Why Central Bankers Really Don’t Want Deflation

The fundamental error behind central planning is being repeated in China. Wen Jiabao leaves office telling his colleagues that, ‘Unbalanced, uncoordinated and unsustainable development remains a prominent problem.’ China’s planners are past caring, though. And as our colleague Greg Canavan has said all along, China’s real estate bubble could be the biggest and most damaging yet.

But a good apparatchik never lets objective reality get in the way of an inflexible theory. In Japan, the man at the head of Bank of Japan has vowed to take ‘action’ on deflation. Haruhiko Kuroda told law-makers that, ‘If I were appointed as governor…I would do everything possible to get out of deflation.’ His plan is to have the Bank of Japan buy government bonds with maturities longer than three years, and buy a lot of them.

Mr Kuroda, like Mr Bernanke, seems to think that by limiting the choice investors have with cash, you will set them free. That is, if you force people into stocks by lowering interest rates, you will somehow make them spend more money. And the most important belief in this world-view is that more spending is the key to greater wealth. If you stimulate demand, the world will become richer!

One trouble with this belief – other than that it’s wrong – is that Japan has defined deflation in terms of falling consumer prices. The deflation we all think about when we think of the Great Depression came about because of a collapse in the global banking system.

As banks fell, credit creation fell and the money supply shrank. Consumer prices fell because the money supply contracted. This lead to the vicious cycle where cash became so valuable no one wanted to spend it or invest it.

But falling consumer prices alone are not an economic evil. In Japan’s case, we suspect that the falling level of consumer prices has to do with productivity, technology, and demographics. Things ought to get cheaper the more efficiently you use energy and the better technology gets. Commodification is all about lower prices.

And in demographic terms, you’d expect that people who get older spend their money on different things not measured by CPI indices. An older population spends a lot more on healthcare and a lot less on day care. If Japan has a spending problem, it’s because Japan has a demographic problem: it’s old.

But all of these nuances fall on deaf ears when it comes to those who would destroy deflation. In the global empire of fiat money, deflation must always be destroyed. ‘Furthermore,’ Cato the Elder was reputed to say at the end of all his speeches in the Senate, ‘it is my opinion that Carthage must be destroyed.’ In Latin, that roughly translates to, ‘Carthago delenda est.’

By the end of the Third Punic War, the Romans finally did destroy Carthage. Their cross-Mediterranean rival was subjected to the normal treatment of a conquering empire. The population, some 50,000 prisoners by the end of the war, was sold into slavery and the rich farmlands surrounding the City were distributed amongst citizens of the Empire.

For central bankers, deflation means stock prices that don’t rise. If stock prices don’t rise, the public will no longer believe that unorthodox monetary policies are effective, or even designed for their benefit. To perpetuate confidence in fiat money, it is necessary for prices to always rise, because rising prices are often confused with growing wealth.

Yes. Deflation must be destroyed. Even if it means destroying the middle class, wiping out their savings, and unleashing a new era of rising prices, high unemployment, and social instability.

Dan Denning
for Markets and Money

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Dan Denning

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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All that matters on the street is “capacity to pay”. If you can’t buy food or shelter, inflation vs deflation matters nought. All that matters to government with inflation vs deflation, where capital markets and debt provide no choice but either, is who gets first use of the money. They and their crony “second use” bankers vote inflation every time.

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