Central Bankers Are Wrong About Inflation and Deflation: The majority of economists view deflation as a general decline in prices of goods and services. This is viewed as a major threat to the public’s well-being for deflation is seen as a major factor that plunges the economy into an economic depression.
US Job Growth Rate Hits 28-Month Low: The Bureau of Labor Statistics released new employment data today, and nonfarm payroll employment increased in May be the smallest amount seen in 28 months.
Bread $2.00/loaf. We see this at our local grocery store. This price sends a signal to us. If it does, what signal is it sending? It is obvious that the $2.00/ loaf is the signal, prima facie. Yet, there is more to this process.
In the past, free traders used barter to exchange goods. The “prices” of those goods were expressed in the other good that was needed by the seller. For example: If a seller of a cow needed two hens, the price would be two hens.
Free Trade: The process that benefits us all. Many political knaves rant and rave about having trade deficits with other nations. They speak of the “trade imbalance”, and something must be done to “protect American” interest. To those who are not steeped in the understanding of economics, this argument, prima facie, seems plausible. However, this polemic, quite frankly, is balderdash. The ones, who seek to intervene in the process known as Free Trade, simply lack the economic understanding of some fundamentals.
Trade takes place with individuals, with not Nations
When one purchases an item from the store, that product may have been made in China, Mexico, Vietnam or some other country outside of the U.S. However, that product was sold by an individual, not a nation. That “individual” maybe a corporate entity, but the fact still remains the “nation” did not “sell” this product. Once one begins employing economic analysis, with the notion that we trade with nations, it becomes quite apparent this position is false and misleading. Individuals purchase products based upon their desire to pursue their individual objectives. Private firms go into business to earn a profit. This profit is used to expand the enterprise, pay back investors, etc. etc. Customers purchase these goods to benefit their well-being.
Trade Deficit is Hogwash
This fallacious notion of a “Trade deficit” is as old as the hills. The entire notion of mercantilism embraced by the elites believed a nation’s wealth was based on the amount of Gold it held. If there was a imbalance of trade with respect to Gold, typically this imbalanced was made “balanced” by employing some sort of tax or tariff on foreign goods. Many of the classical economists, such as Adam Smith, David Ricardo, David Hume and others, argued vehemently against mercantilism, as they believed it was detrimental to the citizens of the “mother” country. Fast forward to the 21st Century, mercantilism still is alive and well. Modern believers in mercantilism want to “punish” China, for example, for selling their goods at a lower price. Using their logic, American consumers should pay higher prices for goods. These modern acolytes of the mercantilism cult do not say this explicitly, however, their desire to have tariffs demonstrate that these folks want that objective. The use of tariffs simply restrict the inventory of that said good in the marketplace, and with the same level of demand, prices will rise.
With respect to the notion of a trade deficit, this myth has been addressed on this blog ad nauseam. Let us take the example of China. Many Presidential candidates, specifically Donald Trump, claim that China has an imbalance of trade with the United States. If trade is simply measured on the same goods that are sold to the buyer, and if the seller buys those same goods from the buyer, then there will be a trade imbalance. Simply put: I purchase bananas from my grocery store. Yet, my local grocery store does not purchase bananas from me. Thus, there is a trade imbalance, in terms of bananas. However, the dollars, which act as a measure of accounting, demonstrate that there is no trade imbalance. If you pay $1.00 for bananas, the store receives the $1.00, you receive the bananas. It all balances out using regular bookkeeping logic. Also consider this: Both parties value their items differently. The Store values the dollars more than the bananas, and the buyer values the bananas more than the dollars. Both parties win. While this seems to be a simplistic example, this holds true at the macro level. Chinese firms sell their goods or services, and in exchange, we give those firms our US dollars. The Chinese firms can re-invest those dollars and expand their enterprise; this benefits them in the present and the long run. The US Consumer has the pleasure of obtaining a product to enjoy. In the notion of free trade, both parties benefit.
Trade deficit between States in the United States?
Since these politicians seek to speak ill of the “trade deficit” between China and the United States, why not complain about the trade deficit between States? Or between counties? Or between Cities? Is it right to argue that Nevada has a “trade deficit” with regards to Gambling, as compared to Utah? Is it wrong to argue that Idaho has a trade imbalance with regards to potatoes compared to Texas? No one would argue for such foolishness. Yet, this argument is equally as risible as arguing about the trade imbalance between China and the US, or the US and any other nation.
Having a trade deficit with China, or any other nation, is simply a mythology. We have a trade deficit with our local grocery store, Gas station, Electronics Store, and the like, since none of those stores buy from us those exact same goods. Yet, in exchange, they take our dollars for those goods. This eliminates the “deficit”. Also, we never hear about a deficit between states, or cities, or counties. This sort of speak is simply reserved for histrionic talk to get voters emotionally engaged to a particular candidate.
Many folks have concerns about inflation and deflation. Addressed below are questions submitted by the vox populi regarding this topic. Before addressing the questions, the definition of inflation and deflation must be addressed.
Definition of Inflation
Inflation is the increase of the monetary base. If the central bank decides to increase the money supply, this is inflation.
Who is negatively impacted greatly by inflation?
When inflation occurs, it increases the monetary base. Once the monetary base has increased, it makes the next monetary base unit less “valuable”, on the margin. The net result is that the currency because weaker, it it loses its ability to store value for consumers. Individuals who are are on a fixed income, such as retirees, savers, and the like are impacted greatly by inflation. Individuals who are creditors are impacted by inflation as well. Why is this the case? When someone creates a debt, it is based on today’s dollars, but the interest rate helps adjust the total amount paid to future dollars. If inflation occurs, the interest rate on the debt is fixed, it does not adjust to the increase in the money supply. So, those future dollars maybe less valuable if there is inflation, and the interest rate on the debt does not account for this.
How Savers are impacted by Inflation
The act of savings is deferred consumption for the future. For example, one may save up to purchase a house in the future, utilizing the savings as a down payment. The saver is placing faith that the monetary base, in most cases the currency, holds the value during the time the person is saving up to purchase the item. When inflation occurs, the value is eroded,
How to protect yourself from Inflation
There are various strategies to mitigate against the risk of inflation. Some advisers suggest purchasing Gold, Silver or other commodities to hedge against inflation. Many also invest into equities, as this can be a way to deal with inflation. Others may look into Real Estate investing, as this is a popular method to deal with an increasing currency supply. While all of these methods, and many others, are appealing, they have their own risks. The main takeaway is to make sure one is educated on how to invest into these various investment classes.