Saturday, 15 December 2012

Response to Philip Pilkington on Deflation

Philip Pilkington made a post criticising the idea that price deflation is if not beneficial, then at least non-neutral from economic point of view:
This post was also reposted by Michel Bauwens with respect to his objections to Bitcoin.

It is a rehash of old fallacies, and I believed others addressed them, however I want to present a more point by point rebuttal. Before however I address the points individually, I would like to explain the three core fallacies that Pilkington makes and are typical for the proponents of inflation.

  1. The first is the assumption that money is the only liquid asset. This is not true. First of all, there are foreign monies, which are also at the top of the liquidity scale, and there are financial instruments (e.g. company shares) and some commodities (e.g. precious metals) which have a high level of liquidity too.
  2. The second is the assumption that money is capital. This is also not true. Money is information about the availability and distribution of capital, but not capital itself. Capital are the heterogeneous capital goods available on the market, which can be used for production processes. Money cannot be consumed in either a consumption or production process (even for commodity monies the industrial demand is typical a small proportion of the whole demand), nor is it a necessary component of any such process. Rather money is a decentralised method for coordinating production and consumption.
  3. The third is the conflation of cyclical changes in the quantity of money (credit cycle) with secular decreases in the price level (money with an inelastic supply) by calling both of them "deflation".

The first argument Pilkington makes is that free market leads to concentration of power. It could not be more wrong with respect to money. We now live in a system of central banking, where the state intervention all but finalised the central planning of money. The production of money through market has been subverted and taken over by the state-banking cartel. Attempts to create money privately are penalised and in the extreme case made illegal (e.g. the case of Bernard von Nothaus or e-gold).

Then Pilkington argues that the position of advocates of deflation has an emotional and not a rational basis, and that it plays on the hoarding impulse. This is based on the fallacy one. If people want to hoard, they do not need to do so using money. They can just as well hoard other liquid assets that have a less elastic supply (e.g. gold), irrespective of whether gold is or is not money. So the argument fails. Unless, of course, the state decides to confiscate these assets too. In that case, the argument is a double fail.

Pilkington also makes the argument that hoarding is not saving. This is based on the fallacy two, that money is capital. By hoarding, the capital available in the economy is unchanged, there will merely be a downward pressure on the prices.

Then he makes the claim that according to the proponents of deflation, the malinvestments are somehow "unjust", again avoiding the economic fundamentals. The malinvestments are merely disequilibria between the availability of resources and the preferences of the consumers. These are obscured by the increases in the money supply. Eventually, the disequilibrium manifests itself through a price changes, or in the extreme hypothetical case, the capital goods are consumed and people will starve to death.

Injecting new money into the economy does not affect the availability of capital goods in the economy. It only changes our evaluation of these goods, by making it appear that some productions methods are profitable, even though in real terms they are not. The "stimulus" that occurs after an injection does not mean that a productive use for the capital has been found, rather that unproductive uses were made to appear as if they were productive. It's a trick.

Then he claims that in a deflationary period resources will remain unused. This is the fallacy 3, conflating of the bust period of the credit cycle with a steady long term behaviour. The best rebuttal of this argument I know of is presented by Vladímir Krupa in his semestral thesis about a falling price level. Allow me to quote/translate:
From the point of view of profitability of businesses it is irrelevant whether the overall price level falls, rises or stagnates, as long as the businessmen are able to correctly predict future prices. If they are able to predict the prices, the real profitability will in reality be the same irrespective of the direction of the movement of the price level. [emphasis added]
In a system with an inelastic money supply (e.g. a system based on gold with fractional reserve banking banned, or a system like Bitcoin where due to its low transaction costs it is unlikely that credit will be treated as a part of the money supply), people will be accustomed to a falling price level, and will arrange their business plans accordingly. A system with a credit cycle will suffer from unpredictable changes in the prices though. But even then, the contraction must stop at the latest when the banks reach 100% reserves.

Altogether the article of Pilkington has no economic foundation, and rather mixes various ideological objections with a random selection of historical data.


  1. Very nice summary, thanks for the article!

  2. I love your blog: It's a great source of argumental ammunition.

  3. great post, do you have a feed I can subscribe to?

    1. At the bottom of the main page there should be a link for an atom feed, it says "Subscribe to: Posts (Atom)". I think you can subscribe to comments too. Let me know how it worked out for you.

  4. @Beautyon_ was wondering on twitter about my claim that money is information about availability/distribution of capital. In an earlier draft of my thesis (not present in the final version), I deal with this in a bit more detail. I begin with a critique of Mises' argument from Theory of Money and Credit that there are three types of goods, consumer goods, producer goods and media of exchange. I'll make a blog post about it later.