Deflation and Liberty

0:00Welcome to the first installment of our lecture series seminar. Each summer we have at least two seminars, two weekly seminars, one of which provides a forum for the more senior people, in case you have any doubts about this, that's me and my likes. and the other one is for the more junior people that you like, we know this all, where you present your research in your papers. My topic today is deflation and liberty that will open the whole lecture series and we will have at least two or three more talks that will follow up on this theme, which is an important and has even been neglected by Austrian economists. I started reconsidering the case for deflation again about one year ago, at least six months ago when I have been invited to give a talk at Grove City College and I thought the subject fitted perfectly the occasion because the reason to go to Grove City College was evidently to honor to honor Professor Hans Zenholz, who has been teaching there for several decades.

1:18And Zenholz is not only a great Austrian economist, but he was an excellent analyst of deflation and of monetary reform. And what I had to say was very much, as I perceived it, a Zenholzian message. So I had very nice things to say about the guest of honor and one reason more, therefore, to take up the subject. And what I did in this subject, in my talk in Growth City, which I will not repeat here, give you the executive summary, was by and large to state that in the theory of money we have a couple of central actions or principles which underpin both the case that Austrians commonly make for the gold standard, which we mean in fact free market money, as Professor and also orient our proposals when it comes to monetary reform.

2:16So what are these principles? First of all, as we have explained last week, the quantity of money is irrelevant in the sense that we can by and large do with any quantity of money. Any quantity of money is equally fit or equally optimal in the sense that and we can perform all indirect exchanges with any quantity of money in the economy. There are certain limitations relating to the physical supply that we have of the money commodities as we have explained last week. So if we have a very high purchasing power due to economic growth and in the monetary area, for example, operating with the gold standard, then this might lead to a situation in which high purchasing power is concentrated in very small coins, which you then cannot use any longer to buy, let's say, a cup of coffee or so, which is already now the case.

3:09Nobody of us will ever try to buy a cup of coffee in the present day situation with a gold coin. So, in these situations then, the demand for gold will be transferred into another commodity money, silver for example, or copper and so on, and so there is currency competition between in different metallic currencies that all equilibrate in the free market. Now, in the case of paper, that is, of course, we don't encounter this problem here, rather this insight that we derive from general monetary theory is important because it squarely contradicts the underlying hypothesis of all inflationist programs. programs, because all inflationist programs are premised on the assumption that we can somehow make things better off.

3:59We can somehow benefit society in the aggregate by modifying the quantity of money. Now, and I don't tell you anything new if I say, modifying the quantity of money is much too nice a way to state the agenda of these people, which, because in practice it always means increasing the quantity of money. As you know, there is the famous theory of contracyclical economic policies, monetary policies, the growth path of the economy, secular growth trend, and then there are cycles around it, and then according to this myth, in times of excessive growth, you take some money out, and then in times of slacking growth, you re-inject it into the economy.

4:45into the economy. Now, that constantly goes on, right? Injects you might think they're constantly in a phase of declining growth, but there's never any taking out going on. So apart from, I will not go into this detail while it's all wrong and profoundly wrong at this occasion, just want to point out so this never happens really. All that happens is a constant injection. And as we are informed, as far as central theorem, the quantity of money is not really important. We know that the whole program is pointless. The whole inflation program is pointless. And this also informs, more or less directly, the Austrian proposals for monetary reform. They all aim at the re-establishment of a gold standard. And clearly, as you see from this line of argument, Austrians favor the gold standard, but again, which would mean any free market commodity money that is spontaneously adopted by the market participants as their medium of exchange It doesn't rest on any aesthetic predilections for the yellow metal.

5:50It's not because somehow we have centuries and centuries where the gold coins have been used. Now we need to go back to the good old times or something like this. No, it's a very simple case. The quantity of money ultimately has no importance. The gold standard therefore is certainly as good as any other standard as well. It can certainly not be deficient on the grounds that the quantity of money behaves in a certain way. So what are then the advantages of gold money or the free market money? The advantages are that the manipulation of the money supply are independent of political control. Now why is this so interesting? This brings us to the second principle of monetary economics that is so fundamental that it can be called an action.

6:39That is the principle that changes in the quantity of money bring first of all about redistributions. Increases in the quantity of money benefit those who first receive the additional units, who enrich themselves thereby at the expense of all other members of society. That is, changes in the quantity of money go in hand with redistribution effects. Now that is not something that is particular to money or to gold or whatever. It is something that results from any change in the quantity of any good. And if you are a very successful carpet producer, you sell more carpets than your competitors, or maybe you are the very first carpet producer ever in Alabama. Well, so certainly you will attract, in so far as you sell them at all, you will attract some demand, which means that this demand is no longer directed to the purchase of other goods.

