Thursday, December 17, 2020

An Inflationary Critique of MMT

Click here to read the original Cautious Optimism Facebook post with comments

6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff closes out his now finished series on inflation and deflation fallacies by saying a few words about Modern Monetary Theory (MMT) and some of its own fallacies that relate specifically to inflation (preview link for illustrative purposes).

MMT proponent Stephanie Kelton

CO himself has posted many articles about MMT over the last year or two, and now that neither Bernie Sanders nor Alexandria Ocasio-Cortez will be sworn in as president anytime soon, the media’s recent MMT blitz has thankfully died down.

There’s no shortage of problems with MMT to criticize, but today's focus is a particularly gaping contradiction in the theory that he hasn’t yet heard articulated by other economists. That said, as much as he’d like to think he’s happened upon an original idea, someone else has probably thought of it already so anyone in CO Nation who happens to find it elsewhere please feel free to post in comments.


Two of the many policy soundbites that MMT’ers like to recite are:

“A government can no more run out of dollars than a carpenter can run out of inches”


“Taxes don’t finance government spending”

The first (dollars, carpenters, and inches) is meant to convey that so long as a government controls the issuance of its own sovereign currency and has few debt obligations in another currency (which qualifies the USA, UK, Japan, Canada, Australia, etc…) then it can never run out of money.

Ironically, a carpenter may not be able to run out of inches either, but he can easily run out of wood which perfectly exposes a huge problem with the “can’t run out of dollars” jingle. That is, yes a government can print money ad infinitum but that doesn’t lead to the creation of real physical resources ad infinitum. There may not be a dollar restraint (actually there is as we’ll see) but there is always a real resource constraint.

Sophisticated MMT proponents such as economists Stephanie Kelton and L. Randall Wray are aware of the resource constraint problem, but promote the slogan anyway which their less informed readers then repeat in social circles and online.

The second soundbite (“taxes don’t finance government spending”) is a paradoxical proverb meant to convey another novel MMT insight: governments can simply instruct their central banks to create and lend them all the money they wish to spend, and taxes only serve the purpose of ensuring the currency’s continued use since governments can require/force their citizens to pay their taxes in that currency. Hence, the public can never completely refuse to use the money and governments can finance their spending programs with borrowing from the central bank’s fountain of paper instead of new taxes or spending cuts (those two fiscal tightening methods being so politically difficult to sell to the public).

Put these two together and we now have the foundation behind the third and crucial MMT claim:

“We can have a Green New Deal, universal basic income, universal socialized medicine, free college education, a government high wage job guarantee, and all sorts of other expensive progressive goodies without raising taxes.”

Not only is this one of MMT’s linchpin selling points, as it promises a huge something for nothing, but it also lays the groundwork for one of the MMT’ers’ favorite rhetorical traps.

When MMT’ers declare the government has no constraint on spending for programs that will literally cost dozens or even hundreds of trillions of dollars—from a current federal budget of only about $4.4 trillion annually—and skeptics retort that “you’ll have to raise taxes sky high to pay for all that,” they savor the opportunity to pounce on the uninformed neanderthals: “Don’t you realize taxes don’t pay for government spending?” The Economics Correspondent has seen many an MMT disciple beam with self-satisfaction believing they have stumped their opponents with such an intricate enigma.

So let’s assume this claim is correct—that government doesn’t have to raise taxes but can still provide a gigantic cornucopia of expensive social programs through massive moneyprinting and borrowing. And whenever debt loads appear to be getting too high, it’s no problem because “a government can never run out of dollars” and the central bank will keep lending whatever it takes to service the debt.


The obvious problem with this theory—quickly recognized by even the layman—is that the moment government spends the new money and it enters circulation the economy will experience price inflation. And when confronted with this problem, many MMT’ers will claim that their visionary form of government financing isn’t inflationary.

One response they use draws from traditional Phillips Curve Keynesianism: If the economy is not at their definition of full employment (which is far below the conventional 5% definition) and idle capacity still lies unused, all that new money won’t be inflationary because it will stimulate more production. Now we already saw that theory flop during the 1970’s stagflation era but let’s grant them for the moment that they really can print away with no consequence so long as unemployment remains above their definition of full employment.

Once their definition of full employment is reached, MMT’ers will argue that there’s still far more room to print money without inflation because everyone is underestimating the extent to which government can stimulate more production with all its deficit spending. Although given that inflation reached double digits in the 1970’s even with stubbornly high unemployment, I’m not as willing to just accept that claim as an article of faith.

The Economics Correspondent was even told once by an online MMT sycophant that printing money isn’t even a source of inflation at all. When confronted with the Equation of Exchange (mv = py) he simply declared the formula invalid without providing a shred of evidence. That’s all it took. Like saying “The law of gravity is not valid, let’s all jump off the Brooklyn Bridge now that I’ve proven there’s no danger.” With the wave of his hand, this one ingenious commenter single-handedly overturned a law of monetary economics that no academic has been able to disprove for well over a century.

BTW, sophisticated academic MMT’ers don’t argue that money doesn’t cause inflation or that the Equation of Exchange isn’t valid “because I said so.” This is also the domain of their fervent disciples.

That said, when you press MMT’ers hard enough, especially the trained academics, they will finally admit that there are limits to how far a government can go printing money before inflation becomes a problem. They rarely express this limitation voluntarily, preferring to lead their followers into believing the printing press can deliver endless gifts to society, and one often has to push and push and push the issue and not let it go like a pit bull. 

But eventually after enough persistence they will finally concede “Well OF COURSE there are real resource constraints. We would never say you can print money forever without eventually causing inflation.”


Once an academic MMT’er is forced to admit that there is a limit to how much money the central bank can print and lend to the government before inflation becomes a problem the remedy, almost as if automatically on cue, is “But if inflation becomes a problem, government can always tax the money out of the economy to restrain price pressures.”

As evidence:

“Taxes are one tool governments can use to control inflation. They take money out of the economy, which keeps people from bidding up prices.”

-“Modern Monetary Theory, Explained,” Vox

“Government taxes can be used to keep inflation under control, to control our behaviour (via fees and levies and rates), and to get us to produce things the government needs.”

