The Achilles Heel of the Global Status Quo: Deflation

January 12, 2015

Rather than being the Monster Under the Bed in central bank nightmares, deflation is the natural result of a competitive economy experiencing productivity gains.

That the global Status Quo is terrified of deflation is the background of every policy decision and official PR sound-bite. The reason behind this unremitting terror: deflation is the Achilles Heel of the global Status Quo. My colleague Gordon T. Long explains why in the latest of our video/slide programs.

Though central banks are constantly claiming their policies are intended to spark "growth," their over-riding motivation is sustaining the colossal mountain of debt that is the foundation of the Status Quo's wealth and power. If interest rates rise, the debt can no longer be serviced without ballooning deficits (i.e. more borrowing just to pay the rising interest) or the extreme pain of budget cuts--cuts that will necessarily come of discretionary government spending or entitlements.

If liquidity (easy, abundant credit) dries up, the portion of the debt mountain that must be rolled over into new loans cannot be refinanced, and the loans and bonds that have come due/reached maturity will default, toppling the system's teetering financial dominoes.

If asset purchases (i.e. quantitative easing) by central banks taper to zero, risky assets will go bidless and/or yields will rise as investors demand higher risk premiums.

The only way to make debt service easier on borrowers is to create inflation, which depreciates the purchasing power of existing loans and lets borrowers service their debts with cheaper (depreciated) currency.

A world without inflation threatens to collapse the Status Quo's mountain of debt.

Meanwhile, all those screaming in terror at the prospect of deflation should note that deflation is the natural consequence of rising productivity in a competitive economy. What does rising productivity means? It means more gizmos/services are produced with less capital, labor and expense.

In a monopoly environment, the gains reaped by rising productivity are skimmed by the monopoly, as there are no competitors to offer customers better deals.

In a competitive environment, the gains in productivity are passed to the customers as lower prices: in other words, deflation. This is why technology is ruthlessly deflationary: as productivity leaps higher, competitors must lower prices to maintain market share.

Rather than being the Monster Under the Bed in central bank nightmares, deflation is the natural result of a competitive economy experiencing productivity gains. isn't this the ideal environment for innovation, enterprise and consumers? Yes, it is.

Is deflation the nightmare scenario for central banks, debtors, central states, monopolies and cartels? Yes. That all these entities share the same interests--anti-competitive monopolies, governments, debtors and central banks--should give us pause.

Which is more powerful in the long-term--central banks' inflationary policies, or technology, innovation and competition? The central banks (and their legions of media lackeys) claim omnipotence over every force in the Universe, but unintended consequences of central bank distortions, technology, innovation and competition look like the better long-term bet to me.

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