What Keynesian economists which infest our academia and government express concerns about “deflation”, they actually mean “prices will go down!” Generally, critics have two main concerns about these “deflationary” prices :

• Workers being outraged at nominal wages falling.
• Lack of growth from savers hoarding appreciating cash / currency instead of investing.

But before addressing those specific cases, let’s establish a basic understanding of how prices function.

Price Basics: Falling Prices Are Natural

Imagine a simple item in a competitive marketplace — let’s say a toothbrush. Now assume every year this toothbrush gets a little bit easier to produce. Perhaps machines get a little bit better at manufacturing, or supply chains get slightly more efficient, etc. If our consumer demand doesn’t change, what should happen to the price? It should decrease.

This should not come as a surprise. Free markets cause product prices to fall as industry becomes more productive and competitors fight for consumers with the lowest possible prices. This is a process that has been happening for thousands of years as humans apply their ingenuity to fulfilling the wants and needs of others.

Do prices always decrease? Certainly not! Plenty of common occurrences that hamper production or spike demand can cause price increases. My point is simply that on long time-frames, as humans invest their labor into becoming more productive, items that were once difficult and expensive become cheap and easy to produce. Thus decreasing prices are natural and intuitive.

Despite this understanding, for decades prices for basic consumer goods have increased and quality decreased. This is because increased productivity requires a constant monetary base to be felt through prices. Money is the unit that measures this process. In a monetary measuring system with a constant base (like Gold or Bitcoin), increased productivity will translate to decreased prices. However, if the monetary measuring stick is tampered with (i.e. printing presses), then prices will increase year after year despite massive increases in productivity.

With this theoretical understanding, let’s turn to the specific instances critics are concerned about.

Concern 1: Decreasing Nominal Wages

Critics are concerned that falling consumer prices under a Gold or Bitcoin standard will spill over to workers wages, leaving workers frustrated and demoralized. The problem is critics forget what wages represent — human time. With a toothbrush, it’s natural that technological advances make them easier to produce each day, but human time is different. It is truly scarce and irreplaceable. While one type of work may be automated, a new role opens up from other advances. Jobs are not finite. Thus, while the price of a toothbrush should be expected to fall with a constant monetary supply, there is no reason to think the same with the price of human time.

Let’s look at data points on this. Below is a chart for prices in America over the 1800s.³

As you can see, this was an era with rapidly falling prices. So, what happened to wages? They went up. The Bureau of Labor Statistics noted:

“overall the trend of money wages were upward, and the movement of the cost of living was downward. These divergent movements of wages and retail prices combined to produce a substantial rise in real wages.”

This dramatic rise is all despite a labor supply that multiplied almost 10x from the beginning of the century and a brutal civil war, devastating economies and killing hundreds of thousands.

Now, you may be tempted to argue that prices fell so dramatically because America was young and being developed for the first time, but we can see the same action occurring in the technology sector today. Prices for electronics have been falling for decades, yet companies still manage to pay employees competitive wages. So, it’s certainly possible that even when prices are naturally falling from increased productivity that the cost of labor could stay the same or even go up.

But if the critics fears come true and wages do go down nominally, what matters is purchasing power. To say workers will get upset despite being able to purchase larger amounts of higher quality goods treats them like children unable to do basic arithmetic.

In comparison, inflationary money loses its value every year, leaving the average person without a safe place to store their savings while the wealthy profit off financial assets. This is especially painful given the phenomenon of “sticky wages”. Below is a chart demonstrating a complete decoupling of productivity and compensation that cleanly lines up with leaving the last remnants of a sound money.

The trends shown above lead to predictably dire outcomes — serious and increasing levels of income inequality, populism and social unrest. If critics were truly concerned about workers, they would support Gold and Bitcoin as a savings technology for the average citizen to protect their savings from involuntary silent dilution.

Concern 2: Stagnant growth from decreased investment or spending

Critics worry that sound will create a stagnant economy as people hoard appreciating money rather than invest in businesses.

This shift will actually promote better investments! Due to inflation, high net worth individuals and financial institutions are forced to harbor their money into speculative ventures just to protect themselves from inflation’s decay. With bitcoin functioning as a storage vehicle that cannot be diluted, the manic hunt for a “risk-free” safety from inflation will be a thing of the past, leading to more accurate and measured investment decisions.

But what about spending when prices are decreasing? Will people spend less and slow growth? Let’s look at the research. Even the Federal Reserve concluded:

“what is striking is that nearly 90% of the episodes with [deflationary prices] did not have depression. In a broad historical context, beyond the Great Depression, the notion that [deflationary prices] and depression are linked virtually disappears.”

This makes intuitive sense as well. Decreasing prices do not mean people are suddenly going to stop spending! People still have needs and will spend their money to meet those needs. This holds for non-essential goods as well. The technology industry has experienced a profound deflationary trend in prices for decades, but consumers keep lining up for new releases.

In fact, we should expect people to spend more as prices drop due to the wealth effect of feeling their purchasing power increase — consumers love seeing prices go down. There’s a reason everything in supermarkets is perpetually “on sale”.

Conclusion

As we have stated time and again at the ILR, deflation is a good thing, not a bad thing. Please refer to our Resources page for more information.