Fear Of Falling

Prices, that is, otherwise known as deflation. This week’s Economist is full of angst about the apparent inability of the central banks to create the inflation that every good Keynesian knows is necessary to save the economy. Frankly, it makes me angry. There is not a shred of evidence that constant inflation leads to economic improvement.

The Keynesians raise the spectre that, faced with the prospect of falling prices, people might actually save up for the things they want, rather than pay for them with credit. Every good Keynesian knows that saving by the public is to be avoided at all costs, because it reduces consumption.

The Keynesians pay no attention to history and common sense, because they contradict their beliefs. As a result, they fail to observe or understand that mild deflation, resulting from capital investment and technological development, is the normal state of a healthy economy. Of course, that capital investment and R&D is funded by – savings.

Years of Keynesian policies encouraging inflation and credit-funded consumption have piled up the debts, which continue to grow despite the claims of austerity and suffering from bloated public sectors. The Economist (rightly) makes the case that the debt burdens of some countries are unsustainable (below).


Just as a comparison, total US debt at the end of the first quarter of 2014 totaled almost $59.4 trillion, approximately 350% of GDP, somewhere between Greece and Portugal. You figure out whether that’s sustainable or not.

The only thing that makes these massive debts appear sustainable is ultra-low interest rates that reduce the costs of debt service. Of course, inflation tends to drive interest rates higher so that if the Keynesians get their inflationary wish, they must have even more financial repression from central banks to prevent higher debt service costs from bankrupting borrowers. This seems unlikely, but the Keynesians, ignoring history, believe it possible. On the other hand, argue the Keynesians, deflation increases the value of these already absurd level of debt causing defaults and the destruction of the banking system. We’ve had two near-misses of this destruction, the third time will be “lucky.” The piles of debt will be destroyed by default. That which cannot be sustained will not be sustained.

We will then be forced to return to a cash-oriented society, just as happened after the Great Depression when whole generations shunned debt in fear. Longer term, this is a good thing. Keynes created the idea that there is a free lunch, where government spending through some “multiplier” effect creates the economic growth needed to service the debt. Time has proven this to be false and high levels of government spending are only possible due to artificially suppressed interest rates. Low rates have pulled forward private consumption as well, but this is now about finished. Reality approaches.

Once nominal interest rates come to zero or close to zero, they cannot be reduced further. But to keep the game going as debts increase, even lower rates are needed. So the last resort of the desperate Keynesians is to use inflation to reduce real interest rates, (hence their fear of deflation which will do the opposite). Japan has taken the lead, attempting to stimulate inflation with with the massive QE known as “Abenomics,” four times the relative size of that tried by the Fed. This grand experiment has indeed resulted in price inflation – but not wage inflation, so that consumption is collapsing, the economy is back in recession and the grand experiment is failing.

It is all over but the shouting.

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