Monday, January 5, 2015

Where Does This Crazy Idea Come From That Falling Prices Are a Menace?

By Peter Schiff

The sudden fall in the price of oil provides a unique opportunity to examine the widely held belief that deflation is economic poison. As many governments and central banks have vowed to fight deflation at all costs in 2015, the question could hardly be more significant.

While falling prices may strike the layman as
cause for celebration, economists believe that it can kick off a nasty, and often inescapable, negative cycle, which many believe leads inevitably to a prolonged recession, or even a depression. However, these same economists acknowledge that falling energy prices may offer a stimulus, equivalent to an enormous "tax cut," particularly for lower and middle income consumers for whom energy costs represent a major portion of disposable income. They suggest that the money consumers and businesses no longer spend on gasoline and heating oil could be spent on other goods and services thereby creating demand in other areas of the economy. Even Fed Chair Janet Yellen, a staunch advocate of the economic benefits of rising consumer prices, has extolled the benefits of falling oil prices.

After considering these competing tensions, most economists agree that falling energy prices are a net positive for an economy (except for oil exporting countries like Russia and Venezuela). But the fact that there is even a debate is shocking. It should be clear to anyone that consumers individually, and an economy collectively, benefit from lower energy prices. As I mentioned in a column late last month, no one buys energy for energy's sake. We simply use it to do or get the things that we want. The lower the cost of energy, the cheaper and more abundant the things we want become.

But if we all can agree that lower energy prices offer a benefit, why can't we make the same conclusion about food prices? Wouldn't consumers get a huge "tax cut" if their grocery bills fell as dramatically? How about health care? Wouldn't we all be better off if our hospital and insurance bills fell dramatically from their currently insane levels? Come to think of it, why wouldn't we be better off if the price of everything fell?  When does too much of a good thing become too much?

Modern economists tell us that while it's okay for one or two sectors to see price dips, the danger comes when prices decline across the board. Their theory is that if consumers believe that prices will fall over time that they will curtail their purchases to get better deals down the road. Even if the overall dip is relatively small, just 1% annually for example, they believe any amount of deflation will eviscerate demand and kick off a cycle where depressed demand leads to weak sales, which leads to business contraction, layoffs, and further depression in demand thereby renewing the downward cycle.

But the truth is that deflation is not the menace to consumers and businesses that governments would like us to believe. Common sense and basic economics tell us that prices fall for two reasons: Either an excess of supply or a lack of demand. In both cases falling prices are helpful, not harmful

For much of our history, increased productivity increased the supply of goods and forced prices lower. Falling prices made former luxuries affordable to the masses, and in so doing made possible the American middle class. Based on data from the Historical Statistics of the United States, the many periods of sustained deflation did not halt American economic growth in the first 150 years of the Republic. (Sustained inflation did not become the normal state of affairs until 1913, when the Federal Reserve was created).

Prices can also drop when demand falls due to economic contraction. Any store owner will tell you that if customers stop buying and inventories get too high, the best way to create new demand is to mark down prices. This is basic supply and demand. Demand rises as prices fall. In this sense, falling prices are not the cause of economic contraction, but the market solution to depressed demand.

But today's economists are rewriting this fundamental law. In their eyes, demand rises as prices rise. This is the equivalent of a physicist suggesting that the law of gravity forces objects to repel from one another, and that a stone dropped from a rooftop will fall upward. They further stand logic on its head by concluding that falling prices are the cause of the reduced demand. (It's like blaming rain on wet sidewalks, and concluding that the showers will stop if the sidewalks can be dried.)

Economists also argue that falling prices will harm business and lead to unemployment. They forget that falling prices also mean falling costs and increased sales, which lead to higher profits, more capital investment, greater production, and higher real wages. Henry Ford succeeded, and his workers prospered, not because he raised prices, but because he lowered them. Cheaper Model T's did not impose a burden on the public or compel Ford to lower wages. More recently, the tech industry has prospered, and has paid its workers well, by consistently lowering prices.

