Which Flation Will Get Us?
Gary North
Saturday, Sept 5, 2009

One of them will. That’s if things work out really well. Two or three will if things go according to the Austrian theory of the business cycle.

Americans have been living in the eye of the monetary hurricane. Prices have been stable. In July, both the Consumer Price Index and the Median CPI were flat compared to June.

There are five flations to consider.

Deflation
Inflation
Stagflation
Mass inflation
Hyperinflation

We had better consider all of them.

FLATION: MONETARY OR PRICE?

We should always keep in mind the fact that there are two ways to define flation: (1) as a change in the money supply; (2) as a change in the price level.

This assumes two more things: (1) we can accurately define money; (2) we can accurately identify the price level. Both are questionable.

The Federal Reserve three years ago dropped M3. It said that M3 was useless as an indicator of future prices. That was a long time coming. The FED was correct. M3 was the most misleading of these M’s: M1, M2, M3, MZM. It always vastly overstated the looming rise in the CPI. There is no doubt which M is best in this regard: M1. For my detailed Remnant Review article on this, go here.


Furthermore, there is more to an M than predicting future consumer prices. There is also the question of predicting the business cycle. There is no agreement here among economists.

Then there is the price level. Which basket of goods and services should statisticians use? What relevance should a statistician place on any of a hundred commodities and services? This weighing will change when consumer tastes change. No index survives intact over time. They all are revised when there are major changes, from the CPI to the Dow Jones averages.

I look for trends. I use M1 and the Median CPI.

The crucial fact is monetary policy. According to the Austrian theory of the business cycle, the cycle is completely the outcome of prior central bank monetary policy. Booms and busts are the result of central bank monetary inflation, followed by reduced expansion. The other schools of thought reject this theory. The other schools of thought are wrong. For an introduction to this issue, see Chapter 5 of my mini-book, Mises on Money.

DEFLATION

Most of those who forecast deflation have in mind price deflation. A few think monetary deflation will take place because of bankrupt banks, but the position is difficult to defend. The FDIC can keep bank doors open. There are no runs on banks involving currency withdrawal. There are only runs involving the transfer of digital money to other banks. This does not affect the money supply.

Price deflation can come through the free market. It results from steady increases in economic output in an economy with stable money. Here is my slogan: “More goods chasing the same amount of money.â€