-“ Modern Monetary Theory: How MMT is challenging the economic establishment,” ABC News Australia

OK we’ve almost reached the punchline. Up until now this is standard MMT doctrine and every economist who has scrutinized MMT has heard this line of reasoning. The final closing criticism is up next:

So as we’ve seen, the big marketing promotion for MMT, perhaps *the* biggest, is that we can have our cake and eat it too. Washington can spend $100 trillion, even $200 trillion on Green New Deals, socialized medicine, free college, universal basic income, and every other democratic socialist’s dream program “without raising taxes or cutting spending.”

But when MMT’ers are pushed hard enough on the inevitable (they say it’s not inevitable, but it is) consequence of higher inflation, they say “Not a problem because government can tax the money out of the economy.”

And therein lies the gaping hole. In the end, the free lunch proposition is false. Ultimately all the programs will require higher taxes after all—despite their promises that taxes don't have to rise—only with the added central bank middleman that prints gobs of money first.


And if anyone thinks those tax hikes will be tiny think again. During the stagflation 1970’s, a monetary expansion that will be small compared to what MMT’ers want for their enormous social programs, inflation hit 15% during some years. If prices rise 15% a year, imagine how large a share of the entire money supply Congress will have to remove through taxation to stop it—and the size of tax hikes needed to do it.

For perspective, consider that federal tax revenues today constitute about 16% of nominal GDP, yet 100% of GDP this year would become 117% or 118% in nominal terms next year, mostly due to inflation. So to get nominal GDP down to a more reasonable level of 102% or 103% of the previous year (this assumes MMT’ers don’t produce a recession with their inflation and taxes), 15% to 16% of nominal GDP will have to be taxed out of the economy atop the 16% of GDP Washington already taxes today.

The math is a little more complicated than just adding fifteen points to the tax rate but yes, Americans’ federal tax burden would nearly double across the board just to control an inflation that will appear tiny compared to what MMT’ers will produce.

In fact, historically every time governments have resorted to the printing press to pay for spending programs they quickly lose control of prices and inflation reaches rates of 25%, 50%, 100% per annum or even higher. To stop a price inflation of 50% per year, Washington would have to tax away a full one-third of nominal GDP on top of the current level of taxation, year after year after year.

And the higher monetary velocity rises, the logical consequence of rising inflation, the greater the share of the money supply the government will have to tax away to get prices under control.

Who knows, perhaps a huge tax hike is really the secret endgame of some MMT proponents. After all, MMT’ers are heavily aligned with ultra far-left progressive movements and even Paul Krugman accuses them of going too far with their big government largesse.

And there’s two more problems with the MMT panacea of taxing inflationary money out of the economy: First, it assumes Congress can even find the wherewithal to raise taxes without being thrown out of office. Raising taxes under MMT will be more politically unpopular than it is now. How many politicians will tell their constituents, already angry at rising prices, that their taxes are going up?

And assuming Congress and the White House can get the tax hikes passed without a revolt then the second and probably most preposterous assumption is that once Congress gets its hands on a huge share of the nation’s money supply elected politicians will dutifully destroy the money in the name of fighting inflation.

Anyone who thinks Congress and even presidents, when given trillions or even tens of trillions of new dollars in tax revenues to play with, won’t resort to spending it to subsidize their districts and buy votes needs to have his head checked. In fact, the Correspondent predicts that the least disciplined and most profligate spenders of that new tax revenue will be the MMT proponents themselves—the likes of Bernie Sanders, AOC, Ilhan Omar, and the rest of The Squad.

So the final result of MMT will be the worst of both worlds: higher taxes *and* higher inflation.

CATO monetary economist George Selgin, of whom the Correspondent is a huge fan, likens MMT’ers to road show salesmen promoting their latest perpetual motion machine. They promise limitless mechanical motion and energy, but when you ask them about the wire running under the tablecloth into the wall they assure you it’s nothing important. If you continue to press them hard enough and force them to answer, eventually they admit it’s an electrical cord but that it doesn’t change the novelty of their new invention. In the end, according to Selgin: “There’s nothing new that’s true, and nothing true that’s new in MMT.”

Tuesday, December 8, 2020

Inflation and Deflation Fallacies Part 6: “Cost-Push,” “Demand-Pull,” “Wage Pressures,” and a Host of Other Official Excuses for Inflation, Part 2 (wonkish)

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 The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff at last wraps up his series on inflation and deflation fallacies with its most eggheady column saved for last. What about those complex counterarguments defending the government's position on the causes of inflation?


As we discussed in Part 1, most government-provided alibis for inflation (other than moneyprinting by the central bank) can be proven fallacious due to the following axiom derived from the Equation of Exchange:

 ***If consumers and firms are forced to spend more money on any one sector of the economy, they will necessarily have less money left over to spend on other sectors, and the subsequent fall in demand will tend to lower prices for other goods and services.***

In this final chapter we’ll look at some counterarguments to this axiom by proponents of the “cost-push” and “full employment wage pressures” theories.

To read more about "cost push" and "demand full" theories go to Part 1 at:

The objections are:

1) “The claim that ‘If consumers pay more for certain products they will have less money left over to buy other goods and services which will tend to fall in price is not necessarily true. Consumers can spend more for certain products and still have plenty of money left over if their incomes are higher.”

While this is rarely the case, the counter omits one very serious problem.

The only way all those consumers can have higher incomes is either a) the money supply has been inflated, b) monetary velocity has increased, or some combination of the two. In which case the true cause of the inflation is still not cost-push due to some more expensive commodity like oil, but rather those same old traditional causes to begin with: a larger money supply or higher velocity. 

So the counterargument by its very logic places blame right back to the very culprit it's trying to exonerate.

Here’s another one:

2) “Yes, it’s true that ‘If consumers pay more for certain products they will have less money left over to buy other goods and services which will tend to fall in price.’ But as those prices fall, many firms will lose money or even go bankrupt resulting in lower output of their goods and services. So in the end the resulting fall in real GDP/output ultimately proves the cost-push inflation model.”

This one will take a little more time.

