Tue, 19 Jun 2007

Deflation 2

I tried to explain my lack of understanding of people's dislike of deflation earlier, but with little success. Two people wrote saying, roughly, "huh??" So, I try again. We are used to prices constantly rising in America. That's because the Federal Government metaphorically prints up new dollar bills. With more money chasing the same goods, prices rise. That's inflation. If the Feds were to destroy old bills and not print replacements, you'd have less money chasing the same goods, prices would fall, and that would be deflation. Everybody's clear on that, right?

Now, stop printing up new dollars. Keep the amount of currency constant.

Note that we don't actually have the same goods. In a free market society, with people constantly trading for things that make them more content, value is constantly being created. With every trade, people value the new thing they have more than the thing they traded it for. They won't be willing to immediately trade again except for a higher price.

So if you have a fixed amount of money chasing higher priced goods, the price of money has to rise to match. That's deflation. Exact same situation as inflation, only mirrored. Excepting, of course, that the price of money can't go up; "price" is what we call the amount of money you need to trade for something.

The natural course of money is to become more valuable over time because there are more and better things you can spend it on. That points the way towards private currencies which could seek price stability by purposefully printing enough new currency to match the increase in total value in the economy. After printing the new currency, they pay for the printing and earn a profit by spending this new currency. They created the value that that currency represents by keeping away forgers and by recruiting new entrants into the marketplace for that money.

In this manner we could return to a system of private currency.

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