Deflating the deflation myth: Fed chief Alan Greenspan is claiming that the specter of deflation is upon us. The truth, however, is that Fed-created inflation, not deflation, is threatening American prosperity. (Economics).

Alan Greenspan is spinning us a new tale of monetary deception. His old tale, in which he cast himself as a financial wizard saving us from the ravages of inflation, has suddenly taken a bizarre twist. No longer are we to tremble at the thought of inflation; Greenspan is now terribly worried we don't have enough of it!

Seemingly having taken root as head of the Federal Reserve, for umpteen years Greenspan has pictured himself as hunkered down over the Consumer Price Index ferreting Out the merest whiff of prices being driven up by -- who else but businessmen? This picture of Greenspan as an inflation hawk has been hugely successful with the public, taught by government, the media, and academe to believe that rising prices are the cause of inflation rather than the result. Somehow Greenspan's old tale overlooked the fact that the one and only cause of inflation is an expansion of the money supply by the Federal Reserve System itself, a power that Greenspan has exuberantly exercised during his entire tenure.

But if Greenspan's old tale has been exposed as fiction by the deplorable consequences of his bubble inflation of the 1990s, his new tale is about to do even more damage. Early in May, Greenspan uttered the dread word "deflation," while his banker cronies on the Fed's Open Market Committee announced in what passed as an explanation that a "substantial fall in inflation" is not only "highly unwelcome" but is even worse than a "pickup in inflation from its already low level." Well, now we know. The Fed is finally admitting it's not in the business of protecting the purchasing power of Everyman's dollar after all.

Overlooking this little revelation, an army of commentators and financial analysts from the World Bank to the academic world sprang into print and speech quivering with Greenspan at the mere thought of deflation. "Just like Japan!" "Just like the 1930s!" In sync with this hysteria, on May 19th the Wall Street Journal headlined: "Having Defeated Inflation, Fed Girds for New Foe: Falling Prices." "This shift came not a moment too soon," the Journal told us, for shortly afterward the government announced the inflation rate has "hit a 37 year low." After enumerating our economy's many woes and concluding they are due to "just too much money chasing too little demand," the Journal agreed with Greenspan that the remedy is more inflation.

Voices on every side, eager to enlighten us, jumped in to explain that falling prices may seem good, but are really a dreadful menace. This is because consumers spend less while they hold their money in anticipation of lower prices. Since consumer spending is 70 percent of Gross Domestic Product, a cut in consumer spending would slow the economy even further, which then would cause business to lay off more workers, which, in turn, would decrease consumer spending even more. Thus, so the explanation goes, falling prices create a downward spiral that would intensify our economic slump, increase unemployment, and end up in long-term stagnation just like Japan.

All this is economic nonsense. To begin with, it is based on the fallacy that Fed intervention can stimulate the economy, create jobs, and fix the stock market. The reality is that the only help the Fed could give for the mess it has created would be to undo its fiction and stand aside.

What Is Deflation?

But what is deflation? Do falling prices cause it? Do we have it? Is it bad? Do people stop buying because of falling prices? Is consumer spending the crux of the matter?

To answer these questions and unravel the web of obfuscation and error that has been spun, let us turn to the economists of the Austrian School of economic analysis. These economists, abhorring the political spin, are dedicated to ascertaining the real causes and effects of economic phenomena and identifying their cure if needed. Run-of-the-mill economists, anxious to "fit in" and get ahead, or protect their current jobs, have it all wrong from the start. Erroneously (or intentionally) they claim that falling prices cause deflation, just as they erroneously claim that rising prices cause inflation. Austrian School economist Frank Shostak, adjunct scholar at the Ludwig von Mises Institute (named for the 20th century's most brilliant economist who happened to be Austrian), clarifies this point: "Changes in prices do not set in motion economic conditions" (such as inflation or deflation). Instead, it is the other way around. "Economic conditions set in motion changes in prices."

For instance, genuine deflation occurs if the money supply remains stable or falls while production of goods and services increases. These economic conditions -- neither of which we now have -- inevitably cause prices to fall because there is simply less money pursuing more goods, which forces prices lower in order for products to be sold. This is the same as saying we can buy more with each dollar. Both consumers and producers, whose costs go down, benefit. Since money is a commodity like any other, the less there is of it the more it is worth. Thus, genuine deflation is far from being the black hole depicted by the Greenspan Bank. It is an expansion of real wealth resulting in a rising standard of living for everyone on every level.

This insight also demonstrates that production, not consumer spending, must come first as the source of economic progress. Austrian School economist Mark Skousen wrote in his May investment letter:

Production, not consumption, drives the economy. Consumption is the effect, not the cause of prosperity.... Supply creates its own demand. I use Seattle as an example. When Microsoft did well, Seattle boomed as income and consumer spending rose rapidly. But when Microsoft came under government attack and business declined, income and consumer spending also declined. In short, productivity, entrepreneurship and hard work create jobs and prosperity. Granted, customers are necessary to buy what business produces, but no nation can advance economically only by consumption; new products and lower prices come from the creative entrepreneurial skills of business people, not consumers.

