Recently, I responded here to an essay by Reality Check’s Gary North that asserted deflation was all but impossible. I have long maintained the opposite – that a ruinous deflation is not merely possible, but inevitable. My comments elicited some interesting e-mail, including a strident argument from my friend Jas Jain, a hard-core deflationist like me. Here’s Jas, responding to some of North’s arguments that appeared here earlier:

Gary North: Let us start with a fundamental economic principle, one which I have been using since 1963: It is cheaper for a fractional reserve bank to create unbacked fiat money than it is for individuals to create wealth. Computerization has made money creation a lot easier than it was in 1963. There is also a fundamental political principle: Incumbents will accept "a little inflation" rather than be defeated at the next election because of a recession. Are there any doubts about these two principles on your part? You don't need any further theoretical arguments for further inflation.  These two are sufficient.”

Jas Jain: Recessions and depressions can and do happen during inflationary periods. In the late 1920s, for instance, at the height of The Roaring Twenties boom, the U.S. experienced a period of sustained deflation. The incumbent Republicans won an easy victory in the election of 1928, with solid majorities in both houses of Congress. And by the way, we had a fractional reserve bank system at the time, along with a Federal Reserve "system". Are you suggesting that we are in some kind of a New Era? I hope not.

I am also puzzled that, in your lengthy essay, you never once mentioned the main cause of deflation: over-financing. It has been the cause of all U.S. deflations, and there is no reason to assume things will be different this time. Have you not noticed the over-financing that has been going on in the U.S.? The main source of it here and in the U.K. lies in the housing sector, and I can guarantee you that there will be serious deflation in home prices as a result. In the meanwhile, builders are doing one heck of a job ensuring that houses are in egregious oversupply, building them at twice the rate of new household formations.

Some who don’t know their history are saying that manipulating yields lower can always reinflate a housing boom. But consider the experience of Southern California after a housing boom there peaked in March 1990. Over the next 42 months, yields on 10-year Treasurys dropped by 3.5% -- yet, housing prices kept dropping with the interest rates. The current housing bubble in the U.S., when it finally bursts, will not be stopped by a drop in rates even if they fall to zero! Why?  Because the collapse will be caused by a combination of vast oversupply and exorbitant prices. Oh, and by the way: Real estate prices in Japan fell for 13 consecutive years despite falling rates that approached zero.

I should also point out that no one, including the geniuses at the Fed, can guarantee "a little” inflation? Jimmy Carter lost during an inflationary recession. Bush I lost following an inflationary recession from which the recovery was slow. And more recently, the Japanese incumbent won by a landslide with the country in the throes of a protracted deflation. Has that country lacked the means to inflate?

GN: For as long as the central banks of the world are allowed to monetize assets without political restraint, deflation is not a threat.

Jas: Was the central bank of Japan not “allowed to monetize assets”? How much money do you think the Japanese have “printed” in the last 15 years? Do you actually think that politicians and their lackeys at the Fed can control the economy, prohibiting recessions as they please, and controlling the inflation rate?  Even the Communists’ all-powerful central planners couldn’t do that. Why do you have so much faith that our government can? What’s to stop our government, and the Fed, from screwing up? Believe me, when they do -- and it is not a question of if, only of when – I can guarantee you that they will screw up Big Time. And then, we’ll have deflation even though our leaders do not wish one.

Before you say the Fed would not “allow” a major depression or a deflation, you had better read what learned folks said about the "power of the Treasury Secretary" before 1873, and about the "power of the Federal Reserve" before 1930.

GN: A complete bank payments gridlock is a terrible but inherently unpredictable threat, but that's not what deflationists are predicting.  A bank payments gridlock would mean that no one could subscribe to newsletters. That would bankrupt all publishers.  This would mean that existing subscribers would not be sent the promised newsletters.  No

deflationist dares to put that in his subscription offer!”

JJ: You seem not to have considered that in addition to factors of supply and demand, the psychology of businesses and consumers plays a big role in bringing about inflation or deflation. What if consumers turn cautious after the housing bubble bursts? Or do you actually believe that Bernanke would not “allow” home prices to fall?

GN: There has not been price deflation in the United States since 1933. The money supply keeps growing.  Prices keep rising.

JJ: Nonsense. There have been three episodes of price deflation since 1933, the most recent of which occurred in 1955. How could you not know this if you are so passionate about the subject? I will be happy to offer you a wager that there will be price deflation during the period 2006-08.