Inflation, deflation and other fallacies

by Alasdair Macleod, GoldMoney: There can be little doubt that macroeconomic policies are failing around the world. The fallacies being exposed are so entrenched that there are bound to be twists and turns yet to come. This article explains the fallacies behind inflation, deflation, economic performance and interest rates. They arise from the modern states’ overriding determination to access the wealth of its electorate instead of being driven by a genuine and considered concern for its welfare. Monetary inflation, which has become runaway, transfers wealth to the state from producers and consumers, and is about to accelerate. Everything about macroeconomics is now with that single economically destructive objective in mind. Falling prices, the outcome of commercial competition and sound money are more aligned with the interests of ordinary people, but that is so derided by neo-Keynesians that today almost without exception everyone believes in inflationism. And finally, we conclude that the escape from failing fiat will lead to rising nominal interest rates, with all the consequences which that entails. The inevitable outcome is a flight to commodities, including gold and silver, despite rising interest rates for fiat money. Demand-siders and supply-siders In a macroeconomics-driven world, economic fallacies abound. They are periodically trashed when disproved, only to arise again as received wisdom for a new generation of macroeconomists determined to justify their statist beliefs. The most egregious of these is that inflation can only occur as the handmaiden of economic growth, while deflation is similarly linked to a recession spinning out of control into the maelstrom of a slump. This error is the opposite of the facts. Conventionally, macroeconomists split into two groups. There are the Keynesians who believe in stimulating demand to ensure there will always be markets for goods and services, which they attempt to achieve through additional spending by governments and by discouraging saving, because it is consumption deferred. And there are the supply-siders, who believe in stimulating production through lower corporate taxes and lighter regulation. Both demand and supply-siders advocate monetary inflation in the belief that their methods stimulate an economy so that government spending need not be cut. The maintenance of government spending is the objective of both approaches, not the welfare of economic actors, who are always regarded as the state’s milch cows. While supply-side reforms have proved more attractive to free traders than Keynesian demand stimulus, the end result is the same: the combination of taxes and monetary seigniorage from the productive economy transferred to the state is the objective either way. The smoke and mirrors to get people to part with their wealth are the misuse of statistics. The price consequences of monetary inflation are suppressed by statistical method, and economic growth is substituted for economic progress, the combination leading to confusion for nearly all economists. But the facts behind the measure of growth, gross domestic product, are easily explained. First, the modelling assumptions. As a starting point we must assume there is no inflation of money and credit and the quantity of money is fixed. That being the case, and assuming no change in the statistical make-up of GDP, nor in the quantity of hoarded cash, and assuming no change in the balance of external trade, there can be no increase in nominal GDP, because whatever people make, sell and consume amounts to the same total expressed in money terms compared with the previous period. It is an accounting identity. Whether savings increase or decrease is immaterial, because GDP is the total of final goods and intermediate goods, so if an economy evolves from being consumer to savings driven or vice-versa, GDP must remain unchanged. The split between profit and costs is immaterial as well, the sum of the two being contained within the GDP total. But variations in the rate of economic progress will always be reflected in the individual prices and quantities of goods and services produced without the total monetary value of all transactions changing. A progressive economy will see more and better goods and services at lower prices, while for a failing economy the opposite is be true. The next step should not be beyond the understanding of anyone. If a fairy godmother magically created some extra money for the people in an economy to spend, it must simply be added to the GDP total, whether they spend it or save it — as long as they don’t hoard it. Saving circulates, because it is money made available for investment. Hoarding is taking money out of circulation, which is why in our model we must assume the quantity of money hoarded does not change. Macroeconomists confuse the additional money injected into the economy with growth. It is growth in the money total only, because it is impossible to judge the degree to which it is used to economic advantage. Economic growth has become confused with economic progress. Economists today appear unaware of this distinction, which Ludwig von Mises separated out into what he called an evenly rotating economy. He defined it as follows: “An imaginary economy in which all transactions and physical conditions are repeated without change in each similar cycle of time. Everything is imagined to continue exactly as before, including all human ideas and goals. Under such fictitious constant repetitive conditions there can be no net change in any supply of demand and therefore there cannot be any change in prices.” [i] The inconvenient truth for statists is that with GDP they can only measure the quantity of money in total transactions, not how it is used. This fits von Mises’s description of an imaginary economy that evenly rotates and it is vital for any student of economics to understand this point. It matters not whether he or she is a demand or supply-sider; both categories of macroeconomic emphasis wrongly believe in targets for GDP outcomes, which are meaningless except for the purpose of maintaining government revenue. And that is the key to their interest. Read More @

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