7:28of Other Goods. So you're certainly creating a redistribution of resources in your favor into the detriment of other market participants. What is the lesson of this? Well, the lesson is that as usual, redistribution per se is not a very interesting question because there's constantly redistribution going on. From a political libertarian point of view, the question The more interesting question is, is this redistribution justified? Now we can justify it under the libertarian considerations, natural law libertarians will not be happy with this, or in any case not be satisfied with this, so we'll point to the fact that only redistributions that result from the use of one's own property are justified, whereas redistributions that result from encroachments of other people's property are not justified.

8:23Now that is certainly the case with the gold standard. It brings about redistributions of property that result from purely voluntary decision making. If I'm a gold miner and I dig gold out of the ground and I clean it and so on, produce nice bars of gold, and even the coin business, right, vertical integration, merger, I offer you these coins, I infringe on nobody's property, I sell you a product that is the result of my labor and of my capital and the labor that I've paid with my capital and so on, so there's no problem from a libertarian point of view than with the redistributions that result from my participation in the market.

9:10It is different in the case of paper money. This brings us to the third fundamental proposition of monetary theory, namely that paper money regimes, or we might say paper monies, facilitate the enrichment of their producers beyond the degree to which this would have been possible for a money producer on the free market. That is clearly, if all that you've got to do is to run the printing press, right, and we don't need to think of very high-tech production processes, at the limit, you could just have your little printing press that you operate by hand in your cave, and then you work the whole night, and the next day you show up, and you have your bags full of newly printed notes and so on.

10:00and so on, clearly that's not a very, as far as cost of production and so on is concerned, cannot be compared to the gold standard, right, where the production is very expensive, involves lots of resources and so on. So then, do we favor the gold standard because it's more costly? It seems to be irrational, right? Let's take always the cheapest product must be the best. This is certainly not an economic principle. Rather what is involved here is that on a free market, if we had a purely free market, paper money could not withstand the competition of commodity monies. And that is precisely for the reason that they can be multiplied, the quantity can be increased almost at the whim of the producer.

10:47Now, put yourself in the position of a money owner, which shouldn't be all too difficult because I guess most of you should be money owners at present. If you have the prospect that you get the choice between two commodities, one can lose its value at the whim of the producer, which would be the case of paper money. And in the other case, the producer, even if he willed, even if he so willed, could virtually have no impact on the purchasing power of the good. Well, clearly the second good is more attractive, because what you expect from a medium of exchange is, first of all, that it preserves its value, it's a store of value, otherwise you wouldn't even adopt it as a medium of exchange. Exchange. Now, since this is so, paper monies cannot withstand the competition of commodity monies and have never been able to do so in recorded history. And as a further consequence of this, we can understand why paper monies have always been privileged by a special legal

11:52protection. Wherever and whenever a paper money has come into existence, it has been protected in particular by legal tender laws, that is, those laws that force you to accept a payment in terms of this paper money, even though you might have stipulated payment in another commodity. Let's say we have your two subversive individuals, Mr. Barlow, maybe, and Mr. Perry, and they strike a deal, Mr. Perry sells his house to Mr. Barlow and stipulates payment in gold. Mr. Barlow goes bankrupt because of whatever and he just happens that you cannot pay in gold but he just happens to have this inflationary paper money and the government now steps in and says look Perry you have this contract and according to our very precise calculations 15 ounces of gold or 1500 ounces of gold depending on the size of the palace equal $3,500 or $35,000 or whatever, and then Mr. Perry will be obliged to accept the sum of money, that means legal tender.

13:03Now, what does this do? Well, it brings into operation Gresham's Law. If you can, if the law enables you to fulfill your obligations in terms of a commodity of lesser value, Obviously you will always do this, you will keep the gold for yourself over the higher valued commodity and pay in terms of the lesser valued commodities. So therefore, the very least that legal tender laws do is to drive out good commodities out of the country, out of circulation anyway. On top of that, we have additional privileges that the Federal Reserve system in the United States enjoys and all the other central banks in other countries. just think of the tax code that penalizes purchases or exchanges of precious metals in some countries you've got to pay excise taxes when you buy and sell gold but in some countries it's also in the United States I do not know the situation very well but for example in Germany or France it has been impossible to conclude even to make contracts denominated

14:09in gold and you couldn't enjoy legal protection it was not just that legal tender laws it Thus, paper money always exists in a monopoly regime, always enjoys monopolistic privileges, and therefore, Austrians want to get rid of it, or more precisely, what Austrians want to get rid of is the monopoly. Therefore, Austrians want to get rid of it, or more precisely, what Austrians want to get rid of is the monopoly. In my eyes, in any case, that would be the only coherent Austrian position on currency reform, but I will not go into more detail about this today.