There is definitely a kernel of truth in this theory. If we use an extreme example, what if food prices were to rise fivefold instantly? A lot of consumers would be forced to set aside a huge portion of their budgets just to eat. Then car, leisure, apparel, electronics, jewelry, and other purchases would suffer horribly as would prices for all those products, ultimately leading to business failures and a lot less production in all those sectors. When production falls enough there are, in theory, the same number of dollars chasing fewer goods and voila, inflation—at least according to government economists.

The problem is where this scenario necessarily leads us. Namely, rapidly falling output is itself the definition of a recession—two consecutive quarters of it at least.

So if prices rise for 50 years straight, can the economy be in recession for 50 straight years? Of course not.


If inflation is climbing but real GDP is growing or at least stagnant then the “cost push leading to falling output” explanation is invalid.

That rules out the theory through at least 77%-85% of recent U.S. history.

Let’s take the famous stagflation era of the 1970’s for example, when government economists were blaming cost-push, wage pressures, the weather, and every other culprit they could find other than the central bank. The economy expanded in 31 of the decade’s 40 quarters (77.5%), yet prices were rising rapidly throughout the entire decade (see link, shaded areas denote recession).

So cost-push pressures can’t explain inflation for most of that lethargic decade, yet government economists were publicly blaming it the entire time.

Furthermore, during the 1980’s and 1990’s the economy was in expansion for 68 of 80 quarters (85%) and yet inflation was present all throughout—albeit at a lower pace. Again, cost-push simply has to be ruled out for most of that twenty year period.

The 2000’s and 2010’s fare even worse. The economy grew 69 out of 80 quarters (86.3%).


So if we look back at the last century or so, the only place where we can find even a tiny sliver of potential validity to this “cost-push reduces output” alibi is a few quarters in 1973 and 1974: the OPEC oil embargo. The shock was so sudden and so great that oil prices did skyrocket rapidly and the U.S. concurrently fell into recession for five quarters. Prices rose by a shocking 15% in five quarters/fifteen months!

But hold on, can we really blame oil cost-push and falling output for that short episode?

Not so fast. A quick glance at what else was happening with the conventional causes of inflation at the same time takes quite a bit of air out of the theory yet again.

During the same period the money supply expanded by 5.9%.

…and velocity rose by 5.2%

When combined these two factors alone already produce a price inflation of 11.4% (1.069 x 1.052 = 1.114) over the same period. So there’s not much room at all for “cost push causes falling output” to explain what little inflation is left.

In order for 11.4% inflation to become 15.0% inflation, we need another 3.2% price increase (2.5% annually over five quarters) or 1.115 x 1.032 = 1.15.

So at the absolute maximum, the OPEC oil embargo cost-push resulting in lower output might have contributed 2.5% annual inflation for fifteen months. And how much of that output decline can be attributed to other factors such as…

-Richard Nixon’s wage controls
-The great bear market of 1973-74 serving as a drag on consumer and investment spending
-A concurrent capital gains tax increase, and
-A two year preceding series of interest rate hikes

…is impossible to say. But for government economists to blame a phenomenon that at most could explain 2.5% inflation, or as little as zero, during fifteen months out of the last century doesn't make for a very convincing theory.

Incidentally, prices rose by 112% (!) from beginning to end of the 1970's, so trying to pin it on a “cost-push” theory that can account for at most 2.5% annualized over fifteen months is indeed missing the forest for a fraction of a tree.

And finally since “stagflation” brought constant high employment with it, none of the decade’s inflation can be explained by full employment wage pressures (another form of theoretical “cost-push” inflation) since full employment was never reached during the entire ten years.


OK, now that we’ve given the government economists their fair hearing, it’s time for a spoiler:

The entire decade-long 1970’s inflation was really caused by the Federal Reserve, which government economists did their best to divert public attention away from. The money supply for the decade measured by M1 rose by 87%...

While real GDP only rose by only 38.5%.

And velocity also rose by 40.6% which is unsurprising. Because the worse inflation gets the faster people tend to spend, or in their minds “get rid of” their money since they know it loses more value the longer they hold onto it.

With the money supply growing that much faster than the real economy, it’s no wonder that from 1971—when the U.S. went off the last remaining vestige of the gold standard—to 1983, the dollar’s purchasing power fell to 38 cents.

Just to put that in perspective, if you retired with one million dollars in the bank to live off of, twelve years later it was worth $380,000, the difference eaten by inflation.

The 163% increase in prices was not caused by cost-push, demand-pull, or full employment wage pressure but simply by printing too much money.

Which brings us yet again to the real cause of inflation that nearly everyone already knows, but government economists never stop trying to conceal. Virtually all price inflation is caused by the central bank’s deliberate policy of creating money faster than real output. Or as Milton Friedman famously said:

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

So whenever inflation picks up and economists and the media begin blaming cost-push, full employment, demand-pull, labor unions, greedy companies, or the weather, just go to the Federal Reserve’s own website to see if the money supply is growing or not.

Here’s a sample for the last sixty years that pretty much settles it. 

In the end it’s usually all about the money. Everything else is just a smokescreen.


 ps. For those interested in learning more about debunking official government rationalizations for inflation the Correspondent highly recommends Henry Hazlitt’s 1960 classic “What You Should Know About Inflation” available free at the Ludwig Von Mises Institute website.

Hazlitt is an adherent of the Austrian School and not a Monetarist, therefore he doesn’t promote the role of velocity in inflation. Nevertheless his placement of primary blame on the central bank, the money supply, and particularly his masterful disparagement of official government “excuses” for inflation is a wonderful read. 

Hazlitt is particularly skilled at writing in nontechnical terms for the noneconomist and delivering his message in short, easily digested chapters.

Friday, December 4, 2020

Inflation and Deflation Fallacies Part 5: "Cost-Push," "Demand-Pull," "Wage-Pressures," and a Host of Other Official Excuses for Inflation, Part 1 of 2

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5 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff nears the end of his series on inflation fallacies by tackling the steady feed of alibis governments and journalists offer the public every time prices start rising quickly.

In this final two-part installment we will dispel a plethora of official and scholarly-sounding inflation excuses that are routinely repeated by government technocrats and the business press. The attached article is simply a corroboration of themes contained within this article.


