The Blessing of Deflation
Asset prices and commodity prices are falling rapidly as the impact
of the global credit crunch permeates the world economy. Newspaper
columnists are now starting to warn of the dangers of deflation. They
have two main concerns about the impact of deflation.
The first concern is that consumers defer their spending when prices
Deflation has other insidious traits. It causes shoppers to hold
back. They wait for lower prices. Once this psychology gains a grip, it
can gradually set off a self-feeding spiral that is hard to stop
(Ambrose Evans Pritchard, Daily Telegraph).
It encourages people to defer spending, as they wait for prices to
fall further. This in turn forces down the price – as retailers slash
prices in a vain attempt to attract shoppers.
As retailers cut prices, so too do manufacturers, who then have less
money to invest in new technology, equipment and, crucially, staff.
Wages then start to fall – psychologically very damaging for
consumers, even those that keep their jobs. As they fret about less
money in their pockets and their job prospects, they further postpone
spending, starting the deflationary spiral once again (Harry Wallop, Daily
These statements are nonsense. Falling prices do not stop consumer
spending. Computer prices have been falling for the last twenty years,
but spending on computers never stopped. Although prices of most
consumer electronics have fallen dramatically over the last decade,
sales have increased significantly. The reason is that when prices of
things fall, more people can afford to buy them, so sales increase.
The benefit of falling prices is that consumers can buy things when
it suits them. During inflation, people rush into purchases before they
can afford them, because they are scared that the price will go up. They
will often get into debt, trying to beat rising prices. Inflation forces
people to make purchases at the wrong time.
Falling prices eliminate this problem. People are not put under
unnecessary pressure to buy. They can save for something they need
knowing that price increases will not push it beyond their reach. People
are free to buy large items when the time is right for them. Falling
prices increase freedom.
The related benefit of falling prices is that people get access to
better quality goods. By waiting a little longer, they can get a later
model, at the same price. This makes them better off.
The other concern of the columnists is that deflation punishes
A prolonged period of deflation can have a pernicious affect on an
economy. The other main reason why deflation can cause so many problems
is that it serves to make debt more expensive. Here's why. If you borrow
£1,000 at the start of the year to pay for a new sofa, the cost of the
loan does not change throughout the year. It remains at £1,000. But the
sofa is falling in price. So at the end of the year – when you are
still paying back the loan – you have ended up taking out £1,000 to
pay for a sofa now worth just £900 or £800. Think of it as negative
equity on a grand scale, spreading itself into every corner of consumer
credit. Of course, in theory there are some winners: savers (Harry
Wallop, Daily Telegraph
The curse of deflation is that it increases the burden of debts.
Incomes fall: debts stay the same. This way lies suffocation…. The
great credit bubble of the last 20 years has pushed debt levels in
Britain, the US and other Western societies to unprecedented highs…
Our sensitivity to debt deflation is therefore greater (Ambrose Evans Pritchard,
This is twisted thinking. The curse of debt has been replaced by the
curse of deflation. Evil is good. The lie is truth. The commentators
dislike deflation, because it rewards those who save and punishes those
who borrow. Falling prices redistribute wealth – the wrong way.
Savings appreciate, which is good for those who have saved. Income is
transferred from those in debt to those. Income is transferred from
borrowers and speculators to those who have been responsible. In the
strange modern world of debt and leverage this is seen as bad.
We have had inflation for so long, that people have begun to assume
that inflation is good. For example, house prices are now so high, that
home owners are only able to cope with the huge debt needed to buy a
house, because the endemic inflation has reduced the burden of their
mortgages. Over the last decade, inflation has made it possible for home
owners to cope with really high debt levels, because rising house prices
increase the equity of people with mortgages.
Governments are usually huge debtors. In the modern world, most
governments have enormous public debt. They love inflation because even
at low rates, it gradually erodes the burden of the outstanding debt.
The declining value of debt, allows the government to increase debt
further. Politicians like debt, because it allows them to spend money,
without having to raise taxes.
Many people now believe that a little inflation is a good thing, but
it reality inflation is a two-edged sword. It might reward those who are
in debt, but it punishes savers. The value of savings is eroded by
inflation. Even if inflation is between two and three percent, which
most government see as a noble goal, the value of a responsible person’s
savings will be halved in fifteen years. In thirty years, the saving
will be worthless. Any phenomena that hurts saving and rewards debt is
dangerous for an economy.
God’s blessing falls on lenders and not on borrowers.
For the LORD your God will bless you as he has promised, and you will
lend to many nations but will borrow from none. You will rule over many
nations but none will rule over you (Deut 15:6).
Borrowing is sometimes necessary, but is dangerous because it removes
The rich rule over the poor, and the borrower is servant to the
lender (Prov 22:7).
Inflation blesses debtors and harms lenders. God works the other way
round. Being free from the need to borrow is a fruit of his blessing.
You will lend to many nations but will borrow from none. The LORD
will make you the head, not the tail. If you pay attention to the
commands of the LORD your God that I give you this day and carefully
follow them, you will always be at the top, never at the bottom (Deut
Inflation fights with against God’s blessing.
