Like a last-minute twist in a movie, February turned out not to be the first month of deflation after all. Despite widespread predictions of the first fall in prices for half a century, the annual rate of growth in the Retail Price Index was stuck at precisely 0%. All the experts ready to warn us of how deflation was the greatest threat since the Black Death had to put their lectures on hold. But they won't go away. As more and more money is printed, we'll carry on being told that the threat of stuff getting cheaper is the real danger the global economy faces.
It's nonsense. There is nothing to fear about deflation. Indeed, it was central bankers' irrational fear of falling prices that helped land us in this mess in the first place. To start clawing its way out of the economic crisis, the world needs to learn to accept there is nothing wrong with prices dropping occasionally.
Deflation is a fairly simple phenomenon. It means prices going down a bit year on year, rather than up. Our Victorian ancestors wouldn't have found that odd. In the 19th century, according to statistics published by the House of Commons library, prices went up some years, then down in others. In 1854, for example, prices rose by 15%, then fell by 8.4% in 1858. The net result was that in 1914, prices were roughly the same as they had been a century earlier. By contrast, prices have risen every year since 1945, making an aggregate rise of 22 times.
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Most people might think stable or falling prices sound quite good. A whole army of economists, however, keeps telling us how terrible it is. But on close examination, it turns out that most of the arguments against it are remarkably threadbare. We are told that it will hurt the economy because people will postpone spending decisions. Why buy that sofa today if it will be cheaper in six months' time? Demand will collapse, and people will be thrown out of jobs. But this isn't really true. If it was, we wouldn't have a computer or electronics industry. Both are subject to savage price deflation, and yet are among the most innovative and fastest-growing businesses in the world. People know they can buy a better and cheaper PC in six months' time. But they really want one right now. Quite quickly a balance is struck.
True, deflation is bad for people who've borrowed lots of money. The debt stays the same while their income may fall. That hurts. But they could always try working a bit harder, and paying back their debts honestly, rather than letting inflation do the job for them.
Then there's the upside of deflation, about which we hear remarkably little. It's good for savers, who find themselves getting magically richer year on year rather than poorer. It may well have a positive impact on consumption as well, despite what we are told. After all, if you reckon that falling prices will make you slightly richer next year, why not spend a bit more now? In truth, deflation, like any other economic event, is fairly neutral. It has winners and losers. It gets a bad press largely because the losers are a lot more powerful than the winners.
Deflation is bad news for the heads of big firms. As long as there's some inflation out there, they can push prices upwards, and keep profits growing without doing much. They can even slip through stealth pay cuts for staff by increasing their wages at slightly less than the inflation rate. With deflation, none of that is possible. It's even worse for the City. One of the main ways the financial industry makes money is through inflation. Without it, private-equity firms would be finished. So would most hedge funds (who rely just as much on debt). Inflation usually means savers the customers, that is get clobbered, while borrowers City institutions get rich. And, of course, it's great for the government. It gets stealth tax rises (by leaving thresholds where they are). And it sees its vast debts quickly wiped out. Deflation would hammer the chancellor of the exchequer before anyone else.
Lined up against this mob of vested interests, the people who benefit from deflation mostly small savers and ordinary consumers are far less powerful. But that doesn't mean they should be ignored. Indeed, as I've said, fighting deflation is one of the ways we got into this mess. The past decade should have been a period of gradually falling prices. Globalisation, and particularly the integration of India and China into the developed economy, put a lot of downward pressure on costs. So did technological change: computers have made lots of things cheaper to produce. In Britain's case, the strong pound was another factor with everything we import getting cheaper, prices on the high street should have been falling. Overall, prices by 2007 should have been 5% or so lower than in 1997.
But central banks fought that. In thrall to a paranoid fear of deflation, they kept printing more and more money to stave it off. They succeeded. The price, however, was a huge asset-price bubble. Now that it has burst, the world has been plunged into recession. It would have been far better to accept a short period of deflation, ignoring the industrialists and financiers who warned it would lead to catastrophe. And you know what? We should ignore them this time too.
Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years.
He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.
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