Inflation and Deflation Are Political Choices

 | Jul 23, 2015 | 12:00 PM EDT
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Driving inflation is a political decision -- just as driving deflation is political. Commodity prices are now at 13-year lows. That is evidence enough that the "powers that be" have chosen the path of deflation. What's odd, however, is that they seem clueless to the fact that they have made this choice and clueless to the fact that their policies, thought to raise inflation, are actually creating deflation.

I never understood why deflation is tolerated and inflation is the bogeyman. Even in the midst of crushingly high debt, wage declines, unemployment, falling commodity prices and weak or falling output, you have people warning incessantly about money printing and inflation. It's ludicrous.

Deflation is just as bad for the overall economy -- if not worse -- than inflation. It's also highly elitist. It takes from the middle class and poor and gives to the wealthy and connected. It rewards creditors inordinately at the expense of debtors. It's a form of usury.

Ironically, monetary authorities have been trying everything that they can think of to stoke inflation -- or at least that's what they have been saying. Their methods, however -- austerity, rate reductions and asset purchases -- all lead to a deflationary environment. In each case, you are either removing income from, or stripping the public of the high-quality assets that they desire in order to feel financially safe and secure. The loss of these assets, along with the loss of income, leads to a loss of confidence, less spending, lower economic output and more deflation.

Although lower interest rates and balance sheet expansion may help fuel the rise in certain classes of financial assets, the gains are not felt equally among all members of society. In fact, they are felt by a relative few -- thus driving the trend of income and wealth inequality, which has been growing.

Should the powers that be even be pursuing an inflationary course? That's the real question. In their minds, have they substituted inflation for growth? In a purely mathematical sense, money times the velocity of money (MxV) equals nominal GDP. You can make the economy look like it's growing faster when all you do is drive up prices. But that's not growth. Real growth is measured in output, so the equation becomes MV=PT, where T is total output of goods and services. Therefore, T equals MV/P. This equation removes inflation as a factor.

This can only be achieved through increases in real production or real output. If you leave this up to the private sector then the private sector has to spend and invest more. Doing this would induce the production of more goods and services.

However, the private sector can only spend whatever income it has. Beyond that, it can spend by taking on debt. The other option is for exports to increase -- meaning foreigners (the foreign sector) spend more. But traditionally, the U.S. has been the world's big spender (importer), while other nations tend to be net savers (exporters).

So the private domestic sector can increase debt levels if it wants to increase spending. This is possible -- except for the sticky problems of confidence and income that I mentioned earlier.

On the other hand, the government sector can spend more. It can buy more of the goods and services (like healthcare) that the private sector produces. It can invest more in roads and bridges and other infrastructure projects, and it can pay more to people by hiring or providing job guarantees. That's where policy has failed. By hindering the ability of the government to spend more -- in essence by forcing austerity -- we are stuck spinning our wheels, or worse, caught in a deflationary spiral.

There's no way out, unless political will shifts. Monetary policy cannot do this and governments are captive to the interests of those who are benefiting from current monetary policy. The economy will become unequal to the point where it shuts down again, and then the spiral will start all over. We are all trapped by beliefs that no longer apply to the world we live in. And that's a shame.

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