STAFF NEWS & ANALYSIS
Noted Economist Criticizes Sensibility of Government Stimulus to Combat Recession
By - January 12, 2009

Contrary to The Times and so many others, deflation is not falling prices but a decrease in the quantity of money and/or volume of spending in the economic system. To say the same thing in different words, deflation is a general fall in demand. Falling prices are a consequence of deflation, not the phenomenon itself. Totally apart from deflation, falling prices are also a consequence of increases in the production and supply of goods, which are an essential feature of economic progress and a rising standard of living. In such circumstances, falling prices are not accompanied by any plunge in business sales revenues or profits, by any increase in the difficulty of repaying debt, or by any surge in bankruptcies. All of these phenomena are the result purely and simply of deflation, not falling prices. Indeed, under a full-bodied, 100-percent-reserve gold standard, falling prices, caused by increased production, are likely to be accompanied by a modest elevation of the rate of profit and a somewhat greater ease of repaying debt, both owing to the increase in the production and supply of gold and thus in the spending of gold. Under such a gold standard, prices fall to the extent that the increase in the production and supply of ordinary goods and services outstrips the increase in the production and supply of gold and the consequent increase in spending in terms of gold. – George Reisman

Dominant Social Theme: It doesn't appear there is one here.

Free-Market Analysis: The above is taken from George Reisman's Blog on Economics, Politics, Society, and Culture. Here's how Reisman describes it: This blog is a commentary on contemporary business, politics, economics, society, and culture, based on the values of Reason, Rational Self-Interest, and Laissez-Faire Capitalism. Its intellectual foundations are Ayn Rand's philosophy of Objectivism and the theory of the Austrian and British Classical schools of economics as expressed in the writings of Mises, Böhm-Bawerk, Menger, Ricardo, Smith, James and John Stuart Mill, Bastiat, and Hazlitt, and in my own writings. Reisman himself is a professor of economics, and one of a very few of the free-market persuasion in Western academia.

And here is Reisman's biography from Wikipedia: George Gerald Reisman is Professor Emeritus of Economics at Pepperdine University and author of Capitalism: A Treatise on Economics (1996). He is also the author of an earlier book, The Government Against the Economy (1979), contents of which are mostly subsumed in Capitalism. Reisman was born in New York City and earned his Ph.D. from New York University under the direction of Ludwig von Mises. He is an outspoken advocate of free market or laissez-faire capitalism.

Reisman reminds us of something very important: Just as inflation in free market terms is an expansion in the money supply, so deflation is a decrease in the money supply – and both of these events are likely natural within a larger business cycle. But as Reisman points out repeatedly, falling prices and monetary contraction are different events.

While this must certainly come as a surprise to The Times, and to everyone else who does not understand the nature of deflation, falling prices are in fact so far removed from being deflation that they are the antidote to deflation. They are what enable an economic system that has experienced deflation to recover from it and thereafter to enjoy the fruits of economic progress.

Bear in mind, Reisman is analyzing an economy from a free-market point of view. And these verities used to be well understood and accepted. One of the reasons that the Federal Reserve is said to have tightened the money supply in the late 1920s and early 1930s is that people had experience with Reisman's monetary archetype and understood that the supply of money was supposed to contract during a time of economic quiescence. The Fed was just trying to mimic a free-market system.

Yes, in the normal scheme of things, deflation is the appropriate and natural prophylactic. A fall in prices, he explains, enables reduced funds available for expenditure to buy as much as previously larger funds could buy. This point applies even when lower prices do not result in greater purchases of the particular item whose price has fallen. Thus, suppose that the price of a gallon of milk is $8 and now falls to $4. Yet Bill and his family do not need more than one gallon in any given week, and so won't buy any larger quantity of milk at its now lower price. The fall in its price still helps economic recovery. It does so by freeing up $4 of Bill's funds to make possible the purchase of other things, that he wants but otherwise couldn't afford because of the lack of available funds.

Falling prices, as Reisman shows above, frees up cash for other purchases, thus "spreading the wealth" to sectors that would not otherwise partake. Reisman again: As indicated, in sharpest contrast to falling prices, deflation is a process of financial contraction. In our present crisis, it is a contraction of credit and of the spending that depends on credit. A fall in prices and, of course, in wage rates too, is the essential means of adapting to this deflation and overcoming it.

Reisman is very clear that falling prices represent the best hope of economic recovery. Thus he is equally emphatic that current steps of Western governments will only prolong the current financial downturn. The prevailing bizarre confusion of falling prices with deflation, stands in the way of economic recovery. In regarding falling prices, which are the effect of deflation and at the same time the remedy for deflation, as somehow themselves being deflation, people are led to confuse the solution for the problem with the problem that needs to be solved.

On the basis of this confusion, they advocate government intervention to prevent prices from falling. The prices they want to prevent from falling are, variously, house prices, farm and other commodity prices, and, above all, wage rates. To the extent that such efforts are successful, and prices are prevented from falling, the effect is to prevent economic recovery. It prevents economic recovery by preventing the reduced level of spending that deflation represents, from buying the larger quantity of goods and services that it would be able to buy at lower prices and wage rates.

After Thoughts

We tend to believe that the current central banking paradigm of Western finance makes it difficult to tolerate, in the short term, the kind of remedies that Reisman mentions. This is because central banks print so much money over the time that economic players will do anything to stave off the implicit pain necessary for recovery. This clears the way for two conclusions: First, some sort of deflation may take place, willy nilly, in such times as the West now faces; second, real deflation, if it occurs, is likely to be interrupted because of the efforts of central banks to re-ignite monetary expansion. Making a dollar go farther may be necessary to resurgence. But ironically, as Reisman points out, the more success central banks have in interrupting the process, the less fervent the economic recovery will be, and the more the malaise will likely stretch out.

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