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BIT & COIN: Merging Digitality and Physicality
The most fundamental difference between inflation and deflation is that inflation is artificial while deflation can be natural.
Mainstream economists would not agree with this characterization or understand it. This is only because they bring an inflationary mindset to judge the natural deflationary environment, failing to appreciate the most essential distinction between two different types of deflations that have different causes and impacts.
The first type of deflation is caused by a lack of demand. The cause of this type of deflation is a negative condition. In fact, this type of deflation is an aberrant condition existing in an otherwise artificially inflationary environment, so it really is more accurately called ‘negative inflation’. It is fundamentally a part of the inflationary environment, only with inflationary forces having temporarily failed.
The second type of deflation is caused by increasing productivity and efficiency. This can be called ‘natural deflation’.
Natural deflation is the true countermeasure of inflation.
The above distinction is of essential importance but not commonly appreciated, primarily because almost all economies today are in an inflationary environment, in which the productivity-driven deflationary factor is masked and invisible.
Although economists are generally aware of the existence of these two types of deflation, they treat them merely as two different flavors of the same thing, thus relegating the most important natural deflation to incidental and secondary status.
For example, you probably have heard this statement often: “Deflation is more dangerous to the economy than inflation.” If the deflation is caused by a lack of demand, the statement is true. But only negative inflation is caused by a lack of demand. Natural deflation is not. Natural deflation is not dangerous. It is good.
It’s time to see inflation and deflation (natural deflation) in their own proper light.
Inflation, because it is artificial, has no ground truth, and is highly unpredictable and volatile, makes the system unstable, less honest, less productive, more pessimistic, and fundamentally unfair.
Inflation is really a measure of how much the system has been manipulated and taken advantage of by people in power.
In comparison, deflation, when it is natural, is based on ground truth, can be stable, and makes the system more productive, honest, and optimistic. Natural deflation is an indication of improving productivity and a measure of how much society as a whole is taking advantage of the power of knowledge.
Inflation
“Inflation is the creation of new monetary units w/o corresponding real world economic value.” –Christian Kameir, commenting on Milton Friedman’s explanation of inflation.
This should be adopted as a standard definition of inflation and taught in the classrooms and to every citizen because it is scientifically true.
On the other hand, Friedman’s statement, likening inflation to alcoholism, is behaviorally accurate and morally true.
Both the scientific and moral understanding of inflation are necessary.
Most people initially understand the moral aspect, at least intuitively, if not experientially. Unfortunately, their common sense is clouded by what they see in the world and hear through the media.
I think a majority of political leaders understand the moral aspect, but much fewer understand it both morally and scientifically. Those who only understand this morally but not scientifically don’t have a firm intellectual ground. As a result, they are easily confused, intimidated, and eventually converted by those who wield wrong science (e.g., MMT—Modern Monetary Theory) against them.
On a broader subject, inflation itself is not the root of the economic problems. An economy with a 10% inflation rate but a growth rate of 15% and fair distribution would be fine. But we have not seen such an economy ever exist, at least not sustained over a meaningful period of time. It is because the economy as a human system is not compatible with that kind of operation.
The fact is that a high inflation rate is never a deliberate and purposeful act that targets healthy productivity but is always a consequence of something that has gone wrong. Usually, the culprit is the government in the first place, and the government then plays the rescuer. And society accepts it. In this sense, society is not only a victim of alcoholism but also suffers from Stockholm syndrome.
Supporters of inflationary monetary policies cite the necessity for government intervention and participation in the economy. However, the only strong case for direct government participation in the economy is infrastructure building, which, on large scales, is very hard to bootstrap by the economy itself. Even in the case of infrastructure, it must be carefully studied and targeted to ensure that the kind of infrastructure that is being built would result in a net positive output in terms of economic activities.
Treating infrastructure as social welfare is an admirable thought, but it only leads to the unintended opposite result if the project violates the laws of economics. The first 20 years of China’s rapid growth are a positive testament to the above principle, while the last 10 years have been a negative one, the consequences of which will only unfold in the ensuing decade.
Inflationary economy is fundamentally harmful
An inflationary economy engineered by the government and the central bank is fundamentally harmful.
An inflationary economy creates an illusion for the common people to pursue debt-based financing schemes, not knowing that they are ultimately consumed as fuel to generate the rich’s gains.
It creates an artificially high level of pressure for people to own more assets than they should own, hoping the prices to go up. When the asset prices do go up, a self-feeding reality sets in, forcing more people to join. It does not take greed but only fear to come on board.