As we’ve discussed previously, the Equation of Exchange (mv = py) defines the only three drivers of price inflation:

1. An expanding money supply,

2. Rising monetary velocity (meaning people and firms spend and banks lend money faster),

3. Plummeting output of goods and services (money chasing fewer goods)

Of these three, the most common by far is an expanding money supply. 

For example, since the establishment of the Federal Reserve System in 1914 the money supply measured by M1 has increased approximately 31,500% (Wenzel, Federal Reserve) which goes a long way in explaining why prices are on average 2,500% higher now than they were a century ago. Yes, the dollar of 1914 is only worth about 3.8 cents today.

The second, monetary velocity, only changes rapidly during major depressions, financial crises, major price inflations, or rapid rebounds from major deflations—all exceptional events.

And finally plummeting output is, after two quarters, by definition a recession. However typical recessions only produce 1% or 2% declines in output with the steeper Great Recession of 2007-2009 slumping closer to 5% over 18 months or at a 3.4% annualized rate. Thus relentless, continuous high inflation is rarely the product of falling output itself.

So when inflation takes off, it’s virtually always due to increases in the money supply.

But whenever inflation “heats up” we begin to hear a litany of excuses—almost as if on automatic cue—flow from government agencies, Fed officials, and many economists that it’s due to anything but the central bank's creation of too much money. These alibis it turn are usually repeated uncritically within the news media.

And for those readers who are old enough to remember the 1970’s, you'll recognize most of these from the stagflation era of Richard Nixon, Gerald Ford, Jimmy Carter, and the first two years of the Ronald Reagan Administration.


Keep in mind when reading the government’s/media’s alternative inflation catalysts that the following axiom will always hold true if the money supply is indeed not being inflated:

***If consumers and firms are forced to spend more money on any one sector of the economy, they will necessarily have less money left over to spend on other sectors, and the subsequent fall in demand will tend to lower prices for other goods and services.***

So let’s review the list:

1) “Cost-Push” Pressures. This is the most common cited today. The idea is a rising price for a major commodity—such as oil—makes every product that uses that commodity as an input more expensive. Since the higher cost of the input is passed through to final products, higher prices will spread throughout the entire economy therefore driving widespread inflation.

The implication, as usual, is that inflation is being caused by something other than the central bank’s constant money creation.

While it’s true higher oil prices will make gasoline, lubricants, plastics, chemicals, etc… more expensive to produce and transport, and that the cost of oil-based final goods will rise to varying degrees, this cannot cause a general price inflation because:

If consumers and firms are forced to spend more money on products that use oil as an input, they will necessarily have less money left over to buy other products which will tend to fall in price.

2) “Full Employment” Wage Pressures. This is just a variation on cost-push using a specific and common commodity: labor. The idea is if 5% or lower unemployment is reached, competition for workers will drive up wages and therefore the price of everything else.

But again, if the price of labor-intensive goods and services rises, consumers will necessarily have less money for capital-intensive and automated goods and services which will tend to fall in price.

One might wonder how it’s possible to escape buying anything that doesn’t have labor as an input and how prices couldn’t rise under full employment. While there are some products which are not at all labor-intensive (IT-based products and highly automated production where the initial capital investment has already been made), the difference could also come out of corporate cash reserves, debt issuances, or even profit margins.

Also wage pressures don’t apply equally in full employment. The wage for IT workers in a tech boom may rise due to an insufficient supply, but many union workers might keep the same wage due to long term contracts. 

And the wage for higher paid chemical engineers may not go up much because there is no greater demand in that particular field and those workers’ skills may not allow them to easily jump to an alternative career that pays better. If a chemical engineer is unhappy that he hasn’t gotten a raise, will he really opt to flip burgers or become an orthopedic surgeon instead?

But the biggest problems with “full employment” wage pressures are first, the theory can’t even explain inflation during the majority of the time that the country is not at full employment (75% of the last fifty years)…

…and even when the country is at full employment the empirical evidence has still not supported the theory.

The U.S. was operating at full employment from late 2015 until the outbreak of Covid in March of 2020. During most of the Trump presidency the unemployment rate was below 5%, even down to 3.5% in late 2019, and yet there was no major inflationary event, nor was the Federal Reserve inclined to raise interest rates to counter inflation. In fact, all that time Fed officials and Keynesian economists were complaining that 1% or 1.5% inflation wasn’t high enough!

There was also full employment during the last four years of the Clinton administration and no inflationary event, although the Federal Reserve did raise interest rates at the very end to stem the record dot-com stock market tech bubble. 

Why no full-employment generated inflation problem? There are several reasons.

-As the unemployment rate drops, previously idle workers become employed, productive workers and total economic output grows. Rising output (more goods and services) acts as a counterbalance that lowers prices, not raises them. 

-Moreover, even at full employment new workers can still be hired who were previously outside the labor force (as we saw in the first three years of the Trump administration) which also boosts inflation-offsetting output gains.

-And as wages rise firms divert budgets away from workers and into labor-saving capital tools and machines resulting in rising output with the same quantity of labor employed (ie. higher productivity), although this process admittedly takes time.

There is even a more sophisticated counterargument in support of the wage-pressure theory with an even more sophisticated rebuttal which we will save for the final column.

3) “Demand-Pull” Pressures. This theory has fallen out of favor somewhat since the postwar decades. The idea is if there is a sudden positive demand shock for a certain commodity or product, the higher market price will spark rising inflation. 

So let’s say consumers go crazy for a new iPhone because it can actually wash your clothes, do your taxes, and run your errands for you. If people are suddenly willing to pay double the previous price for iPhones the theory states the consequence will be higher inflation.

But once again, if consumers are in this case willing to pay a lot more for the new iPhone, they will necessarily have less money left over to buy other goods and services which will tend to fall in price.

4) Finally there’s the basket of miscellaneous excuses used throughout the 1970’s such as labor unions driving up the cost of their members’ wages. Or greedy businessmen who raise prices to boost their profits. There have even been attempts to blame bad weather for inflation pressures.

Assuming any of these occur, as soon as consumers are forced to pay for more expensive products resulting from higher union pay, greedy businessmen, or bad weather they will necessarily have less money left over to buy other goods and services which will tend to fall in price.

UNLESS the central bank expands the money supply. In that case not only will consumers pay more for oil-based products, labor-intensive products, or a space age iPhone, but they'll also have enough new money left over to pay more for everything else.

Which leads us to the real problem.


All the alibis of cost-push, wage-pressure, and demand-pull seem like rearranging deck chairs on the Titanic when placed next to the real culprit: a 31,500% increase in the money supply since 1914. 

Looking at any decade period or even a few years shows the same pattern: where there’s inflation, the money supply is growing faster than output. Check out the high inflation 1970's, the decade when government economists were peddling all those theories at once:

And as if that isn’t enough to settle the matter, there’s one last important piece of empirical evidence refuting all these fictional inflation hobgoblins.

The phenomena of “cost-push,” “demand-pull,” “full employment wage pressure,” greedy businessmen, bad weather, and even some labor unions also existed during the entire pre-Fed era of 1792-1914, when the U.S. money supply was constrained by the bimetallic and classical gold standards. Yet over those 122 years prices actually fell every year on average. The only difference between then and now is the money supply grows much more rapidly today under our monopoly central bank’s fiat money regime.

We’ll wrap up inflation fallacies in the next and final chapter where we’ll dive deeper into a few of the more sophisticated counterarguments by those who contend the claim that “consumers will have less money to spend on other products” is an invalid criticism of their own cost-push theories.

Wednesday, December 2, 2020

Left Coast Correspondent: Hewlett Packard Enterprise Latest Company to Leave the San Francisco Bay Area

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The Cautious Optimism Correspondent for Left Coast Affairs and Other Inexplicable Phenomena views this news as yet another exhibit of the San Francisco Bay Area's failed economic policies... and another opportunity for those failed policies to metastasize into red states like Texas.

Hopefully the CEO will make good on his comments about retaining the work at home model. That way the HP Bay Area workers who vote woke and progressive can stay behind and continue to destroy only their own state while the company's tax dollars relocate to a new one.

Read full San Francisco Chronicle story at:

Saturday, November 28, 2020

Left Coast Correspondent: Twitter and the CCP Work to Ensure Covid Doesn't Produce Another 1644 or 1912

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1 MIN READ - The Cautious Optimism Correspondent for Left Coast Affairs and Other Inexplicable Phenomena has been known to dabble in Chinese history and gives credit to the Chinese Communist Party for one thing: they know their country’s history and all the ways thousands of years of emperors and dynasties before them were overthrown and ousted from power.

The last two dynasties, the Ming and the Qing—pronounced “ching,” also referred to as the Manchu dynasty since the rulers came from the northeastern region of Manchuria—fell in 1644 and 1912 respectively, both overthrown by the Chinese masses who were long fed up with decades of dynastic decline, corruption, poverty, and hunger.

But even though the peasantry had suffered throughout the last failing decades of both dynasties, can it be just a coincidence that major plagues broke out right before the rebellions?

A major bubonic plague epidemic spread throughout China from 1641 to 1644, 1644 being the year that armies led by peasant rebel general Li Zicheng marched victoriously into the Forbidden City as the last Ming emperor Chongzhen hung himself from a tree overlooking the palace.

A pneumonic plague outbreak struck the Qing’s home territory of Manchuria in 1910, followed by a bubonic plague epidemic in greater China that lasted from 1911 to 1912. The domestic uprising against the Qing began in 1911 and the dynasty was finished by 1912.

So in 2020 with China ruled by the Communist Party dynasty, is it any wonder that the regime will spread whatever disinformation and propaganda necessary to deflect blame for the modern plague of Covid? 

Despite the CCP’s tight control of media and information, they are not very popular with most everyday Chinese who effectively put up with them so long as the economy keeps growing. 

And the communist leadership isn’t stupid. They know plagues and epidemics at a minimum coincided with the fall of China’s last two dynasties’ 276 and 268 year reigns, and they aren't taking any chances that theirs will be cut short after just 71.

No wonder then that both they and their political allies at Twitter are determined not to let history repeat itself and will do or say whatever it takes to prevent another 1644 or 1912.

Read Fox News story: "Twitter slammed for not acting on Chinese media tweet alleging COVID-19 came from 'imported frozen food'"

Sunday, November 22, 2020

Inflation and Deflation Fallacies Part 4: “My Grocery Bill Went Up Which Proves the Country is Experiencing Inflation”

 Click here to read the original Cautious Optimism Facebook post with comments

4 MIN READ - This is not one that would typically be on the Economics Correspondent’s list, but a lot of comments in previous articles by well-meaning readers made it worth examining.

To define inflation, one has to measure it comprehensively (ie. everywhere, not a single product, industry, or sector).

Going back once again to the Quantity Theory’s Equation of Exchange tautology:

mv = py


m = money supply

v = monetary velocity

p = price level, and

y = total output of goods and services

…changes in “p” reflect macroeconomic changes in prices, ie. across the entire economy—in this case the United States. Or...

p = mv/y

And as we all know, price movements vary across industries or even individual products. 

For example, the price of healthcare has been rising relentlessly for decades, but the price of DVD players has also fallen consistently for years and years. I’ve never heard anyone argue “DVD players have been getting cheaper for fifteen years. That proves the economy is undergoing massive price deflation” and for good reason.

So if we focus on just a single sector then yes, the Economics Correspondent has seen his own grocery bill go up too, particularly during the initial months of the spring pandemic. There was definitely food price inflation in March, April, and May due to massive new demand for at-home eating combined with lower supply from Covid-related processing and supply-chain bottlenecks. 

In fact the Bureau of Labor Statistics reported in April that food prices rose at the fastest monthly pace since 1974.

(the BLS also reports food prices have moderated significantly since supply factors were resolved in the summer, something else the Correspondent has seen reflected in his grocery bill).

But to determine if the dollar is losing its overall purchasing power requires looking at all prices, not just grocery prices.