Wages, of course, also decline monetarily in deflation. This is always cited as a disaster. Left unmentioned is that the lower monetary wage buys more than the former inflated wage. This is because prices decline further and faster than wages, just as prices rise much faster and further than wages during an inflationary period, a true disaster we are all familiar with. By pumping up the money supply, the Fed forces prices to rise, which is obviously a form of theft, making us all much less wealthy than we otherwise would be.

Inflation Benefits Government

The government, however, perpetually desires inflation because it benefits enormously. First, it uses depreciated dollars to help float away the national debt; i.e., it pays interest to the holders of Treasury securities with dollars worth less than the dollars used originally to purchase the securities. Second, the government uses the newly created dollars first before they become worth less by increasing the amount of money already in circulation. No country with a central bank and a currency not tied to a precious metal (which describes them all) has ever had the character or plain intelligence to resist inflating its currency, lured by the unshakeable belief that more money is better. Hans Sennholz, adjunct scholar at the von Mises Institute and emeritus Professor of Economics at Grove City College, wrote in a May 17th essay:

Declining prices do not call for contravening central bank maneuvers.... Actually, whether the given stock of money is large or small, it renders the desired exchange service. The popular notion that an increase in the stock of money is economically desirable is one of the great fallacies of our time. It has lived on throughout the centuries embraced by kings and presidents, politicians and businessmen.... It has shattered numerous currencies, inflicted incalculable harm.... It springs forth, again and again, no matter how often economists may refute it.

For instance, for a brief period (1880-1896) the U.S. experienced a genuine deflation. There was no central bank; the currency was stable. Production had taken off following the Civil War. Wholesale prices fell on average by 1.8 percent per year while income grew at 5 percent per year.

Contrary to current woeful prophecies, the Great Depression of the 1930s is not an example of deflation. To extinguish -- and secretly reap profits from -- the runaway inflation bubble that Fed Insiders had created during the 1920s, the Fed suddenly and drastically turned off the money spigot, causing the stock market crash. The economy, if left alone, would have adjusted to this lower money supply and no depression would have resulted. But this severe money supply reduction was accompanied by a collapse in production as FDR handcuffed the entire economy -- from agriculture to manufacturing to finance -- with fascistic notions of total control from Washington. This was a case of a lust for power, not an example of a deflationary environment.

Neither is Japan an example of deflation. If it were, Japan would be thriving instead of languishing in recession for 12 years. The problem in Japan, as explained by Hans Sennholz, is that "political blunders and economic follies are depressing the Japanese economy." Sennholz notes that ever since the Japanese bubble burst in 1990, the government has been frantically trying to spend its way out of the meltdown, always preventing needed corrections and adjustments. There is no deflation abyss that can swallow an economy, says Sennholz, but "there are abysses that swallow countries with governments that conduct abysmal policies."

Like Japan, we do not have deflation, or even the threat of it. Every sign points in the opposite direction. As of this writing, gold is $367 per ounce, up from $323 one year ago. Why is gold rapidly escalating? Because, having real value, it rises as the dollar's value falls, acting as a hedge. The dollar is down 24 percent versus the euro and 13 percent versus the yen. Why? Because there are far too many dollars versus these foreign currencies, even though they themselves are seriously inflated, plus the fact that Greenspan has knocked down the official interest rate to 1.25 percent, the lowest in 45 years. Meanwhile, the European Central Bank has kept its rate higher.

To knock down the U.S. rate, Greenspan bought billions of dollars worth of U.S. Treasury bonds on the open market with a flood of new money created out of thin air by writing checks on the Federal Reserve, which has no money. (This does not change the national debt of over $6 trillion -- only the ownership.) These checks went to Federal Reserve banks where the scam of fractional reserves multiplied their face amount 10 times. The money supply has risen $67.6 billion, or 9.6 percent, since one year ago. There is no sign that Greenspan is selling bonds from the Fed's own massive hoard (about $600 billion) to pull money out of circulation, as he would be doing if he were not trying to pull the wool over our eyes.

As is to be expected, prices of the majority of goods and services are reaching new highs while falling prices are narrowly confined to goods such as cars, appliances, televisions, and computers that have been falling for a number of years due mainly to foreign competition and technical advancements. Nor do statistics verify that these falling prices have caused people to postpone buying. Between January 1992 and January 2003, the price of appliances fell over 20 percent while sales increased 129 percent; the price of personal computers fell 80 percent while sales increased 127 percent. But anyone who spends over two cents knows that the price of haircuts, greeting cards, plumbers, insurance, houses, veterinarians, drugs, natural gas, electricity, gasoline, household help, yard help, admission to sporting events, and auto repairs (to name a few) are higher than ever, while tuition at leading colleges has hit an astounding $38,000 per year.

Correction, Please!

Clearly, our problem is inflation, not deflation.