It essentially transforms the economy into a giant Ponzi scheme.
This is one of the biggest tragedies of modern societies. People have forgotten how to live naturally and be happy. With the rapid growth of productivity driven by technology and innovation, more and more people could and should be happy. But in reality, fewer and fewer are.
The truth is that people have more and more things but are less and less happy. Part of that is due to human nature, namely discontent and greed, but a part of that is also created by the inflationary system and policies of economy and finance.
Besides, discontent and greed are not constant, as they can be either amplified or reduced (though not eliminated) depending on the environment. An inflationary environment does exactly the former: it amplifies discontent and agrees.
If you survey the media, you will see that all economic theories, policies, and operations, along with reports and discussions thereof, focus on one thing: Growth. Growth has become the ultimate goal in itself, propagandized and worshiped along with the sacrifice of actual living quality. It is further falsely assumed that an inflationary environment is absolutely necessary for any growth.
The government and financial industry are in perfect agreement to do this. No wonder, they are the biggest beneficiaries of the scheme. The government gets power, and the financial industry gets the blood-sucking pillage.
People find the above hard to believe. “If it is that bad, how come the world did not collapse long ago?”
The collapse is certain because the model is unsustainable.
But the collapse is delayed. It is delayed by the very alternative healthy deflationary force: natural deflation diligently works as a saving force that automatically counters the destruction of artificial inflationary policies.
There are also other reasons that contribute to this delay: (1) the sheer size of the macroeconomic system creates long scales; and (2) the artificial inflationary system isn’t only drawing from the current economy but also from the future generations, further increasing its scale and the level of deception.
Had it not been for the productivity-driven deflationary factor, which simultaneously exists in spite of, not because of, the inflationary environment (see below), inflationary policies would have long destroyed the world.
If the inflation represents the ‘water out of the mouth of Dragon’, the natural deflation represents the earth that swallowed up the water to save (Revelation 12:15-16).
Deflation
As said above, there are two different types of deflation: ‘negative inflation’ as in a failed inflationary environment, and ‘natural deflation’ driven by positive productivity. We focus on the latter below.
Without the interference of the inflationary policies, a natural economy would be deflationary.
For example, without the manipulative fiat monetary system, the economy should be naturally deflationary if measured by the most fundamental ‘money’ which is time (time is money), or a precious metal such as gold as a secondary choice.
The reason is very simple: cumulative human knowledge improves productivity through technology and other innovations, and improved productivity makes things cheaper when measured by time.
In fact, even with the existing manipulative fiat monetary system, the deflationary nature of the modern economy exists anyway when the prices of the common goods are measured by time, for example by a worker’s hourly income.
One inflationary view regarding this is that fiat money is only an intermediary means for conducting the economy. Therefore, we can take advantage of its transitory nature to promote growth while being fully prepared for the ultimate fall of one fiat and welcoming another.
But this argument ignores the systematic and permanent harm done by something that is fundamentally based on deception, not truth, and is, by design, optimized for manipulation through power to result in an uneven distribution of benefits.
The argument is especially unacceptable when an alternative can also result in growth but in a much more stable and honest way.
Note, the above is not about equalitarianism which has to resort to redistribution through social and political means. The analysis here is based on the economics of productivity.
At the same time, we do not argue natural deflation would not need any form of money and currency to operate.
Monies and currencies may still be needed for more efficient agreement, exchange, measurement, and transmission of value (see Money & Currency), but there is no need for inflationary money in this healthy environment.
Natural deflation is more moral and healthier
Natural deflation is an indication of improving productivity and a measure of how much society as a whole is taking advantage of the power of knowledge.
Deflation is also one of the very few ways that can narrow the economic inequality gap. But today’s financial machinery is far cleverer than Mises’ time in finding and designing ways for the rich to take advantage of the real economy even with deflation.
(Broadening economic participation by activating creative energy and reducing friction is another way to reduce the economic gap. Decentralization and blockchain, if done properly, will bring this true social benefit. But it is another subject and is beyond the scope of this article.)
Deflation helps to narrow the economic inequality gap because of proportional budgets in people’s lives. Deflation benefits consumers more than it does investors (it may even curb the type of investment that is too speculative). The rich have a smaller portion of consumption and a greater portion of investment in their total wealth than the poor.
These healthy natural self-adjusting economic forces are impaired by artificial systems, including central banks and financial systems. For example, with just a slight sign of deflation, the central bank will print money to ‘save the economy’ (but really does the opposite in the long term).
