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.
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| 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.
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| 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.
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| "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.
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| 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.