14:55The idea is that libertarian currency reform would involve abolishment of the legal privileges of the Federal Reserve, not necessarily physical dismantling of the Federal Reserve as an institution. There would be no necessary case to be made for selling the buildings and the equipment of the Federal Reserve offices and so on. and so on, they could even keep the printing press, or that what we need is that they return the gold and silver that they have stolen in former times from their rightful owners to these very persons. Okay, so the Austrian sense on principles of monetary theory informed therefore both their views on the superiority of the gold standard or commodity standard and on monetary reform.

15:47Now, this case has never been adequately addressed by the proponents of our current regimes, that is of the current regime, which is in fact a paper money regime. And therefore, Austrians are by and large the only ones still today who pioneer or develop this literature. and this is what I've done in these two papers. Now again,

16:29in the light of the principles that I've enunciated just before, it is easily understandable why we have in the present day such great apprehensions about the introduction of Paper Money System, but also about simple things such as letting deflation happen. Some of you might recall that at the end of last year, November 2002, Federal Reserve Governor Ben Bernanke gave a talk with the revealing title, Preventing It from Happening in the US, or something of the sort. Making sure it does not happen in the US. By it, he meant deflation. So why is deflation this terrible thing?

17:17Well, the case against deflation is the mirror inverse case of the general case for inflation. So it should not surprise us that the inflationists, who in the wake of the Keynesian revolution of the 1930s, have taken over not only political decision-making as far as monetary policy is concerned, but also the teaching of monetary economics in most universities in the economics department or universities in the world. So the case for inflation and against inflation is constantly with us. And it is a weak case indeed because it rests mainly on an amalgamation of myths In the light of the second principle, the third principle that I've explained before, changes in the quantity of money bring about redistributions, these redistributions have a much more ample scope once you have a paper money.

18:17Well, it's clear why they have such resistance against deflation on the side of our political economic establishment. Clearly, this is because many of them profit most from the present regime. This concerns in particular the members of government on all levels. There's those who run the welfare state, there's many, many million people who run the welfare state, but also people who are the guardians of monetary policy. Just think about how many intellectuals, how many economists of undoubted intellectual capacities the Federal Reserve has in its employment. How many hundreds and thousands of economists are working for them? Same thing applies to the World Bank, same thing applies to the International Monetary Standard.

19:07And, of course, these persons define the standards of monetary analysis. But in fact, for anybody who takes a sober look at these institutions, at the conditions where you cannot help wondering what meaning it has if one grants special expert status to people working for agencies that are charged merely with the technical details of spreading inflation. There is a non sequitur implied in granting expert status in matters monetary to the employees of these organizations. An obvious parallel is the case of the economists who are on the payroll of labor unions.

19:57They are considered to be experts because labor unions pay them. What we here see is, of course, again, the power of language. The labor union rather than, say, for example, the associations for the destruction of the labor market. Then it would be clear that they are not experts on matters of labor at all, but rather experts in the destruction of labor. The same thing was true for those writers in Monetary Affairs who happened to be on the payroll of the various associations for the destruction of our money. Of course the point is not to deny that these are bright people or good monetary economists. The point is that it is wrong to just infer on a priori grounds they are working for these institutions, therefore they know particularly well things monetary.

20:45It's rather the obvious, rather the other way around, given the incentive structure which pushes them, it's their own monetary pecuniary interest to push for schemes involving more inflation, come up with justification for ever more inflation that explains their behavior. So we should expect them rather to be monetary experts in spite of the incentive structure that they face at their workplace.

21:23So, but these people, again, so they stand to profit from the present regime, which we can understand on the basis or in light of these elementary propositions of monetary theory. And it is these people who constantly propagate or pay people to propagate the myths on which our present monetary regime still rests. And I have come up with a short list of 11 myths. I'm not happy with the number, it should be something else, it would be 10 or 12, but you will help me, you'll say, well, this is not a myth and we take it out of the list. But in any case, so short list of subdivision of the most essential myths that we here face in this field.