As a result of these ideas, economists advocate for policies that push up prices. But all this does is kill off more demand and prolong the slump they are trying to cure.

Since Janet Yellen acknowledged the beneficial effects of falling gas prices to consumers, I wonder if she could name even a single category of goods that would impose a burden on consumers if it were to fall in price? My guess is that she can't. If a decline in the price of any individual product is good, then a decline in the price of all products simultaneously is even better. Am I the only one who notices the inconsistency in this logic?  

Perhaps this disconnect can shed some light on a topic that central bankers are desperately trying to keep hidden in the shadows: Falling consumer prices are good for the consumer and the economy, but they are bad for central banks looking to maintain asset bubbles and for governments looking for a graceful way to renege on their debts.

If we continue to insist that falling prices are the cause of economic malaise, we will continue to produce economies where malaise is the only possible outcome.

Peter Schiff  is Chairman of gold bullion dealer SchiffGold and CEO of stock brokerage firm Euro Pacific CapitalHe is the best-selling author of The Real Crash: America's Coming Bankruptcy - How to Save Yourself and Your Country.


  1. peter should do another video where he talks to consumers at gas stations and asks them if they are postponing their fuel purchases because prices might be lower next week.

    1. I've said this elsewhere: I have run out of gas 4 times in the last month waiting on prices to fall further.

  2. I would love to hear one of the lapdog media hacks ask Ms. Yellen to cite a single example of someone delaying a purchase because it might be 1% cheaper in a year. She'd be left yammering.

    Strip away all the intellectual mumbo-jumbo and you're left with one inescapable conclusion: the deflation scare is cover for stealing our purchasing power so that Uncle Sam can continue spending uncontrollably.

    1. People do actually do that. Lots of people held back from buying the new Xbox One because they knew the price would go down in a year or so. Others paid the higher price to have it NOW. The real point is that the central planners are saying that the time preferences and values of the individual people don't matter, and all should conform to the central planner's time preference, which always to be spend spend spend NOW.

  3. While I wholeheartedly agree with the sentiment, people DO sometimes delay major purchases in the face of falling prices. For example, I need to buy 200 gallons of heating oil sometime this winter, but I have been delaying while oil prices continue to fall.

    1. Yes, the real point here, though, is that your are exercising your own time preference with regards to the value of heating oil and whether or not the savings is worth not having the oil sooner. This is something the central bankers and economists who propose the doom of deflation can't have. You see, you must spend your money now, or borrow so that you can spend more so that the economic metrics they use will look good in the present. That's what really matters. GDP. Never mind your own silly personal system of value and time preference or the fact that if you wait and save, you will be able to afford both the heating fuel and more later, meaning more economic activity in the future. What matters is now. So do the American thing and patriotically spend your money right now. Do your part to make the numbers look good.

  4. Conservation, high quality and enduring products are favored by a deflationary environment. People who favor a "green economy" should desire a deflationary economy. The habits of thriftiness, savings and planning for the future that we admire so much in the depression era generation is a result of a deflationary economy.They understood a dollar today would be worth more tomorrow and only spent what was necessary. Throw away items were not well received. The best recycle reuse system is building things that last and do not need frequent replacement.

  5. but you will still make your purchase this winter.....

  6. Another well written article by Mr Schiff.

    Yes, simpleton and naive articles will often mis-equate one sector of the economy as if it signals the entire market. For example if oil prices are falling due to decreased demand, that could mean a economic contraction. But I think many readers here will agree that oil prices are going lower partly as a correction due to over speculation in oil commodity futures. This has likely caused the high prices of the last decade. Therefore, a downward correction is in order, and well deserving of those hedge funds churning the markets. These are likely toxic investments that produce little if any net wealth or productivity.

    Of course, many financial writers would love to get us panicking, by phrasing this healthy oil price correction as a doomsday scenario. I bet you they are even foolish enough to believe it.