In the Inflation vs. Deflation debate, Gary North has come up with this grabber-of-a- headline: “If Deflation Is Coming, Sell Your Gold,” he writes at LewRockwell.com. If North is trying to scare deflationists into abandoning their arguments, giving banner play to such bad advice should only make them snicker and hoot. For in fact, deflation is already here in spades, in the form of a financial implosion that has wiped at least $80 trillion dollars worth of “wealth” from the world’s books. And in the midst of this, of course, gold has performed superbly for investors.
North would ignore these facts to argue that no deflation has occurred, technically speaking. He points out that the money supply in the form of excess bank reserves has actually doubled recently, as indeed it has. But the supposed robustness of M1, M2 and M3 will be scant consolation to investors who have seen their net worth evaporate by 30% to 50% or more in the last year or so. It will also not cheer the hundreds of millions of homeowners and investors who are getting crushed by the main symptom of the deflation that North says does not exist – i.e., an increase in the real burden of debt.
A Helicopter Ben Believer
North’s arguments represent monetarism’s last stand. A True Believer in the inflationist creed of Helicopter Ben, he is one of those guys who has been arguing for decades that, if deflation were to threaten, They would not let it happen. In fact, deflation has not only happened, it has completely overwhelmed the central banks’ collective ability to pump even a dime’s worth of inflation into the real estate market, or to stimulate a mere ripple of new borrowing. We always thought North was smarter than the “They-would-never-let-it-happen” crowd, but apparently not. It would appear that he is just another die-hard monetarist who sees the world through economic blinders. As such, he has been unable to fathom that, for a few brief years, just about any type of asset that could generate a stream of income, or appear to appreciate in value, was a fungible source of new money.
North seems all but certain that a monetary expansion lies ahead, a consequence of the Fed’s new policy of paying interest (of 0.1%) on reserves that it holds from banks. “The banks are losing money hand over fist,” he notes, “because they have to pay depositors a rate of interest, and they are not lending the money at the FED at a higher rate of interest. So, they cannot make any profit on the difference between the interest rate to the borrower and the interest rate to the depositor.”North does not acknowledge that the banks might prefer to lose a little bit on the spread in order to keep their money “safe,” rather than lend it for whatever purposes. (And it is only a relative pittance in opportunity cost that will be lost, since, as readers will have noticed, the banks are not exactly paying generous returns on customer deposits right now.)
New, Improved Bank Failures?
North is similarly unpersuasive when he asserts that banks are no longer allowed to fail in a way that removes money from the system, as occurred during the 1930s. The money is simply moved to another bank, he notes. We say, what money? Merge Citi with another bank and you have not preserved anything of value; rather, you have saddled the new owner with liabilities that are hundreds of times as large as whatever assets Citi is said to have passed on.
We’ll go a step further and reject the implication that U.S. money itself is an asset; in reality, and as North must know, the money in the banks comprises worthless IOUs – Federal Reserve Notes printed by the U.S. Treasury. Moreover, this digital money might just as well have been erased from the Fed’s hard drive, for all the success it has achieved in promoting inflation. North is the first guy we’d have expected to acknowledge that the banks in which the money supply supposedly resides are themselves hollow shells. To say that these banks have not been allowed to fail is to ignore the fact that they already have failed. Their imminent nationalization might fool North’s followers into believing the banks’ assets had been preserved, but by whom? A bankrupt U.S. Government?
Lend to Whom, and for What?
An even bigger hole in North’s argument is the notion that banks will have to start lending when a recovery begins. To whom, we would ask? And for what purpose? And on what collateral? These are crucial concerns, and it is dumbfounding that so astute an observer as North has evidently failed to consider them. Even the mainstream press has belatedly caught onto the fact that the mere availability of credit does not necessarily create eager borrowers. People need to believe they can get rich by borrowing rather than by saving in order for money velocity to multiply banking reserves significantly. But North, for whatever reason, has not even mentioned money velocity in his essay.
He issues this challenge: “If somebody is predicting serious price deflation or serious price inflation, make that person answer this question: ‘Under your scenario, what is the relationship among the monetary base, the money supply, and prices?’ Our answer is, Who cares? As long as the implosion of debt continues to suffocate the global economy, and to crush borrowers, we are experiencing deflation. End of argument. “Then ask this,” North continues: “When the banks pull their money out of the FED when the economy revives or else they are going bust because of interest paid to depositors, and when that money gets to the general public, what will be the result: price inflation or price deflation? Make certain that these are the two issues that the person who predicts either serious price inflation or serious price deflation deals with in print. If you don’t understand his answer, you can be pretty sure that he doesn’t, either.”
Here’s a simple answer: The economy isn’t going to revive – at least, not sufficiently to trigger inflation beyond the grocery store. North is being devious when he says that money pulled out of the Fed will somehow “get” to the general public. In fact, it will only “get” to the public in such quantities as individuals are eager to borrow. The grim reality is that it could be another 50 years before the public is so very eager to borrow as it was when all the borrowing in the world barely sustained 3% GDP growth.
North, always one of our favorite pessimists, appears to have abandoned his dark view of the economy to stand logic on its head. Forget about inflation, Gary. The Second Great Depression is upon us, and it threatens to become even deeper and more prolonged than the first. Under the circumstances, the banks are not likely to experience a surge in the demand for credit, other than from businesses and borrowers about to drop dead without it. Are we to believe that such borrowing could possibly trigger off inflation? North might, since he ends his essay by offering the following bet: “What I am saying is this: prices are more likely to rise by 10% or more for three consecutive years than fall by 5% for three consecutive years. I will up the ante. They are more likely to rise by 20% than fall by 5% for three consecutive years.”
A Losing Bet
By our reckoning, he has already lost this bet, since our price index comprises just one item: real estate. North take pains to explain why no price index, let alone one that tracks only home prices, can hope to provide a true picture of inflation or deflation. We’ll concede the point about inflation indexes in general, but we believe nonetheless that a housing price index is as useful and informative as we could ask for at present, since it is an absolutely crucial component of the bottom line for so many of America’s 80 million homeowners.
North argues that falling home prices do not create deflation, nor rising home prices inflation, simply because neither causes the money supply to change. But consider this: Until a couple of years ago, rising home prices were inarguably a mainstay of money supply growth, allowing homeowners to harvest spendable cash that might just as well have come from trees in their back yards. And now, although the collapse of home prices may not have diminished bank reserves, it has all but extinguished the desire of borrowers to multiply those reserves into quantities that would be inflationary. Monetarists can continue to ignore this, insisting that inflation/deflation is simply an increase/decrease in the money supply, but this is just academic poppycock that is blind to what is going on in our economic lives. If it walks like deflation, and quacks like deflation, it is deflation.
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