22:10So the myth number one is, you cannot earn a living and make profits when the price level falls.

22:18The answer also, is this true? Well, it is not true, of course. Successful business does not depend at all on the level of prices, but on price spreads, between prices, price spreads between selling receipts and cost expenditure. And these can exist at any level, not only at any level of prices, but at any evolution of the level of prices. Prices between selling receipts and cost expenditure can exist at a stable and high price level, at a stable and low price level. They can exist if the price level moves from a high to a low one, or inversely from a low to a high one. Again, so the quantity of money at the level of prices is no point whatever on the success of businesses and on the living standards of the members of society.

23:04Why is this so? Clearly because entrepreneurs provide for these spreads, right? They enter the market and say, well, I want to realize the price spread, and I can do this only if I buy factors of production at a sufficiently low rate. If they cannot do this, they won't even start producing, right? And therefore, we see that businesses often make very good profits at times when the price level falls. For example, both the US and Germany enjoyed very solid growth rates at the end of the 19th century, when the price level fell in both countries during more than two decades. In that period, money weight rates remained by and large stable, but incomes effectively increased in real terms, because the same amount of money could buy ever more consumers' goods.

23:56So beneficial was this deflationary period for the broad masses that it came to the first great crisis of socialist theory, as some of you might know, because socialist theory had predicted the exact opposite. Edward Bernstein and other revisionists appeared and made the case for modified socialism. So I think today we are in dire need of some revisionism too, deflation revisionism, that is. Myth number two, while falling prices are good, lacking aggregate demand is bad. Now clearly here we have a variant of myth number one. Only here we assume that our anti-deflationist says, okay, well you are right that falling prices are good for the consumers, but they are bad for business and your counter argument does not hold for the following reason.

24:48Profitable enterprise in time of falling prices presupposes that businessmen can bid down factors of production in anticipation of the event. If they are unable to bid down factor prices, they will not invest at all. Quod erat demonstrandum. But this argument overlooks that all resources are invested at any point of time. At every single point of time, all our resources are invested. The physical structure of production, the physical asset that we can use in productive ventures is never affected by changes in the quantity of money. So the question is why are our far-sighted entrepreneurs unable to bid factor prices down? Clearly there are only two possibilities. Either the present owner is not willing to sell them at the price that the entrepreneur offers, Office. Then this means that he himself knows of a better employment for them.

25:43He himself knows of a better way to make use of them and he just thinks well so at this price well that's not worthwhile I can I can use the resource and obtain a higher return on it. So who are we to tell the present owner well look I mean you're obviously wrong right I mean the prices will be so-and-so and you cannot know any project that will earn a higher return. Well so that is precisely is something to be found out through the market process or and that is the other possibility the present owner does sell the resources but only to an entrepreneur who offers slightly higher prices than our entrepreneur who anticipates falling prices in the future. Now there again you can say well this is this is foolish or they make malinvestments or whatever but you cannot say there's a lack of demand and there is certainly not a lack of aggregate demand there's There is not a lacking demand for investment purposes.

26:40Myth number three. You cannot earn a living and make profits when the money supply shrinks. So that is slightly different from the case that I discussed before. I said, okay, when the prices fall, now it's even more serious. Now the money supply shrinks. And as we know, the money supply is one of the causes of money prices on the market. The other courses being evaluations or value scales of the individuals relating to money and goods that can be bought for money.

27:16So against myth number three, we have to object that human beings are able not only to anticipate falling prices, but also the consequences of a shrinking money supply. Such anticipations will usually accelerate the deflationary process and make it reach the rock bottom of a stable money supply very quickly. But here two cases need to be distinguished. A, the case of a fractional reserve system operating on the basis of a commodity money, such as gold or silver, and B, the case of paper money. And indeed there are different dynamics at work here. So in case A, the supply of physical gold or silver can obviously not just vanish in thin air and thus it remains at all times to provide rock bottom in case of a deflation.

