Roger recently posted in comments that deflation was bound to continue for “the next 2-3 year period.” His argument referenced a number of different sources and pulls in a lot of complex theories. I feel that it would be best to analyze these points one by one because these are the same points that get tossed around by people on a daily basis. I figure that doing so will take three different posts in a series where I explore economic myths. In so doing I’m going to provide a lot of definitions that are slightly different from the definitions that we here economics spouting. You will find that my explanations provide a great deal of clarity and reduce the situation to mere common sense.
Let’s start with what wealth is. Wealth is a stock of assets. Assets are, for the most part, unconsumed economic goods. We traditionally think of wealth in terms of money and, back in the days of the gold standard, money was itself an unconsumed economic good. However today our modern money has been technically divorced from economic goods and services. It’s not a complete divorce because we can still use Federal Reserve Notes to pay for things. But the rate of exchange between money and good and services fluctuates from day to day. If we ever found that we could not exchange US Dollars for goods then we would cease to desire them at all and someone who had a lot of them would not be considered rich. This proves my point about wealth. If someone has a mass of things that either are unconsumed/functional economic goods (i.e. real estate, a car, a storehouse of fine wines) or things that are immediately convertible into such (money) then we would consider him wealthy provided that he did not also have debts that exceeded his assets.
Which brings us to the next question, what is a debt? A debt is a future promise to pay. That which must be paid is, again, a representation of an unconsumed economic good. If we held bonds that were denominated in a currency that was no longer able to be converted into an economic good, then we would consider those bonds worthless. Yes, debts tend to be denominated in a currency, but the debt is only valuable to the extent that it is convertible to a economic good or service. Now let’s look at the definition of credit. By these terms credit is simply the acceptance of present goods from a lender in exchange for the payment of goods in the future back to that lender. Therefore credit is present goods for future goods.
Now in modern societies we have traditionally dealt with assets, debts, and credit in terms of a money. As I said, if the money in question were itself an unconsumed economic good such a silver or gold then all the definitions I have given would work perfectly. However that’s not the world we live in. Instead today we live in the land of fiat money, and that’s where things get confusing. Few things could be more confusing than our present situation whereby we have one group of people arguing that the dollar is going to lose purchasing power and another that the dollar will actually gain it.
At the root of the problem lies the myth of the consumer economy. If we revert back to our classic definitions, we see that to consume one must produce. After all, where can one get the goods to consume unless one has produced something. Sure, one can borrow the goods to consume but, as we see from our definition of credit, one must repay those goods in the future. Stated another way, we are borrowing today from someone else’s production but are promising them to repay them out of our future production.
Looking at things in these terms, it is obvious that we can not drive an economy through consumption. Only production is the key to economic growth. How we got so turned around was that the United States ended up with the ability to print almost limitless amounts of money and have the rest of the world accept that money in trade for their goods. It worked for a while. Foreign countries enjoyed booms as they built factories to produce goods to send them to us and we grew fat from consuming without having to produce. What could be better?
But logically this situation must come to an end. That is what we are seeing today. The United States must embrace production once again. There is no alternative. As long as the powers that be try to keep the myth of the consumer driven economy going, they are just going to drag this economic crisis on longer. The more Washington goes into debt in order to “stimulate” consumption, the more of a hole they are digging for all of us.
America was going to end up here, pure and simple. America experiment of trying to replace production with consumption as a method for economic growth, was doomed from the start. Nothing could stop us from coming here. Paul Krugman’s notions that we could have continued down this path forever if only we had enough regulation and oversight to stop the reckless lending is pure nonsense. It is, as he puts it, “a matter of simply arithmetic.” Credit expansions must eventually come to an end because at some point the consumer can no long afford to borrow because he has no future production left to divert to creditors.
In my next blog, we’ll take a closer look at Roger’s argument that massive amounts of US Dollar debt must fuel an accelerated demand for US Dollars.