Wednesday, March 19, 2014

Inflation is actually good for "the producers"

It must be economics week in my head because I keep coming back to goldbugs and Bitcoin. Based on the first comments I quoted in my last post, I thought a bit more about the illogic of libertarian and goldbug preference for a currency whose value is not inflated away by the evil government.

Because what is the problem with inflation? The complaint can only be that it devalues the money you own. But why should we complain about that, in principle? Yes, I don't like my stuff loosing value either, but ultimately what matters is that I have a pleasant existence. Take cars, for example. Year to year, they loose value like whoa, but that doesn't matter so much because having a stable value store isn't what having a car is about; being able to drive around is. The same for money: hoarding a pile of money with a stable value is not what currency is about; moving money around so that the economy works and delivers us what we need is what currency is good for.

But it gets weirder. People complain that inflation is theft - but who is actually suffering from inflation?

Assume you have an economy in which inflation takes place. Who loses? If all prices and salaries rise gently by, say, 2% per year, then companies that produce and sell stuff as well as the workers are pretty much fine. Who is not doing quite so well are those who sit on a heap of money and don't do anything with it except perhaps invest it into somebody else's business. So we are talking about (a) big money and (b) people living off a pension fund. The problem of the former can be solved by investing into ventures that produce more return on money invested than the rate of inflation; the problem of the latter can be solved by having the pension fund invest into ventures that produce more return on money invested than the rate of inflation or by having a government run pension system that adjusts payouts according to inflation.

(If there is no investment to be had that returns more profits than 2% per year then your economy has serious issues that have nothing to do with the choice of currency, and you are probably screwed either way. Sitting on a pile of gold is not actually any help when your society collapses from an eroding resource base and the barbarian hordes move in.)

So in summary, the only people who lose from a bit of inflation are those who want to sit on a heap of money instead of doing anything productive. Clearly when seen from this angle, goldbuggery seems like an odd proposition, and thus that is not the argument that a goldbug would make.

What they often do to justify their position, then, is either to pretend that the salaries don't rise with the other prices (which is unrealistic and not exactly the same issue as inflation as such, which is a general rise in all prices, including labour prices); or they make a morality play out of the discussion and claim that devaluation of the currency amounts to parasites stealing from the producers and innovative risk-takers, where the producers are assumed to be the people who have a lot of money. Because how would they get a lot of money unless by being productive, right?

At this stage it would perhaps be a good idea to look at the real world out there. Under the Marxist view, the producers are the workers, but we can safely assume that this is not what libertarians mean. They are most likely talking about small business.

So under that view, and in the real world, assume that I have a good idea for a new product - does that mean that I will magically have money to produce it? No, in reality I go to a bank and take out a loan or to investors and ask them to buy shares or whatever (if I can convince them my idea is good). Or assume that I am a qualified florist and have found a town that could really do with a flower shop - does that mean that I will magically have money to open such a shop? No, in reality I go to a bank...

And that is only half of it. Most real life companies are pretty much constantly in debt. Business is about finding an opportunity where you can make 20% profit, and then taking the opportunity by getting a loan or investment at 12% from somebody who cannot use that opportunity themselves but who has the money.

Okay, the goldbug or Bitcoiner will say, but what difference does that make? Wasn't the argument that nobody would spend money because it becomes more valuable? Surely that cannot be true because people will still buy what they want and need, be it pizza or cars. So just get the loan, open your flower shop, people will buy your flowers, you profit!

Now here is where that aforementioned first quote comes in. It demonstrates clearly the problem that a deflationary currency, i.e. a fixed supply currency such as gold or Bitcoin, would cause, because that problem is not only or even primarily one of demand but one of being able to run a business.

Even if people buy the flowers from my flower shop, I will still have to bear a heavier debt burden every year. 2% inflation would help me to get rid of my debt more quickly because every year I get 2% more absolute number of monies for my flowers while the absolute number of monies in my original loan certificate remains constant.

Conversely, under 2% deflation, I will earn less absolute number of monies every year even if I sell the same amount of flowers because the flowers have to get cheaper in monies or people won't buy them (that's what deflation means), but the absolute number of monies in my original loan certificate remains constant. It gets harder and harder every year to pay down my debt, and if deflation gets too bad, that is if the gold or Bitcoins we are using as currency rise too much in value, as they MUST as long as the economy grows and/or money gets lost, I will at some point not even be able to service the debt and go broke.

That is a great irony, isn't it? Putting it into terms that a libertarian can understand, deflation is really punishing producers and risk-takers (if small businesses are defined as those), and at the same time rewarding non-producing creditors. Well, to a point at least. Once the debtor/producer goes broke, the creditor/investor will also loose most of their money, which would not have happened under a bit of inflation.

So perhaps it would be better to say that deflation punishes everybody who wants to put money to a productive use and rewards those who want to sit on theirs, count it and maybe take a bath in it. Well, to a point at least. Once the whole economy grinds to a halt because there are less and less functioning enterprises, even they will see that you cannot eat gold, and that the whole point of a currency is to circulate.

Again: At first inflation may feel like "theft", but the alternative is worse. Low inflation is not a sinister scheme thought up by the bankers, instead it is what we have found to work for us.

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