Authored by Tj Roberts via freedomandeconomics.org
The world is sitting on the largest financial bubble ever created. While the economic elite says that we will never see another crisis in our time (just as Keynes said two years before the crash of 1929), we have been living in a bubble for more than a century, and it will inevitably break. This bubble, however, is unlike any economic boom we have dealt with before. The inflated commodity that will cause the future bust is the currency which the US Federal Government forces us to use: the US Dollar, and this is all because of the unnecessary fear of deflation.
Estimates say that as much as 98% of the value of the US Dollar has disappeared since the Federal Reserve claimed a monopoly power over currency in the United States. The only reason the Dollar has not collapsed already is due to legal tender laws, which requires businesses to deal in US Dollars within the US.
So, how did it get so bad? As alluded to in the first paragraph, it is because the government is terrified of deflation. They fear that since prices have a tendency to decrease, people will hoard their money since they can make a profit by simply refraining from spending in the present. Since consumers hold on to their money, firms earn less revenue, which causes them to decrease their spending. This leads to a decrease in employment, and therefore production. With this loss of production, those who make the factors of production also lose revenue, leading them to cut spending, thus decreasing production and employment. With the loss of employment, consumers spend even less. This ultimately leads to a complete collapse of the economy according to the Keynesians (see Chapter 12 of John Maynard Keynes’s The General Theory of Employment, Interest, and Money).
Deflationary Spiral will not destroy the economy
The process outlined in the prior paragraph is known as a “deflationary spiral,” in which deflation causes the entire economy to disappear. This, however, is an economic myth. In truth, a deflationary spiral can only occur under special circumstances. The reason why Keynes is wrong in assuming a deflationary spiral will happen is two-fold.
First, it is not possible for human beings to reduce spending externally. Although money does possess deflationary tendencies when unregulated, this does not mean that people will hoard their money indefinitely. Humans have basic needs, namely food, water, and housing. It simply isn’t possible for the people to cease all forms of economic activity.
The second reason why a deflationary spiral will not destroy an economy is time preference. Time preference is the concept that human beings prefer present goods to future goods. If one offered you one thousand dollars today or one thousand dollars in one month, people will typically take the money today. This is why we have an interest in society. Interest gives an incentive for one to refrain from present consumption so that they may have even more future consumption.
People, however, have varying degrees of time preference. The lower your time preference is, the more willing you are to forego present consumption for future consumption. Simply because something is cheaper in the future does not guarantee that someone will wait to consume it. If the price drop is high enough, then they will wait, but that only applies to those with low enough time preferences to be willing to wait. Those with higher degrees of time preference will still consume and the economy will not totally disappear.
What are the causes of deflation?
There are four immediate causes of deflation.
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An increase in the demand for money will cause deflation. If the demand for money increases relative to the demand for goods, then price deflation will occur. Money will have an increased purchasing power due to the increased demand for money.
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A decrease in the supply of money will lead to price deflation. If less money is in the system, then people will marginally value money more than goods. Simply put, with less money in the system, people will be able to purchase more goods for less money.
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A decrease in the demand for goods. If the demand for goods decreases relative to the demand for money, then money becomes more valuable and deflation occurs.
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An increase in aggregate output. In other words, an increase in the supply of goods will cause price deflation because production has become more efficient.