In deflation, debt hurts the poor too. However, the effect of debt largely depends on the type of deflation that causes it. With deflation that is caused by an artificial inflationary environment, debt is itself a result of false economic theories promoting inflation as a driving force of the economy. It’s predatory on human psychology.
It creates a death cycle. People don’t realize it only because each cycle is multigenerational.
In a healthy, productive, and naturally deflationary economy, fewer people are forced to borrow debt.
There will also be the rich and the poor in a natural economy, but the division would be mostly proportional to people’s personal resources and effort, not amplified by leveraging an artificial financial system.
One argument against deflation is that deflation encourages savings and discourages businesses from borrowing money for development.
But why is that a bad thing? When it makes business sense, businesses will always borrow. A natural deflationary environment only discourages unreasonable borrowing. This actually has a positive effect of making businesses more disciplined and clearing out ‘dead cells’ in the economy, such as zombie enterprises that shouldn’t exist. Both of these, in turn, improve the overall productivity of the economy.
The overall effect of deflation depends on the conditions of the economy. In an economy that is already addicted to money printing, any deflationary measure is painful and usually discourages business development and investment excessively. This is because an addiction to money printing creates an addiction to borrowing, which is characteristic of a ‘debtor’s economy’ that favors debtors and punishes savers. A deflationary condition arising in such an economy is clearly painful for businesses that are addicted to borrowing money.
For example, concerning borrowing, in a deflationary environment, if the deflation rate is 1% annually, at a nominal interest rate of 8%, the real interest rate is 9%. In comparison in the inflationary environment, if the inflation rate is 2%, at a nominal interest rate of 8%, the real interest rate is 6%. Therefore, under the same nominal interest rate, the borrowing cost is higher in a deflationary environment.
However, in a healthy economy without money-printing addiction, a sustainable scenario arises.
The nominal interest rate in a natural deflationary environment (in which deflation is really caused by increasing productivity, not decreased demand, see above) and that in the inflationary environment are not comparable.
First, from the borrower’s viewpoint, even though borrowing seems more expensive in a natural deflationary environment, it is not all bad news. It is a better discipline to start with, but more importantly, the same amount of capital borrowed tends to create more value in a natural deflationary environment than in an inflationary one because the former tends to have a healthier and more stable business environment.
Second, from the lender’s viewpoint, an interest rate of x% in a natural deflationary environment is better than the same interest rate in an inflationary one. This is not only because the lender can have the same real investment return with a lower nominal interest rate in a deflationary environment as compared to that in an inflationary one, but more importantly, because the lending risk is lower in a natural deflationary economy. For money lending, lower risk means the lender’s acceptable interest rate is also lower.
Third, for the same reason, a natural deflationary environment may also paradoxically encourage good investment. Here, the key math is whether at a given deflationary rate, the positive outcome of the economy outweighs the deflation, for otherwise, one who has money would rather save than invest. A healthy economy ought to have a positive net effect in this regard because a productive economy is not a mere zero-sum game of money but a net growth caused by human creativity.
On a broader philosophical basis, a natural deflationary economy is preferable because it is based on truth. It is healthier, more productive, more honest, fairer, more stable, and more sustainable.
In such an economy, growth is not the goal; better living is. But growth comes as a result anyway, as long as human ingenuity continues to improve productivity.
In contrast, an artificially inflationary economy is based on a lie. A lie can be convenient and even profitable in the short term, but it will always lead to bondage. After several generations of experiments, the effect of that lie has made itself glaringly obvious. It has become increasingly unbearable. It is only a matter of time before a total collapse arrives.
But at the same time, few people can see the healthy alternative. People have lived under a lie for so long and so thoroughly that the very idea of the truth sounds ridiculous.
Stop using an inflationary mindset to judge the natural deflationary environment, and we might start to see some light.
An extra reflection: When you really think about it more, you start to understand why God in His infinite wisdom prohibited interest-bearing debts among Israelis (Exodus 22:25, Leviticus 25:37, Deuteronomy 23:19), but permitted it to Gentiles (Deuteronomy 23:20). It is because God did not want a brother to enslave a brother, even if it is only done using soft means (such as voluntary financial settlements) rather than force. God knows that debt causes inflation, and inflation begets financial schemes that make the rich richer and the poor poorer, which eventually leads to slavery.
[Recommend my two-volume book for more reading]: