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Lagarde’s Low-Flation

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QUESTION: Mr. Armstrong; Christine Lagarde of the IMF has stated that the problem with Europe and Japan is that they have no appreciable inflation. She calls it low-flation.”  You have stated that the U.S. and Germany are always fighting their last economic war so the U.S. inflates and Germany deflates. So is Lagarde correct this time? Is there a difference between technology deflation and economic deflation?


ANSWER: As with everything, there are always two sides to every coin. It is never just black and white because the economy is highly complex.  Lagarde is correct from the standpoint that economies never reverse until inflation appears. Just look at the Great Depression. Each country reversed only when it abandoned the gold standard or devalued. As long as money is more desirable than assets, people will hoard cash and not spend concerned about the future. You can see the dollar devaluation created inflation and only then will the economy reverse. If money rises in value, that means assets must fall along with wages = economic deflation.

You cannot confuse new technology that starts out as expensive and then declines with overall economic deflation. They are two distinct trends. Technology deflation always takes place during the Schumpeter Waves of Creative Destruction. Yes, this is unfolding right now in computers and the internet area. Prices decline so you have Technology deflation, but it also displaces jobs from the old technology contributing to economic deflation.


This took place with the railroads bringing mail order and competition to Main Street. Then there was the automobile and Henry Ford’s invention of the assembly line that caused prices to plummet and $240 made the automobile affordable for the middle-class that changed everything economically. However, those in the old technology (horse & buggies) lose their jobs while generally the younger generation takes up the new technology. This is taking place right now as the internet wipes out newspapers, magazine and internet shopping like at Amazon wipe out book stores.


The combustion engine brought tractors to the farm and that wiped out jobs where in 1900 41% of Americans were farmers and by 1980 that was 3%. This is simply the waves of Creative Destruction and is not indicative to the entire overall economy. It is simultaneously inflationary on the one hand a deflationary costing others their jobs.

Miles Corak Study


Protectionism-3This introduces the issue of wages over the generational gap as well often referred to as the Intergenerational Earnings Elasticity. Unions have fought against such trends in wages losing entire industries in the process. New York use to be the largest US port where today nobody shows up at all. Unions basically gutted Detroit. Unions only look at wages for the worker at the expense of the consumer failing to grasp that the consumer is free to buy what they want. Every action has its opposite reaction. You cannot impose high tariffs on steel to protect steel workers that reduce car sales and cost auto jobs. Everything has implications that ripple through the economy as a total societal economic system. There are always the plus and the minus. They lower interest rates to try to “stimulate” demand to borrow and wipe out pension funds and the elderly who relied upon high interest rates. You cannot intervene to help one segment without destroying another.

The economic deflation is when the economy as a whole is declining and in that context she is correct. The value of money rises in purchasing power as assets decline. In the very early stage you get the traditional flight to quality. However, prolonged deflation is indeed a serious problem for people will not borrow if they do not see an opportunity to make a profit. That is the key. This is what Japan created with its low-interest rates. Merely increasing the money supply will not cause inflation. It requires people to stop hoarding cash and have confidence that there is a profit to be made.

This is where most people go seriously wrong in ASSUMING that a mere increase in the supply of money must be inflationary. That statement is fundamentally wrong because it PRESUMES people will stop hoarding if you simply increase the supply of money. All the evidence demonstrates this imaginary relationship. Inflation will erupt even when the supply of money does NOT increase – it depends upon DEMAND. If the people decide to hoard toilet paper because of a coming storm, the price will rise with demand. It has nothing to do with the supply of money. Hence, central banks, including the ECB, have been increasing the supply of money steadily to no avail, Only when people have confidence in the future economy or a collapse of confidence in government will they no longer hoard cash. It can never be reduced to a single cause-effect relationship.

Lagarde is correct in the prolonged deflation is highly destructive to the economy for money supply must grow with population at the very minimum or you will have massive economic revolts and civil unrest. If there is only $10 and 10 people than everyone can have $1. But if population doubles to 20 and you still have only $10, then each can have 50 cents. Money supply MUST increase with population or you unleash deflation. This was the problem with the gold standard. Inflation was created by discovery, not planning. There was California, Australia, Alaska, and South Africa. Each sparked waves of inflation as gold declined in purchasing power with the rise in supply. The Spanish discovery of silver and gold in the New World ruined their economy and sent waves of inflation throughout Europe.


This is what we are faced with right now. The technology deflation is contributing to the overall economic deflation from the standpoint of job destruction as prices decline making it easier to replace workers. There are always going to be undercurrents that prevent simple statements in a one-dimensional world of cause and effect. It is called simply – complexity.

Where Lagarde is incorrect is that keeping interest rates low does not stimulate the economy as long as people see no opportunity to invest for simultaneously they wipe out the ability of retired people to live off the income of their savings. This creates more deflation and stimulates nothing. Larry Summers is of the same one-way thought process suggesting interest rates have to go negative to force people to spend. Just raise interest rates and watch the action cascade.


Those that keep harping that inflation is evil because it diminishes the value of savings are only looking at savers – not investors. That is only one slice of the economic pie. To the homeowner, his house is declining in value as the purchasing power of money rises. So there is no escape. You cannot insist upon no inflation and a return to a gold standard yet simultaneously want higher wages and rising values of real estate and investment. You cannot have your piece of the pie and eat the rest too. Those who espouse such statements never really think clearly about what they are truly saying.

You cannot reduce this to a single cause and effect relationship for it is far more complex that meets the eye. This is our problem. People fail to see there are two sides to every action – never just one.