Why prices no longer speak the truth
By
Bill Bonner Feb 26, 2010
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Poor Ms Cosgrove. The Florida woman wrecked her car in 1976. While driving under the Brooklyn Bridge, a tarp filled with rainwater fell on it. Then, she lost the $17,500 compensation cheque from the insurer.
Her luck seemed to change last week – 33 years later. She found the cheque in a drawer. But now she discovers two disagreeable things at once: that the private sector is unreliable and the public sector is untrustworthy. Her insurance company has gone out of business, and the government has taken more than two-thirds off the value of her claim cheque. It would be worth barely $5,000 – if she were able to cash it.
What follows is a brief reverie on the way credits go bad. There are accidents. There are mistakes. There are acts of God and acts of parliament. We suspect that the world's savers and investors are about to follow Ms Cosgrove – losing money due to bad luck, bad judgment, bad management and bad policy decisions. We leave God to explain His own acts, if He cares to. Our attention is on Ms Cosgrove's claim cheque.
In a properly functioning economy, prices go up and down. Rising prices suggest scarcity, signalling to consumers that they should switch to substitutes. And they tell producers to get on the ball and stock the shelves with new supply. Falling prices send the opposite message: cutting profit margins and telling producers to hold off.
Here on the back page, when we go into a liquor store and find lower prices, we're delighted. We stock up. But we're clearly out of step with mainstream economists. Most economists think they can fine-tune the economy by forcing prices upward. Their beef with falling prices is that they trigger what Keynes described as a "propensity to save". Consumers see lower prices, he theorised; they then delay spending in the hopes of a better price. Demand falls, incomes go down. And you have a depression on your hands.
"Unfortunately, most historians and economists are conditioned to believe that steadily and sharply falling prices must result in depression," says Murray Rothbard in his History of Money and Banking in the United States. Rothbard noted that falling prices were neither a cause nor an effect of depression, but a natural feature of prosperity.
In the decade of 1879 to 1889, for example, wages in America rose by 23% – in real terms. "No decade before or since produced such a sustainable rise in real wages," says Rothbard. In terms of improvements to material well-being too, the economist RW Goldsmith concluded that no decade matched the 1880s – with 3.8% annual gains. But this was also a decade when prices fell. Prices at the wholesale level fell 10%. Retail prices dropped 4.2%. How come falling prices didn't cause a depression?
In 1884, several big Wall Street banks, including Grant and Ward, the Marine Bank of New York and Penn Bank of Pittsburgh – along with 10,000 businesses across the country – went broke. There was panic on Wall Street. But even this did not cause a depression. The government did nothing. Thanks perhaps to its incapacity, within weeks the economy was back on its feet and the decade of prosperity continued. This is just the way of the world, when the world is allowed to have its way. In a normal economy, prices are honest. They tell capitalists where and how to invest their money. Businesses increase capacity. They get better at what they do. Unit costs go down. Increased productivity brings higher wages and lower prices – prosperity. If that is all there were to it, the world would be more prosperous, but less entertaining.
There are honest price movements. And there are the other kind, prompted by changes in the money supply. Natural price movements send useful information; inflation- (or deflation-) driven signals are a form of economic counter-intelligence – fraudulent signals intended to mislead. Monetary inflation pushes prices up; but only because money is becoming more abundant, not because goods are becoming more scarce. Businesses, investors and consumers get the wrong idea. Typically, consumers overspend and businesses overinvest. The consumer thinks he sees increasing scarcity. The businessman thinks he sees rising demand. Both are wrong. Both lose money. Even the government is misled by its own flimflam; it sees increasing tax receipts and expands services.
Last week, economists at the IMF and the Fed wondered aloud whether they shouldn't deceive the public even further, by setting higher inflation targets. Currently, central banks aim for 2%. Talk is of doubling it to 4%. The world has never seen so much monetary inflation before. In just the last seven years worldwide monetary reserve assets have tripled – from less than $2.5trn to more than $7.5trn. Yet, consumer prices continue to fall. In January, despite the Fed's target, The Wall Street Journal reports that, "consumer prices [in the US] actually fell by 0.1%". Maybe government employees can fine-tune the economy by targeting inflation. Maybe they can't. But some advice to readers: if you get a large cheque, don't wait 33 years to cash it.
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