28:03Let's illustrate this maybe here. So we have here the time x and here we have the money supply. Okay, and then we say, okay, we have this inflation process, inflation, inflation, inflation, and then suddenly we hit, there's a big deflation setting in, poof, nobody wants the money substitutes anymore, nobody wants fractional reserve notes anymore. And so the demand shrinks, and according to our assumption, we had fractional reserve system based on the gold standard, some commodity money. So, there was some minimum amount that consisted in physical gold or silver and on this, on top of this amount we had money substitutes that is this is what Mises called the quantity of money in the narrower sense and if we count this plus the money substitutes that are dealt with as if though they were money we have the quantity of money in the larger sense what happens in a deflation is that the quantity of money in the larger sense shrinks and the point is it cannot shrink more than until it reaches the

29:28physical money stock and cannot shrink further than that and this then is what in financial circles is usually called the rock bottom. Then you have a hard landing or more or less hard landing there but you have a landing and based on this quantity of money which as we know will in any case be sufficient to perform all indirect exchanges we can go on. How long will this process take? In principle, there is no reason why it should not be finished. It could be finished within a second.

30:15If all people, all members of society, all market participants realize at once, ah, now it's over, the banks cannot redeem their banknotes anymore, they know at once, but nobody will accept them. They don't even bother to go to a shop and offer them for payment anymore. They just sit on their money and they know the banks won't give them any money, so it's just paper. Just decently good paper plus decently good ink transformed into a completely valueless scrap of banknote, former banknote, so that's what it is. So it can take place within a second. Usually, of course, it takes somewhat longer, but there's no reason why it should not be finished within a few hours or days.

31:02Empirically, that has been the case with many recessionary periods. So this here is no reason again why this shouldn't take just a few days.

31:16When it has ended, many banks will be bankrupt and many entrepreneurs will be bankrupt too, namely to the extent that they have financed their firms with debt rather than with equity. This explains, of course, why the present debt finance establishment ferociously resists deflation, but it does not, of course, mean that the production could not go on without them, that is, without these entrepreneurs. It could very well go on and it will go on with other entrepreneurs in charge. They are bankrupt, the physical assets are still in place, they are taken out of their leadership position, drawn back into the ranks of the workers, employees, No more companies, no more entrepreneurs, no more capitalists, and other people will take over, typically the creditors, and then go on.

32:04It's not that we are dependent on any particular person to run a shoe factory or whatever. Now in case B, that is in the case that we have a paper money regime, we don't have this year, we don't have any rock bottom because paper money ultimately suffers from the same essential deficiency as any money substitutes that are only covered by a fractional reserve. So in this case, we might face something like a deflationary spiral. People no longer wish to own a paper money and start selling it at any price, so the result will be an ever-declining purchasing power of this money, which in turn might convince even those who had bought it before that they better get rid of it, and the sooner the better.

33:06So there is the deflationary spiral, less willing owners, less purchasing power, means less willing owners, means less purchasing power and so on, until the money has completely vanished from circulation. Now notice that this does not necessarily mean that the economy will be thrown back into a state of barter. What usually happens in such cases is that people start using other monies, such as gold and silver coins or foreign paper monies. The deflationary spiral therefore has the healthy effect of replacing an inferior sort of money, that is inferior from the point of view of the money users, with superior money. And let me mention also in part, so here you see the importance of currency competition. It is currency competition in fact that saves an economy that has found its way by one way or another into a deflationary spiral.

34:02In the same way as we know that currency competition saves the monetary economy in times of hyperinflation. In 1923 when we had the hyperinflation in Germany, in August, September, October, at many places people adopted spontaneously various other commodities that they used for indirect exchanges. I could have been gold or silver, but it were usually also foreign currencies, not the pound or the Swiss franc, French francs and so on, French francs may be less, must be in VEDA money, but so the point is clear, currency competition provides objective limits to these spirals, spiraling us into and prevent that these spirals bring us back back into a barter economy. And conversely, of course, if we prevent currency competition by law, it has especially harmful effects in such a situation.

35:10That is, if we upkeep at all costs and enforce at any cost the monopoly laws that protect the present currency in the case of a deflation spiral or a hyperinflation spiral, Then we, in fact, have good chances of bringing us back into barter, into a primitive exchange economy, hand-to-mouth production. Unfortunately, even the Germans were wise enough in 1923 just to let it happen as far as it was necessary, and then later in the year, in November, they set out to introduce a thoroughgoing reform that salvaged the old money. But again, from an Austrian libertarian point of view, that is not necessarily the best result that you would aim for.

35:56It would have been, from a libertarian point of view, in many ways, it would have been preferable just to get rid of the old mark and have it replaced by these and other commodities. Gold, silver, coins, foreign currencies, whatever. So again, even in this case, there's no reason why this process should not be completed in a few days, and there's therefore no reason to expect that production will not resume very quickly under new ownership. Myth number four. Deflation entails slower economic growth than inflation. Now, okay, I don't need to go into much detail here. Essentially, that's wrong because inflation finances on a constant basis projects that would not find the voluntary support of other members of society.

