As we saw in yesterday’s blog posting, per Say’s Law of Markets (and basic common sense), we don’t really purchase what others produce with money, but with what we produce by means of our labor or capital. This is, in fact, one of the reasons why the currency — the measurement of “money” — must be uniform and standard with a fixed value.
|When $1 was $1|
Otherwise, the dollar that paid for an hour’s worth of my production yesterday, might only buy half an hour’s worth of your production tomorrow if there is inflation. Similarly, a dollar I borrowed when it was worth a hour’s worth of production might buy two hour’s worth of production when it comes time for me to repay if there is deflation.
This was the primary issue addressed by William Jennings Bryan and the Populists in the latter part of the Nineteenth Century. As a result of the inflationary policies used to finance the Union war effort in the Civil War and the vast increase in demand for food to feed the army, farmers expanded production on credit extended on easy terms.
|When $1 in paper was 37¢ in gold.|
After the war, due to many factors such as continuing rapid increase in agricultural production due to the 1862 Homestead Act, advancing technology, expansion of transportation facilities beyond existing needs funded by government subsidies and expansion of commercial bank credit, restriction of farmers and small businesses to existing savings for financing, Prince Otto von Bismarck’s money manipulations against Austria and, later, France, and the at-first official and later unofficial policy of the United States government to restore parity of the paper currency with gold (did we miss any of the major factors? Oh, yes, the oversupply of silver just as silver was being demonetized in many countries), prices fell drastically, and anyone who had borrowed when money was “cheap” now had to repay when money was “dear” — i.e., money borrowed when wheat was, say, $2 per bushel had to be repaid when wheat was $1 per bushel . . . meaning a farmer had to produce twice as much wheat as the loan was worth when he got the loan.
|"The Great Commoner": William Jennings Bryan|
Had inflation not been an issue, of course, and the currency retained a standard value with both gold and paper at par during the war and afterwards, the problem would have been different, and quite possibly negligible. The need to restore the faith and credit of the government, however, ensured that the method chosen, deflation, would harm the very people it was intended to help (farmers and small businessmen), and benefit the people who didn’t need help: big business and the financial services industry. This was why Bryan demanded that as much silver as was necessary be coined to inflate the currency and raise prices.
The main question, then, was not whether the money supply should be manipulated. That was a given. The only question was who was to benefit from the manipulation. That determined whether the government should follow a policy of inflation or deflation.
Both inflation and deflation, however, are Currency Principle phenomena. If an economy has a reserve currency that is fixed and uniform in value, is asset-backed, and expands and contracts directly with the present value of existing and future marketable goods and services in the economy, there will be neither inflation nor deflation.
|Inflation as the cure for economic woes|
“Inflation” we define as “an increase in the price level due to an increase in the money supply without a corresponding increase in the present value of existing and future marketable goods and services.” More accurately, this is “demand-pull” inflation, a monetary phenomenon. “Cost-push” inflation results not from manipulation of the money supply, but from actual changes in the supply and demand of and for marketable goods and services, an economic phenomenon.
“Deflation” we define as “a decrease in the price level due to a decrease in the money supply without a corresponding decrease in the present value of existing and future marketable goods and services.” It is a monetary phenomenon. Deflation should not be confused with “currency appreciation.” Appreciation is an economic phenomenon in which a currency will buy more goods and services because those goods and services are in greater supply, become less costly to manufacture or procure, or demand falls.
The real solution to falling prices, however, is not to raise prices through inflation, any more than the real solution to rising prices is to lower them through deflation. Consistent with Say’s Law of Markets, the real solution to both problems is to make people who are not productive, productive. This was the question that Louis Kelso addressed and solved with binary economics.