During the same period energy prices fell far below their pre-pandemic levels. So did airline fares and hotel rates. Auto insurers gave rebates to their policyholders reflecting lower claims costs. Rents in many large cities plummeted including the Correspondent’s own city. Used cars and trucks, and car and truck rental prices fell. Evidently a great deal of men’s apparel fell in price although the Correspondent can’t speak for women’s apparel (women readers feel free to comment). Nancy Pelosi’s hair stylist is even reported to have lowered her prices.

There are undoubtedly other sectors that saw falling prices but the Correspondent doesn’t track them all.

All these falling prices and other rising ones are factored into changes in the general price level (ie. price inflation).

Most people instinctively understand this whether they realize it consciously or not. If they notice the price of baseball cards is going up they typically don’t conclude the country is experiencing a major price inflation. And food prices, while a much larger component of the economy, represent only one segment of the market as well. 

So American food purchases are much larger than baseball card purchases. Food purchases represented a full 9.7% of GDP in 2019, although that includes restaurant dining which plummeted during the spring lockdowns.

But even when food prices rise, the other 90.3% of GDP must still be accounted for to draw final conclusions about inflation.

Incidentally there is another theoretical basis for not overweighting one sector’s prices too much, one we will discuss in greater length in the upcoming final column of this series. It is:

If consumers are forced to spend more on food they will necessarily have less money remaining to buy other products. The corresponding fall in demand for those other products will tend to drive a reduction in prices elsewhere.

The only reason this paradigm will fail to materialize is: 

-The money supply rises

-Velocity rises

-Output falls

….in some combination that results in such a surge in overall prices that other sectors become more expensive too.

Well during this spring that perfect combination definitely did not play out.

-The Q2 money supply measured by M1 rose 22.9% (not exact as M1 is measured by week not by month)

-Q2 real GDP fell 9.0% (-31.4% annualized)

Both of these had massive inflation written all over them, but…

-Q2 velocity plummeted a record 26.5%.

Plug all those unprecedented and volatile numbers into the Equation of Exchange and the price level for Q2 fell by 0.7% (1 x 1.229 ÷ 0.91 x 0.735 =  0.993), close to the BLS’s monthly inflation reports at the time of -0.8%, -0.1%, and +0.6% for April, May, and June.

And that’s why food prices alone can’t tell us if the entire country is undergoing inflation or not.


ps. The Correspondent believes it’s completely understandable that Americans and consumers around the world tend to equate grocery prices with inflation for several reasons:

-Human beings tend to stress what they see going up in price more than what they see going down.

-Grocery shopping is near universal. Almost everyone sees grocery prices but not everyone sees baseball card prices, bulldozer prices, or ethylene prices.

-People tend to buy the same grocery products over and over and are exposed to even minute changes in price in repeated, short intervals. In other words the act of weekly or biweekly grocery shopping provides a more frequent sampling of apples-to-apples pricing than any other consumer activity with the possible exceptions of buying gasoline, cigarettes, or paying one’s monthly cell phone or cable bills.

However people only notice the change in rent once a year when they renew the lease. They usually only notice a change in home prices when they’re home shopping, and the house they’re buying is never exactly the same house in the same location that they previously bought (unlike buying a twelve pack of Budweiser this week and a twelve pack of Budweiser again next week from the same store).

People only notice changes in used car prices when they buy another used car, and even then only if they buy a car of identical make, model, age, mileage, and options. No one concludes major price inflation when they trade in their used Kia for a used Lexus.

And people only notice their auto insurance rebates twice a year, assuming they even associate rebates with lower inflation at all.

In other words, consumers have much better and more frequent comparative information when sampling changes in food prices than they do in many sectors that experienced deflation during the spring outbreak and lockdowns. Therefore they acquire an observation bias with food prices and tend to associate them with a more general inflation.

In the last installment we’ll address a basket of fallacies employed by economists and policymakers everywhere such as “cost push,” “demand pull,” labor unions, and greedy businessmen.

Sunday, November 8, 2020

Left Coast Correspondent: Joe Biden's Miraculous Post-Election Night Comeback That Happened in Only Three States

 Click here to read the original Cautious Optimism Facebook post with comments

3 MIN READ - The Cautious Optimism Correspondent for Left Coast Affairs and Other Inexplicable Phenomena confesses to stirring up quite a discussion last Friday when he suggested that Joe Biden’s miraculous post-Election Night erasure of Donald Trump’s sizable leads in four critical battleground states may have been a little too miraculous.

The huge comeback was credited to record numbers of mail-in ballots that were still being counted after hours, a phenomenon that, if valid, should have occurred in just about every other state too since fears of Covid and social distancing are prevalent everywhere, not just in Wisconsin, Michigan, Pennsylvania, and Georgia.

As before, the four states where Biden enjoyed the largest gains after polls closed--three of them colossal (see chart)--happened to not only all be states he trailed in, but also the very four he needed to save any chance of winning as the window of opportunity had almost closed on him.

Based on the 33 states that mandate waiting until Election Day/Night to begin counting absentee and mail-in ballots, the odds of the four best-performing randomly matching the exact four Biden needed to win are 40,920 to 1.

Therefore such a miracle is not scheduled to occur again in a U.S. presidential election until the year 165,700 A.D. That’s U.S. history beginning in 1776 elapsing another 679 times before this should happen again.

The Correspondent’s friends “shared” the original story and sparked many heated debates elsewhere across Facebook with some skeptical commenters demanding more states and more data.

So Cautious Rockers get first dibs at the exclusive research available at CO Nation. Please enjoy the chart before it's fact-checked out of existence.

Note again that the four states where Biden enjoyed the largest—in three cases absolutely massive—improvement in vote percentages against Donald Trump just happened to be the very four that:

1) Remained uncalled, and...

2) Had 10 or more electoral votes at stake, and…

3) Were already long anticipated to be critical battleground states, and...

4) He trailed Donald Trump in (all four, plus NC), and most importantly…

5) He critically needed to win since Donald Trump was performing far better than polls had predicted and the window to salvage a victory was nearly closed.

ps. Note also how many points Biden needed in each state and how many he got.

WI: Needed 4.9. Got 5.6.

GA: Needed 8.9. Got 9.0.

MI: Needed 10.6. Got 13.3 (the only "not a squeaker" rebound)

PA: Needed [an incredible] 14.4. Got an even more incredible 15.0.

