecuniary alteration.
    • This is not the way they do it.  What happens instead is they (basically) give a bunch of newly-printed cash to politically connected cronies and the financial adjustment happens slowly as the additional cash makes it's way through the economy.  During the time between it's introduction and it's saturation, many people are going to make incorrect assumptions about the relative scarcity of goods and services because of the new money.  This causes resources to be poorly allocated, and that is what detracts from the wealth of the economy.
    • In the case of artificial deflation, again, the removal of cash from the economy does not happen instantly everywhere.  It occurs at specific points in the economy and ripples through, causing damage by inducing people to misallocate their resources.
So why does the government favour inflation over deflation, especially given the general public's dislike of inflation?  As always with government, follow the votes...
  • Inflation transfers wealth from creditors to debtors by making the debt owed less valuable.
  • Deflation transfers wealth from debtors to creditors by making the debt owed more valuable.
  • There are more voters who are debtors than there are who are creditors.
  • It is therefore in the self interest of the politician to pander to debtors by preventing deflation.

Science hijacked by.... Natural Science???

So I went on a little rant a while back about the improper use of the term "science" when one really means "philosophy."  Turns out I was a little inaccurate in my assertions.  Apparently the history of the word is that as recently as the 17th century it was used interchangeably with the word "philosophy."  Of course when I use the word I think of (and mean) those pursuits that utilise the "scientific method."

Anyway, I just wanted to acknowledge that I was somewhat in technical error in some of my criticism of the misuse of the term "science."

Lo teer tsakh

So words mean things, and sometimes words written in one language get a little muddles when they make it into another.  Sometimes, however the original source material is available.  Take the 6th commandment (or 5th for Roman Catholics.)  It is most commonly translated as "Thou Shall Not Kill" which seems to be kinda odd for a group of people who were omnivorous and engaged in periodic warfare which involved, necessarily, killing.  So how can these two contradictions coexist?

First, there are no contradictions.  If you find one, re-examine your premises, one of them is faulty.  The faulty premise here is the translation of the Hebrew word "tsakh" (also phonetically spelled "ratsach" I think) to kill - the more accurate translation is murder.