36:48Think of the welfare state again, right? The welfare state could not exist without paper money because nobody of us would be ready to give sufficient amount of credits to the welfare agencies or make donations or whatever. donations, therefore they need the printing press to allow the government to incur ever more debts which in fact finance these projects. So here we have an enormous waste of resources which alone, and we don't even need to talk about the Austrian theory of the business cycle, that is about the possibility that increases in the quantity of money bring about inter-temporal misallocations of resources. and also a waste of resources, cornering of resources, but you don't even need to make this sophisticated point, right?

37:37It's just sufficient to look at the welfare state, look at the extent of the welfare state, how many resources are wasted in these bureaucracies and the projects that they run. and compare this to, well, the waste of resources, if you might call it thus, that result from deflation, which are in fact very short run, very one-time waste, right? They relate essentially to market participants adapting themselves to the new conditions. Myth number five, deflation is particularly burdensome for lower income groups. That is wrong, as we know from the Austrian theory of value, because the higher a good is up in the order of goods, the more its value will be affected by changes in the value of the consumer goods.

38:27Now, in the case of labor, what saves labor, in fact, is that it is relatively non-specific. So it can be easily moved from one stage of production to others. So it is not so much affected by changes of value in any one branch of production. But all capital goods are more or less specific. Just think of this building. Which use could we make of this building if the Mises Institute weren't here? Well, that's probably a bad example because it is a very charming and beautiful building and we have a university next door. But even then, right, so you wouldn't have exactly a use that is comparable, you have a huge decrease in value. But think of other things, a tool machine, for example, that produces replacement tools, let's say, for a very specific other machine that is used for car window wipers and so on.

39:20Now, if there's a lacking demand for that type of car, well, immediately all the equipment needed to produce these different parts for the car will become valueless too. So the changes of value that can be induced by deflation are much higher in the case of capital goods than in the case of labor. And this means that the owners of the capital goods, which are typically the richer people, will be affected by deflation much more than lower income groups. So it's not true that deflation is particularly burdensome for lower income groups. It's precisely the other way around. And that is also the very reason why, again, our establishment is a porous inflation to such an extent. Sure, it hurts the leadership most.

40:08And this does not only concern, well, political entrepreneurs, it also concerns, well, decent people who just happen to be capitalists. Myth number 6. Deflation destroys the credit of the state. So the idea is, once all prices are much lower, tax returns, the tax income, revenues of the state will be much lower than it had been before. On the other hand, they have still their debts in the old nominal extent, so they can't possibly pay back the debts. So therefore deflation would disrupt the credit of the state. I can only say well it takes some audacity to come up with this argument because to anyone who is right minded and sane it is obvious that it's just a question of time until our state or our governments won't get any credit anyway.

40:58Already now, until a couple of years ago, some 15-20 years ago or so, there were still politicians and other officials saying, well, one day the debt will be paid back. Margaret Thatcher in England even did pay back part of the English public debts, British public debts. She was the last one. ever since as we know not only the money stock has exploded but public debts have exploded as well and there's no more talk even of ever paying this back and it is clear that well since we are on some influential exponential growth path of public debts the point will soon be reached when our governments won't get more any more credits and have to file bankruptcy anyway with or without The only thing that deflation would do is merely to speed things a little bit up.

41:51The second point to be made here is, why is it actually so bad that government wouldn't get any credit anymore? That's very important. It's not cynical to say this, as Austrian scholars have stressed again and again. So even if we adopt the point of view of democracy as the most efficient, just and so on, form of government, then precisely from a democratic point of view, debts and inflation are highly problematic because they withdraw the control of the resources of government from the direct influence of the citizens.

42:36It's one thing to knock on each door and say, good man, give me your taxes, it's your government. Robin Hood, when the sheriff from Nottingham comes in, takes away the last penny from the very poor people. So that rouses resistance, that rouses people like Robin Hood to spring into action. That is also the reason why governments which are dependent on mere taxation remain moderate. Governments who can use public debts to some extent are already much less under control. They don't have to ask anybody to strike a deal with somebody who will lend them some money and they always find such persons because these persons know the government has the is a special resource of taxation, and they are even less controlled if they can rely on the printing press.