Price Deflation is Normal
Very few people realised that deflation should be normal. If
governments did not inflate their currency, price inflation would not
drop to zero. In a country where the monetary policy is neutral, the
price level would gradual fall over time. A few prices might increase in
response to shifts in demand, but the prices of most goods and services
would fall, as new technology and economies of scale reduce the costs of
Declining prices are a powerful economic mechanism, because the
benefits flow to everyone in the economy. People on fixed incomes
benefit, because the things they have to buy get cheaper. Those who are
weak and powerless benefit, because they can purchase more with what
they have. Inflation benefits the few, who can work the system and know
how to use debt to speculate in property. Falling prices benefit
One of the best ways to help the poor is to eliminate inflation. Even
if price inflation is only three percent per year, poor people will be
worse off unless they can increase their income by that amount. Poor
people generally do not have sufficient political or market power to
negotiate that kind of increase in their incomes, so inflation harms
their situation. On the other hand, declining prices benefit the poor
without any need for negotiation.
Over the last few years, cheap imports of electronics and clothing
from China have been so pervasive that the level of consumer prices has
generally declined slowly. This should have turned into a downward flood
that brought increased prosperity to everyone, but unfortunately
governments continued to inflate their currencies throughout the period.
The world thinks that inflation has been low over the last few years,
but that is wrong, because prices would have been falling much more, if
governments had not been manipulating the money supply.
When economies of scale and technological advances should be reducing
prices, even zero price inflation is harmful. Over the last decade,
people on fixed incomes have been robbed of the benefits that would have
come their way, by governments that have stopped prices from falling.
This inflation has eased the pain of those who are heavily in debt.
Inflation punished those on fixed incomes and benefits and benefits
those in debt. Gradual deflation would benefit everyone, especially the
Inflation makes investment easy, people can buy assets, do nothing,
and watch them slowly increase in price. The benefit comes at the
expense of people on fixed incomes, as inflation robs them of their
wealth. Of course, inflation does not affect all assets evenly. Some
assets increase price more quickly than others, and housing has done
better than most other asset types. People have brought dwellings and
watched their wealth increase, as inflation pushed up the value of their
Our long experience of house rising in price is actually an illusion.
The reality is that houses age and suffer from wear and tear over time.
Therefore to be a good indication for economic decision making, the
price of dwellings should decline slowly to reflect that reality. In ten
years time, my house will be ten years older, so its price should be
less than it is now. If inflation were eliminated, residential dwellings
would gradually decline slowly in price year by year, reflecting the
fact that they are getting older and less modern. A thirty year old
house would be worth less than a two year old house.
Unfortunately, people have become so used to inflation that the
thought of their home not increasing in value over time is quite
disturbing. The reality is that most capital goods decline in price over
time. Manufacturing plant and equipment can be almost worthless when it
has reached the end of its useful life. Nevertheless, business people
are happy to buy plant and equipment knowing that its resale value will
decline over time, because they can use it to produce goods that can be
sold for a return that will compensate them for the depreciation in
value of their assets. In the same way, we have no problem with buying a
car that will be worth less next year than it is this year, because the
transport services that the car provides are worth more to us than the
decline in price and the cost of maintenance.
The reason that we would be disturbed by a decline in the price of
houses is that we tend to think of a home purchase as an investment.
This is incorrect thinking. In the absence of inflation, the purchase of
a home is consumption expenditure. The person buying a home consumes all
the shelter services that it provides. The purchase price is actually an
up-front payment for a very long-term stream of services. (Some of the
shelter services that are not used up may be sold when the owner is
ready to move on)
The only way to turn the purchase of a dwelling into an investment
that produces a return is to rent it out to some willing to pay for the
shelter services. In addition to providing a steam of income, the rent
would compensate for any decline in price.
If there were no inflation, people would have to stop seeing their
home as an asset that will increase in value over time. People would
only buy a house to live in, if they valued the shelter services it
could provide more than the decline in price and the cost of any
If inflation stopped completely and prices began to decline slowly,
investment strategies would also have to change dramatically. Buying an
asset and just waiting for the capital gain would no longer be a
feasible strategy. That would be a good thing for the economy, as
investors would shift to assets that are actually productive.
Investment decisions would require real wisdom and prudence.
Ownership of a house would not be viable unless it could be let out for
a rental that covered all expenses and any decline in price. Most
investors would have to switch to investments that produce something
real and valuable.
Inflation has disrupted investment patterns in a very negative way.
One of the reasons is that real incomes in the western world have not
grown as much as we would like is that most savings (and massive
imported savings) have been ploughed into residential dwellings. The
problem is that residential dwellings do a produce a return that
benefits the economy in turns of jobs and output.
If inflation disappeared, investment would flow into assets that are
productive and produce goods and services that people are willing to
purchase. Declining asset prices would push investors into more
productive investments, which would be good for the economy. More
productive investment would benefit society be increasing employment and