The Scary Deflation Monster: The Fed Vs. Prosperity

Janet Yellen may be the new monetary sheriff in town, but she harbors the same old phobias her predecessors had—a fear of the scary deflation monster.

The new Fed chair told the Economics Club of New York, “The FOMC strives to avoid inflation slipping too far below its 2 percent objective because, at very low inflation rates, adverse economic developments could more easily push the economy into deflation. The limited historical experience with deflation shows that, once it starts, deflation can become entrenched and associated with prolonged periods of very weak economic performance.”

This irrational fear that prices will fall and won’t be able to get up is repeated often by Keynesians, who believe consumers will destroy aggregate demand by waiting indefinitely to buy at lower prices. In turn, lower profits will cause companies to cut expenses by laying off employees. This all leads to a downward spiral impervious to central-bank machinations—think “pushing on a string” from your Econ 101 class.

This mindset is wrongheaded at best and dangerous at worst. Profits are the difference between the price it costs to produce a good and the price that good is sold for. As economics professor Jörg Guido Hülsmann makes clear in his book Deflation and Liberty, “In a deflation, both sets of prices drop, and as a consequence for-profit production can go on.”

Lower prices increase demand; they do not reduce or delay it. That’s why more and more people own flat-screen TVs, cellphones, and laptops: the prices of these goods have fallen, and people with lower incomes can afford them. And there are a lot more low-income people than high-income people. This is not something to avoid at all costs—it’s called prosperity.

Lower prices don’t mean lower profits; nor do they mean employees will be laid off. More demand for a good or service means more employees are needed to produce those goods and services. “There is no reason why inflation should ever reduce rather than increase unemployment,” professor Hülsmann writes.

He goes on to point out that only if workers underestimate the amount of money created by the central bank and therefore reduce their real wage-rate demands will unemployment be reduced. “All plans to reduce unemployment through inflation therefore boil down to fooling the workers—a childish strategy, to say the least.”

“Deflation is one of the great scarecrows of present-day economic policy and monetary policy in particular,” Hülsmann says. It seems a nation will destroy its finances battling a non-threat.

While the monetary mandarins lie awake at night worrying about lower prices, since 1971—when Richard Nixon cut the last tether of the dollar to gold—the effect of creating more money (inflation) has showed up in exponentially higher prices. A gallon of gas was 36 cents in 1971. New-home prices averaged $28,300 that year. A dozen eggs was 53 cents. The Dow Jones Industrial Average vacillated between 790 and 950.

The average home price today is $334,000. Eggs cost $2.06 a dozen. Regular gas goes for $3.75 a gallon, and the DJIA is north of 16,700 as I write.

However, Ms. Yellen is not only not alarmed by these price increases, she wishes them to be greater—to the detriment of the average person.

The Fed’s reckless money creation has distorted the price of everything, especially in financial markets. Which brings us to Robert Prechter’s work provided by Elliott Wave International. A section of the March edition of the Elliott Wave Theorist is offered below to Casey readers.