43:34So, certainly getting rid of the printing press and thereby of public debts is a good thing. Myth number seven, deflation creates unemployment. Now, whether labor or not, the unemployment of a factor of production comes about only in two cases. Case A, if the owner of the factor is not willing to rent it out at the price offered to him. Case B, if the law is preventing from doing so. It is therefore not true that declining wage rates bring about unemployment by any sort of inner necessity. People are not just unemployed, they choose not to work for somebody at the wage rate that he offers to him.

44:20It is clear that no sane person will accept to work for somebody else if the wage rate does not allow him to survive anyway. So if somebody offered you in a present circumstance is, okay, you're going to work for me for two cents an hour, well, you would do it because you couldn't go on very long like this. But that is not the situation that we face in deflation. Because in deflation not only wages go down, but all prices go down. that is the footstuff and other things in which the survival of our workers depends goes down as well and usually these prices decline even faster than weight rates and the last time we had in Germany any decent deflation in the periods the years 1931 to 1933 approximately we had a reduction of weight rates of some 10 to 20 percent now that certainly that can hurt But it's not a catastrophe. Imagine if you had 10 to 20 percent less. Well, you're poor fellows and so on.

45:19But even you could survive. Even you could survive with 10 to 20 percent less. And imagine that on top of that, the prices for all the things that you like, like cinema tickets and beer and what you guys consume, all this will go down. So you wouldn't even necessarily be worse off. Involuntary unemployment might arise in the deflation only if the letter is combined with minimum wage laws, which prevent the worker from offering his services at lower rates. But clearly in this case, unemployment is not the result of deflation, but of minimum wage laws, which infringe on freedom of association. Myth number eight. Deflation entails unequal and arbitrary burdens for the citizens.

46:08Now, it is true that deflation does involve heavy burdens for many individuals, as I have just said, well not for you though. Just consider the fact that today the great majority of US households have incurred considerable liabilities, usually in the form of real estate mortgages. If the contraction of the money supply sets in, household incomes will decline and it will be impossible to pay back these liabilities. It will then be necessary to renegotiate debts and some individuals will have to file individual bankruptcy. It is also true that deflation has unequal consequences for the individual citizens. Some will prosper in a deflationary environment, others will fare worse than they would have fared if the deflation had not set in. Finally, it is true that these redistributions are often difficult to square with one's notions of what is just and unjust.

46:57So where then is the myth? The myth consists again in the belief that only deflation entails unequal and arbitrary burdens for the citizens. So the idea is that if we didn't have deflation, well, how everything would be perfect and equitable and so on. It's only the evil, evil deflation that brings about redistributions that are unjust and burdensome and arbitrary. The truth is that the present inflationist regime is no less redistributive and arbitrary than any deflation could possibly be. Inflation constantly redistributes income from people who offer genuine services to people who happen to enjoy political alliances with the masters of the printing press. Even if inflation is used only to prevent an impending deflation, that is, if it is used to reflate, oh yeah, there's a whole vocabulary that you have to learn.

47:50There's not only inflation and deflation, there's also disinflation and reflation. And then there are different definitions of what deflation is all about according to some. So deflation means an absolute price level that is deflation, right? So the price level goes down, then according to some others, it means, well, until now, the price level has increased by two percent. If now suddenly we have a slower growth rate, only one percent, that is deflation. There's another school, there's always the next frontier, right? That says, OK, the relevant thing that we have to consider is the expectations. So if the market participants expected 5% inflation rate and we offer them only 3, that is also deflation.

48:36So the fantasy is usually unlimited. And of course this whole thing only serves to cover up the effects of the present inflationary regime. So even if inflation is used only to prevent an impending deflation, these arbitrary and unequal redistribution effects cannot be avoided. The very last thing, the least thing we could say is therefore that deflation is certainly not more unjust, not more arbitrary, not more unequal than inflation. But as I will explain in a minute, there are in fact very tangible benefits to be derived from it that make it actually better and preferable to continued inflation. But before I come to this, another short point, myth number nine. It will take decades to settle deflation induced legal disputes.

49:26That is a very prominent argument in the arsenal of one Austrian economist, who otherwise is an excellent economist, but who happens to have a weak spot on deflation. on Deflation. He might ask, have I not been too over-optimistic in assuming that deflation might be a matter of a few hours or days? Is it not rather likely that deflation will upset a great number of long-term contracts, from mortgage contracts over industrial bonds to real estate leases? And is it not rather likely that it will take the course some twenty years or so, that is the number that has been given in the literature, some twenty years or so to sort out all the different claims and counterclaims. Now it is true that while the adjustment of the price structure to the new deflation created conditions might take just a few hours or days, but could take much longer if government interventions hamper the process, the settlement of legal disputes could involve much longer time periods. But based on the

50:30empirical evidence it is certainly exaggerated to assume that more More than a few months would be needed. Again I refer myself here to the case of the German deflation of 1931 to 1933 on which I have the only data so far and what we observe here is that in spite of all the difficulties that have been created, I saw bankruptcies and unemployment over 6 million, production was stopped in many firms, salaries and wages plummeted, mortgage was jeopardized as well as the financial titles backed up with mortgage claims. Well, so what happened was that these things were settled both within and outside of the courts.

