The Deflation Story Is That There's No Deflation

The philosopher Confucius long ago observed that "When words lose their meaning, people will lose their liberty." Though he probably wasn't thinking in economic terms at the time, it's easy to apply his point about false definitions to the alleged deflation discussion at present.

Never has a word's real meaning been so perverted.

True deflation is monetary, and it reveals itself through the rise of a currency price from a stable, non-inflationary level. But since currencies presently lack any definition due to the absence of policy that is floating money values, deflation, inflation, or money price stability can't be understood or confirmed through the measurement of undefined currencies against other undefined currencies.

That's why we use gold. Love it or hate it, it's been used as a money measure for thousands of years precisely because the commodity itself is in the words of John Stuart Mill, "least influenced by any of the causes which produce fluctuations of value." Gold is the constant, and when its price moves it's a function of the currency in which it's priced changing in value as opposed to the metal itself fluctuating.

This is important considering an argument recently made by a financial commentator who goes by the name Curious Capitalist. He argues that "The surging dollar is a clear sign that inflation is not the concern of global investors." If only inflation were quiescent.

More realistically, the surge this person describes is the dollar's rise against other, undefined currencies. And it really tells us nothing about inflation or deflation.  Not asked is whether the dollar is presently the strongest of a lot of strong currencies, or merely the least weak of a lot of weak currencies? Gold, as it will soon become apparent, tells us that the dollar's illusory strength is solely a function of even greater non-dollar weakness.

Right now the gold price is signaling an ongoing run on paper currencies of all shapes and sizes that is by definition inflationary. Since 2001 the dollar price of gold has skyrocketed over 400%, and during much of the period in question, the dollar's extreme weakness obscured the fact that all paper currencies were in decline.

Since December of last year, the dollar has surely surged against other currencies as Curious notes, but in gold terms it has fallen, albeit less than other currencies. Over that timeframe the price of gold in dollars has risen 4%, in yen 12%, and in Euros, over 24%. Deflation results when currencies rise from a long-term stable level against gold, and with all currencies in decline versus the yellow metal, suggestions of dollar deflation speak to a gross misunderstanding of the word itself. The dollar is only strong insofar as the currencies it's being measured against are very weak. This is an important distinction.

The Wall Street Journal's Kelly Evans defines deflation through prices while ignoring currency values altogether. She suggested in a column this week that a subdued Producer Price Index would likely "reinforce the views of Fed members who still consider deflation a greater threat than inflation." Her view too is that deflation, not inflation, is the dilemma.

The problem there is that prices move for all manner of reasons, and unless money values are the driver, price movements themselves by definition cannot change the broad price level that some use to divine inflation or deflation. Considering producer prices, they could be falling due to productivity enhancements that have lowered the cost of production, the still uncertain economy's continued liquidation could be another factor, or it's possible that enhanced global trade itself is moderating pricing pressures thanks to the inflow of production inputs from locales where they're most cheaply made.

Notably, none of the above is deflationary. If production costs are declining, that simply expands the range of goods producers can access, thus driving the prices of other, formerly inaccessible goods, up. As Mill put it, "a general rise or a general fall of values is a contradiction", and any change in the price level is the result of an "alteration in the value of money." With the value of money in decline it's once again apparent that we're inflating, thus raising the question of how much lower producer prices might be if the dollar were strong and stable.

Of course some define deflation as a function of government parsimony. USA Today's David Lynch wrote this week that the public debt crisis in Europe could lead to "a protracted period of austerity" that will "siphon demand from a eurozone economy" on the way to a "dangerous malady" that he sees as deflationary. Lynch's definition perhaps confuses deflation's true meaning the most.

To see why we must remember Mill's essential point that "no act of saving ever detracts from demand." In this case, European governments can only spend to the extent that they confiscate money from the private sector. If the governments there spend less, demand will simply be shifted back to the private sector where it belongs. Not only does Lynch mis-define deflation's causes, but assuming a correct definition of deflation on his part, it would not be deflationary per his very definition.

And what about the "asset deflation" that some reference as evidence of actual deflation? This speaks to poor analysis and incorrect defining. As the last four decades show, equities tend to decline (the ‘70s, the decade just passed) when we devalue money, and they tend to rise (the ‘80s and ‘90s) when currencies are strong. No surprise here considering capital usually goes into hiding and away from investment opportunities when money is debased.

In the end it can't be stressed enough that deflation is but one thing: a powerful rise in the value of the dollar versus gold. And with gold at all-time highs presently, we're nowhere near deflationary territory.

Back to Confucius, he had a point about individuals losing their liberty when words lack meaning, and at least here it's economic. If the deflation worriers win what shouldn't be a debate, even greater currency devaluation will occur, and individuals will lose their liberty through enhanced inflationary theft meant to slay what doesn't exist.