If we don't have deflation, what do we have? In a few words, we are having a shake-out. We are seeing the inevitable bust following Greenspan's inflationary bubble of the past decade. All the maImvestments, overemployment, excessive expansions, high inventories, and especially the exorbitant debt of businesses and consumers must be shaken out and unwound. As Frank Shostak explained in an essay posted on May 13th on the von Mises Institute website:

Once the bubble is burst this undermines various non-wealth-generating activities that sprang up on the back of the prior monetary pumping....This [undermining] is welcome news because it indicates that the diversion of real wealth from productive activities has been corrected.

American businessmen and entrepreneurs are unwinding the mistakes of the easy money of the boom in a hundred ingenious ways to cut costs and boost productivity. Manufacturers are correctly slashing their work forces, consolidating operations into fewer and more efficient plants, raising revenue by tacking on service fees for maintenance, closing excess distribution centers, and wheedling deals out of suppliers. Some are reducing the number of parts and raw materials suppliers, giving the remaining suppliers more sales volume in return for lower prices. Rather than expanding into new buildings, some companies are clearing out inventory to free up floor space. Other companies are scheduling employees to work longer shifts but fewer days. In this way the plant is never idle and no one has to wait to use equipment. These efficiencies, though painful in the short term, are exactly what must be done and are good news, although reported as bad news supposedly proving that the economy is in extremis.

In his world-famous book Human Action, Ludwig von Mises penned a warning for central bankers just like Greenspan:

Any attempt by government to prevent or delay this post-bubble adjustment merely prolongs the stagnation.

This is precisely what Greenspan is doing by dishonestly calling for more inflation as the "cure for deflation." His claim that "inflation is now sufficiently low that it no longer appears to be much of a factor in the economic calculations of households and business" is pure hogwash. Far from inflation being a nonfactor, people have come to expect that rising prices are inescapable and must be figured into everything from insurance policies to writing a will to a child's education to next week's food bill. Certain U.S. Treasury bonds are indexed for price inflation, as are Social Security payments.

Greenspan's insistence that the present inflation rate is one percent per year is absurd in the face of the billions he himself and George Bush are pouring out. Greenspan is taking this inflation figure from the Consumer Price Index. Although all government figures are suspect, the CPI is probably the most untrustworthy of all. The Labor Department chooses a "basket" of products and compares the average price level with that of the previous year. Exclusions and inclusions enable the government to produce whatever inflation level it needs for its own purposes. One of its purposes is to keep the annual increases in Social Security payments as low as it can get away with.

At this particular moment, Greenspan needs this fabrication to make his call for more inflation seem justified and reasonable. For cover, he is even hiding behind a pretense of ignorance about this strange new thing called deflation. As reported by the Wall Street Journal on May 22nd, Greenspan declared that another reason for avoiding deflation is that it takes the Fed into a world it doesn't understand well:

Inflation obviously is something that for a half century we've been struggling with. Not having had any experience in the modern world dealing with deflation, our knowledge base is virtually non-existent.... We now have been putting very significant resources into trying to understand, without actually seeing it happen, what this phenomenon is all about.

Coming from Greenspan, this is absolutely ludicrous. How do we know he is dissembling? Because it is safe to say that probably no other person has the depth of understanding of money, or of the fine art of its manipulation, or of the consequences of each and every monetary maneuver, that Greenspan has. This is why he is where he is. His astuteness on all sides of the subject of money is legendary. During the 1960s he was a brilliant proponent of a gold standard as the only way to protect our property from rapacious government. Thirty-seven years ago he wrote:

Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of society.... This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the hidden confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.

For a long time, however, Greenspan's allegiance has not been to truth and honor but to his Insider bosses who have raised him to the pinnacle of fame and fortune. According to Murray Rothbard in his indispensable book The Case Against the Fed, from its conspiratorial beginnings the Fed has been controlled by the financial empires of the Morgans and Rockefellers whose agents wrote the Federal Reserve Act and lyingly maneuvered it through Congress. The key to controlling the economy is the Fed's monopoly of the issue of bank notes, which means it can consistently inflate and keep the inflation going indefinitely. In short, the business of the Fed is to inflate and thereby control bank credit expansion through the scam of fractional reserve banking.

In the beginning the Morgans were on top but are now junior partners in the powerful Eastern Establishment led unchallenged today by the Rockefellers. Nevertheless, no one ever becomes Fed chairman without intimate ties with one or the other financial empire. It is one thing to set up a cartel but another thing to select the "right" people. Paul Volcker was a longtime prominent servant of the Rockefeller Empire, having been an economist for the Rockefellers' Exxon Corporation and for their headquarters institution the Chase Manhattan Bank. Alan Greenspan sold his gold-standard soul for 30 pieces of silver and suddenly emerged as a member of the executive committee of the Morgans' flagship commercial bank, Morgan Guaranty Trust Company.

Will Greenspan's call for accelerated inflation be disastrous?Yes, for the purchasing power of our dollars. Yes, for continued liquidation of the bubble's excesses. Yes, for a permanently sound economy and stock market.

And yes, there is a great danger we might become like Japan. Greenspan is following the same disastrous route.