Monday, September 5, 2011

Jesse's Monetarist View of Deflation

In his latest post, Jesse backtracks somewhat on deflation, limiting the concept to "monetary deflation."

When you redfine deflation to limit it solely to its monetary component, it is hard to argue with Jesse's conclusions.  But I will.

In the short term, Jesse is absolutely correct.  We have no "monetary deflation."  Now.  But we will. 

Where I disagree with Jesse is in the long term outlook.  As I've said before, we are in a period of managed deflation.  What I mean (and have always meant) by "deflation" is an economy in contraction (as opposed to expansion).  What I mean by "managed" is that financial speculation is being used to mask that contraction by creating higher prices for consumer staples.  In short, I've argued that stagflation, what I call "screwflation" is not inflationary at all but is, in reality, deflation.

The problem, I think, is that Jesse's understanding of inflation/deflation is fully informed by Milton Friedman's Chicago School brand of monetarism.  It was Friedman, after all, who famously stated that "inflation is always and everywhere a monetary phenomenon."  (I've argued, as Henry George did long before me, that inflation is, in fact, always and everywhere the result of leveraged financial speculation.)  Indeed, Jesse believes that the Federal Reserve, through its monetarist policies, has a profound influence over the economy.  (As I've said before, with John Kenneth Galbraith's support, I believe the Federal Reserve is largely irrelevant.)

As a result in his belief in monetarism, i.e., the demonstrably false quantity theory of money, Jesse mistakenly believes that things like "monetary deflation" and hyperinflation are purely "policy decisions."  Well, they weren't during the Great Depression, and the only reason they are at this point of the Greater Depression is because of the automatic stabilizers that world governments put in place as a result of the Great Depression.  The problem is, as Jesse notes, that without substantial reform of the current system, things are going to get worse, to the point where no central bank and no government will be able to influence, let alone control, the final outcome.  Why?  Because the same cannibalistic system that ate the real economy is eating the automatic economic stabilizers. 

One final note: Jesse says that "credit is NOT money."  While I agree that credit is not M0, I'd argue that M2, which he relies upon, is credit.  Riddle me this: what would happen if all of the owners of M2 would simultaneously demand that their "wealth" be turned into cash, i.e., M0?