[End of main article. Readers who wish to know more about the source data read on]

I. Here is an example of how a state’s change in margin is calculated:

VIRGINIA: At the point that NBC News had both called a winner and the percentage of precincts in exceeded 75%, Joe Biden held 52.4% of votes and Donald Trump held 46.0%, a lead of 6.4 percentage points.

On Saturday, November 7th, after the bulk of absentee and mail-in ballots had been added to count totals, Joe Biden held 54.0% of votes and Donald Trump held 44.5%, a lead of 9.5 percentage points.

Thus Biden added to his margin of victory and gained 3.1 points (9.5 – 6.4 = 3.1)

OHIO: At the point that NBC News had both called a winner and the percentage of precincts in exceeded 75%, Joe Biden held 45.2% of votes and Donald Trump held 53.3%, a deficit of 8.1 percentage points.

On Saturday, November 7th, after the bulk of absentee and mail-in ballots had been added to count totals, Joe Biden held 45.2% of votes and Donald Trump held 53.4%, a deficit of 8.2 percentage points.

Thus Biden’s margin of defeat worsened and he lost another 0.1 points (8.1 – 8.2 = -0.1)

(It’s worth noting that Ohio was a major battleground state where a large number of mail-in ballots, largely Democratic, were expected and received)

II. Source data:

The Correspondent spent many hours combing through Election Night video from NBC News to find leading or trailing margins of every state that was called and then recorded data when the percent of precincts in exceeded 75%. Using vote percentages with only 2% of precincts reporting was unreliable and could lead to wild changes in margins leading to November 7th.

Then the Correspondent compared the leading or training margins on Saturday, November 7th when AP called the election for Biden and calculated the difference.

For the five critical states that remained uncalled (WI, MI, PA, GA, NC) the Correspondent noted the vote percentages for each candidate at 12AM ending Election Night.

Although he has data for NC, AZ, and NV, those three states permitted counting absentee and mail-in ballots prior to Election Day/Night and therefore don’t appear in the chart. Also, as of this posting North Carolina totals have not changed since late Election Night.

A few states had not yet reached 75% precincts in by the time the NBC livestream ended late at night. Therefore the Correspondent was forced to seek another livestream that ran later. However most livestreams have been taken down from YouTube and the only one he could still find was NTD--not his favorite source but all he wanted was numbers--that had later evening data on just a handful of states.

Alaska and Hawaii closed so late that no data was available in either the NBC or NTD livestreams before they ended. Therefore the Correspondent has no Election Night totals for those two states which he considers uncritical anyway. Hawaii is particularly inconsequential since absentee/mail-in ballots can be counted early in that state.

Finally, the states of Maine. Maryland, Massachusetts, and New Jersey had not reported 75% or more precincts in before either livestream ended. Therefore the Correspondent had to use Election Night data using only 58%, 67%, 73%, and 61% of precincts for those states respectively. Maryland and New Jersey are not included in the chart due to early absentee/mail-in ballot counting.

Wednesday, October 28, 2020

Q3 GDP 2020 Forecast to Grow at a Record 35.3% Annualized Rate

"The Atlanta Federal Reserve estimates that GDP will grow at an annualized rate of 35.3% in the third quarter..."

"The Economics Correspondent has access to annual GDP figures going back to 1800... ...Just one quarter after many in the media were predicting another Great Depression the economy is showing resilience with a rebound which, measured by GDP, will set a record going back to before the days of George Washington and Benjamin Franklin."

Analyzing Upcoming Q3 GDP Numbers

Click here to read the original Cautious Optimism Facebook post with comments

As CO readers may have already noticed, the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff doesn’t comment on every single monthly or quarterly jobs, unemployment, GDP, or inflation report.

But these are historic times. The arrival of Covid, government lockdowns, and then economic reopenings has generated wild swings in the economic indicators that we may not see again in our lifetimes.

Therefore it’s worth putting Thursday’s upcoming Q3 GDP report into perspective.


The Atlanta Federal Reserve estimates that GDP will grow at an annualized rate of 35.3% in the third quarter.

You’re not misreading that. It’s not 2% which was so common during the Obama years, or 3% as we typically saw during the first three years of the Trump administration.

It's +35.3%, with twenty other forecasting institutions averaging a lower estimate of about +29%.

Keep in mind +35.3% is an annualized growth rate, meaning real GDP actually grows 7.85% for the quarter (1.0785 ^ 4 = 1.353).

But whichever estimate you use—the Atlanta Fed’s or the private forecasters'—these are simply historic numbers.

The Economics Correspondent has access to annual GDP figures going back to 1800—using academic scholarly estimates up to 1944 and official government statistics afterwards. Let’s compare +35.3% annualized per quarter to past records:

Quarterly: GDP statistics by quarter are only available starting in 1947 and the record stands at 16.7% in Q1 of 1950 when the USA was coming out of a recession. 

Going back before 1947 the Economics Correspondent’s best guess for a potential rival would be the second quarter of 1933, right after the great banking Panic of 1933 (February/March). The government’s March audit of the nation’s banks and mass return of deposits by bank customers launched a strong economic comeback that was abruptly squelched that fall by Franklin Roosevelt’s National Recovery Act.

Annual: GDP by year is more interesting. Unsurprisingly the highest gains are in wartime when the government engages in large military purchases. However, wartime GDP is misleading since private GDP often suffers as government spending “crowds out” private consumption and investment spending.

Consistent with this problem is 1942, officially the highest year at +18.9% GDP growth and 1943, the next highest at +17.0%. Unsurprisingly these were the first two full years of America’s involvement in World War II, and just as predictably private sector GDP was negative in both years. So even though 3Q20 eclipses both, it’s not suitable to compare “mostly peaceful protesters” 2020 to wartime 1942 and 1943.

Thus the strongest year of private GDP growth in American history was 1946 at +18.7%. Ironically this is the same year the federal government drew down wartime spending resulting in an official GDP loss of -15.8%, but in fact it was the greatest year of private sector economic growth in American history.

Readers who are curious about the economics of the World War II spending drawdown and 1946 boom can read the Correspondent's 2019 article at:

But for now let’s compare these records to 3Q20.

