The benefits of deflation

In this guest post, Leo Mattes explores the benefits of deflation and argues that reducing prices through technological progress and improved productivity can contribute to economic stability and equity in the long term.

Who benefits from deflation?

Why is everything getting more and more expensive? Why are living costs, rents, food prices, travel costs rising? Are rising prices signs of an advanced society? How do you know how much you need to save so that you have enough on your side in old age or in a crisis situation? How can you achieve greater security and a better financial situation despite the circumstances?

Shouldn't prices fall or at least stay the same as a result of technological progress? What would a world look like in which prices fall in the long term? Shouldn't saving create more security instead of uncertainty? Let's get to the bottom of it below.

What are inflation and deflation?

When we talk about inflation and deflation, there are different definitions and causes. On the one hand, we speak of inflation when money supply is expanding and deflation when money supply is declining. Instead of describing the money supply, however, we can also think about the price level. When this rises, we speak colloquially of inflation; when this falls, we speak of deflation.

The economic theory of the Austrian School makes a strict distinction between the monetary phenomena of changes in the money supply and the effects of changes in productivity.

What are the effects of inflation?

Before we look at the common criticism of deflation, let's look at the effects of inflation. The expansion of the money supply has redistributive effects. Whoever receives the new monetary units first benefits the most, because market prices are still at a level that was set by the previous money supply. However, the scarcity of resources is not changed by an expansion of the money supply and therefore no new prosperity is created, but only a redistribution of previous wealth.

However, rising prices must not only be caused by an expansion of the money supply, because rising prices can also be the result of higher demand or lower production and thus a shortage of supply. Reasons for sharp price increases can include hypes, natural disasters, crop failures, armed conflicts or social disruptions. The resulting high prices give entrepreneurs and producers the signal to produce more, as there are profit opportunities. By increasing production, the needs of more people can be met. Prices and a functioning monetary system are the basis for functioning control loops and for dynamic adjustment processes in our society.

What is the common criticism of deflation?

Economists argue that deflation is much worse than inflation. What are the effects of a scarce money supply and falling prices?

As a result of a scarce supply of money, there is no longer a redistribution of wealth at the expense of the final recipients. This also has the advantage that the prices of products and services do not change as a result of the money supply, but only as a result of people's supply and demand. Entrepreneurs and producers receive more precise signals as to where an investment could or could not be worthwhile. Production processes can adapt more dynamically and effectively to people's needs and the prosperity and satisfaction of society increases.

As a result of constant competition between companies, they are striving to reduce manufacturing costs and increase productivity. Competition is about who can best serve the customer. The reward is a win. As a result of these competitive forces, investments are being made in innovations and optimizations. The use of new technologies often results in sudden increases in productivity, which ultimately result in lower prices for end customers.

Falling prices have obvious advantages for customers and for companies they send the signal that other projects may prove to be more worthwhile and that their resources can therefore be used more profitably elsewhere. Both rising and falling prices are important information for entrepreneurial activity and promote control loops for optimal resource allocation.

Continuous deflation due to technological progress is a characteristic of an advanced society, while constant inflation indicates that a society is doing something fundamentally wrong — either through expansion of money supply or through steadily declining productivity.

But why is deflation criticized and feared by economists?

Some economists criticize deflation because they fear the so-called deflationary spiral. According to these, it could arise when people spend less and less money due to falling prices, as saving is becoming more and more worthwhile due to falling prices. As a result, the turnover of companies would fall and unemployment due to insolvencies would be the result.

But this is an assessment that does not take the control loops into account. No one is going to delay consumption forever. At the latest when it comes to not starving to death, people will want to exchange their savings. When a company's products and services are no longer in demand, this is the result of people's free choices. The existence of companies is not an end in itself; they must serve people so that they can continue to exist. People's demand is therefore a constant judgement of the usefulness of the goods and services offered. There is nothing economically wrong with a society in which people only consume carefully and in which saving is worthwhile.

Are economists therefore wrong?

We currently live in a credit money system that depends on everyone, and in particular companies, repaying their loans. Overall, this system is also dependent on an increasing money supply, as interest on the loans is paid and must come from somewhere. A fall in the price level in a credit money system means that loans are increasingly defaulting due to falling nominal sales and profits. A credit money system is therefore similar to a pyramid scheme, which either has to continue to grow compulsively or collapses. Economists therefore argue against a short-term collapse, but for compulsive growth, because they regard this as the lesser evil in the short term. In the short term, ending path dependency is of course painful, but the continuation of the expansion of credit money supply and the resulting redistributions also end in a painful situation in the long term.

Economists would be well advised to describe the two options simply as taking a position on continuing path dependency. This is because this plays off the deflationary spiral in the credit money system against the redistribution of wealth. But we already know that a credit money system cannot exist in the long term.

For the individual, the question is therefore how to protect themselves from the redistributive effects and how they can best switch to a monetary system without expanding the money supply.

Falling prices for the individual

Every individual is born into a monetary and economic system and has the opportunity to improve their living conditions through their actions. Your own worldview is fundamental, as every decision has a consequence. In order for individuals to be able to increase their standard of living, it makes sense to look at the world from a perspective that will benefit them in the long term.

Both savings processes and the productivity gains of technological progress should improve individuals' living conditions, because the value of a monetary unit should be maintained or even increased as a result.

An inflationary unit of calculation has the disadvantages that prices are constantly rising and savings are constantly losing value. However, the individual benefits from choosing a unit of calculation for themselves in which prices tend to fall. This is the only way to make austerity worthwhile and to increase prosperity and the future. By choosing a unit of calculation whose money supply cannot be increased at will, the individual can make himself independent of a monetary policy and avoid the redistributive effects of inflation.

Deflation as a Schelling point in a society

The choice of a deflationary view or a deflationary system offers the individual the opportunity to improve their life themselves and to reduce dependence on external circumstances. The more people understand the benefits of deflation and adjust their actions accordingly, the more the entire economic system changes. A deflationary monetary system is a fast moving point, as every individual willing to learn comes to the conclusion for themselves that deflation is better than inflation.

A progressive society, which consists of independent and long-term oriented people, is bound to synchronize itself with a monetary system with a scarce supply of money, and inflationary systems are increasingly losing influence and importance.

About the author

Leo Mattes

Leo Mattes is a technology manager and deals intensively with the topics of praxeology, deflation, decentralization and Bitcoin. With his project FixYourMoney he showcases the change of perspective from an inflationary to a deflationary world.

Disclaimer: The views and information expressed in the guest contributions should not be interpreted as financial advice. It is important to note that Coinfinity does not necessarily represent the same positions and views as in the content provided here.