51:18There was a huge number of cases, legal settlements that took place outside of the courts. Another huge chunk was settled within the courts. and still another chunk of problems was solved through special emergency legislation. So there was a series of four laws enacted from July 1931 when the crisis set in, with the bankruptcy of one major German bank, the Darmstädter Bank, and the last of the emergency laws was passed on December 8, 1931. So within a couple of months, all legal dispositions, legal institutions have been in place to solve the legal problems at hand and these seem to have been addressed within six months, a year or something like this.

52:08So it certainly seems to be, well, over the top to assume that things would be handled much less efficiently in the present day United States. Especially if legal scholars turn their energy into analyzing the problems that are here at stake. And I can only encourage those of you who are interested in legal analysis to keep an eye on this issue and work out maybe some sort of libertarian legal theory of deflation, which we would need. Myth number 10, I'm now approaching the end. Deflation confers no positive net benefit. Granted that a heavy contraction of the money supply is merely on equal footing with increases of the money supply when it comes to the distribution of burdens among the citizens.

52:56But is it not the case that we have pretty well adjusted our behavior to the present inflationary environment? Whereas letting deflation happen would impose on us a readjustment? Even if this adjustment is only a temporary affair, still it involves cost for all members of society. So what are the benefits of deflation that could prompt a responsible citizen to endorse it, apart from the uncertain prospect of being on the winner's side in the zero-sum, short-run redistribution process that inflation entails? So again, the point is, if the quantity of money is irrelevant, we can do with any quantity of money. So then we say, well, deflation is not worse than inflation, but the other conclusion, the other way around would hold as well, deflation is certainly not better than inflation, there is no way, no inherent reason for us to prefer a deflationary setting to an inflationary setting.

53:50But here I think the following considerations come into play. First of all, deflation is a very efficient mechanism to speed up adjustment to new circumstances in the wake of a major financial crisis. The reason is, as we have noticed above, that deflation affects the prices of factors more than it affects the prices of consumers' goods. And as a consequence, deflation increases the spread between selling receipts and cost expenditure. In other words, the interest rate, and that creates powerful incentives for increased savings and investments. That is, of course, the argument that Rothbard emphasized in his treatment of deflation in Man Economy and State. And now consider the present context, so the reaction of the Fed officials is exactly the wrong way around.

54:41I said, oh, we have now this financial crisis, now the only thing that we need to make sure is that it, that is, inflation does not happen again. Whereas in the light of sober economic analysis, it's precisely the other way around. Let it happen because it will speed up the adjustment process. Of course, it will not be allowed to happen because of the political cost that it involves. So here the following second consideration comes into play. Deflation is a one-time process that, however, has the potential to destroy the very institutions that produce inflation on a perennial basis. In particular, fractional reserve banks and fiat money producers, which we call central banks, misleadingly.

55:26The destruction of these institutions eliminates the advantage at the margin enjoyed by liability finance as compared to auto finance. In other words, economic and social power is taken away from the feds and the banks and returned into the hands of individual citizens. Firms will operate on a far higher equity basis than before and households will, in more cases than before, save, first save, and then buy a home. Furthermore, the destruction of the inflation machine will destroy the main financial engine of the welfare state. Governments will henceforth have to obtain their resources exclusively through taxation, which is subject to far greater social control than the unworthy stealth method of gaining resources by inflating the money supply. So this brings me in conclusion to myth number 11. Letting deflation happen is passivism.

56:18In the light of my discussion it is clear that letting deflation happen must not be simply equated to an apathetic resignation before the power of mysterious and blind forces and market mechanisms. Deflation can fulfill extremely useful social functions and those who cherish individual liberty and the sanctity of private property are on good grounds in consciously striving to let deflation run its course. If anything, it is letting inflation happen that amounts to a pathetic resignation. Resignation that is before the power of a money monopoly that thrives on ignorance and which benefits political networks at the expense of capitalistic civil society.