An annualized gain of +35.3% is greater than double the previous quarterly record of +16.7% in 1950, and nearly double the greatest private sector annual record of +18.7% in 1946.

And it’s important to note that since +35.3% is an annualized figure, the economy would have to sustain an impressive double-digit annualized rate of growth for three more quarters to compare suitably with the entire year of 1946.

But by any measure, 35.3% annualized GDP growth in one quarter is an off the charts, unprecedented record.


So the Economics Correspondent is willing to bet his next year’s salary that when these numbers are released, the media will immediately try to spin them like wet laundry.

Fearing any good news that might reflect positively on Donald Trump and detract from their campaign's chances of victory, the Correspondent predicts any combination of these headline narratives:

1) “GDP growth lower than expected”

2) “GDP up but expected to slow”

3) “GDP up but millions still out of work”

4) “GDP growth misleading because it follows a revised -31.4% annualized loss in Q2”

5) Blackout. Or bury the story at the bottom of page B7.

Nowhere in the headlines will we see the words “record” or “historic” or “unprecedented” unless it’s in conservative leaning outlets such as Fox News or the Wall Street Journal.

But regarding the fourth and final “spin,” there is actually a lot of truth to the argument that +35.3% growth is simply digging out of the hole of the -31.4% annualized contraction of the previous quarter.

No one seriously believes the economy will be 35% larger this Christmas than it was last Christmas, so it’s true that there was a huge drop in Q2 followed by a huge bounce in Q3. An economy starting at an index of 100 that loses 9.0% for the quarter (-31.4% annualized) and then gains 7.9% the next quarter (+35.3% annualized) settles at 98.2, not 135.3.

And of course there are more quarters to come post-election which will probably raise the index further. 

Well, the index will rise assuming a giant Covid autumn/winter second wave doesn’t produce a negative enough affect on consumer behavior or worse yet a return to economic lockdowns. Most economists think the result would be a slowdown of the recovery, not a reversal, but it all depends how bad the new cases and how bad the local/state government restrictions get.

But despite the media’s likely spin that it’s only a bounce after a giant contraction, the key point is that there *is* a bounce—a gigantic, record bounce.

Just one quarter after many in the media were almost gleefully predicting another Great Depression the economy is showing resilience with a rebound which, measured by GDP, will set a record going back to before the days of George Washington and Benjamin Franklin. It’s already broken records for the pace of reduction in the unemployment rate.

Contrast the current 2020 rebound with the “recovery” under Barack Obama where the media declared him the Messiah when an isolated quarter came in at 5%, but the average over his eight years was more like 2.2% in which case it was the fault of Congressional Republicans.

Yes, yes, Obama had a real structural recession in 2009 and Trump has an economy that was artificially put to sleep and then woken back up. Yes, they are two completely different kinds of recessions, but few in the media will even try to make that distinction because it will mean first acknowledging that the economy has woken up with a vengeance in the first place.

So CO Nation will have to read it right here because you won’t get it from CNN or The New York Times. If Q3 GDP numbers are anywhere in the ballpark of the forecasts, it will be validation that the economy is rebounding from Covid-related lockdowns with a strength never before seen.

But instead we’ll probably see negative headlines about malaise, joblessness, and suffering.

And inequality. You're supposed to never, ever forget about inequality.

Saturday, October 17, 2020

Inflation and Deflation Fallacies Part 3: Why So Many Economists Get Deflation Wrong

 Click here to read the original Cautious Optimism Facebook post with comments

4/6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff continues discussing inflation and deflation fallacies by explaining why so many economists just don’t understand deflation.

As we demonstrated in the Correspondent’s previous installment on deflation, zero inflation or gently falling prices don’t cause or prolong recessions and depressions. And the USA has 138 years of history before 1914 to prove it, when prices gently fell throughout and the economy grew at breakneck speed into the world’s largest.

You can read that article at:

But in the meantime, how then could so many mainstream economists and the media (restrain laughter) get deflation so wrong?

As monetary economist George Selgin of the CATO Institute never tires of explaining, most economists don’t understand the difference between good deflation and bad deflation.


So what’s bad deflation?

Bad deflation is rapidly falling prices associated with a catastrophic shock to demand, typically the result of the many banking crises that occurred throughout the 19th century and during the Great Depression.

When banks fail in large numbers their demand deposit (ie. checkbook) balances become worthless and the money supply suffers a sudden contraction. Furthermore, during a crisis even surviving banks tighten up credit and curtail lending—a measure to conserve scarce reserves. 

As debtors pay back debts but no new loans are made, the money supply further contracts, so all other things being equal prices fall.

The most famous case of bad deflation, which virtually all mainstream economists cite, is the 1930-1933 period of the Great Depression when 10,000 U.S. banks failed, the money supply shrank by one-third, and prices fell a whopping 10% per year on average for nearly four years.

In a deflation that extreme, not only were prices falling very rapidly but the bank failures themselves and associated drying up of lending harmed the economy even more. In other words, it wasn’t so much falling prices themselves that were tanking the economy, but rather a collapsing financial system. Rapid price deflation, while certainly problematic, was as much a consequence as a cause of depression.

In such a scenario debt can also becomes a problem since debt payments are fixed in nominal terms but prices and wages quickly fall so more borrowers default, placing even more strain on the credit system.

This is pretty much all most economists think of when they consider falling prices. They're taught, and believe, that deflation of any kind must necessarily produce Great Depression conditions.


Yet as bad as the 1930’s deflation scenario is, assumptions about the extent of its malignance have to be questioned because there is historical precedent of rapid deflation that didn’t produce a Great Depression.

After the mostly-forgotten Panic of 1839, prices also fell by even more than one-third over four years in a deflation that exceeded the Great Depression’s. 

But the macroeconomic results were quite different then. As Professor Jeffrey Rogers Hummel of San Jose State University writes:

“During the Great Depression, as unemployment peaked at 25 percent of the labor force in 1933, U.S. production of goods and services collapsed by 30 percent. During the earlier nineteenth-century contraction [1839-1843], investment fell, but amazingly the economy's total output did not. Quite the opposite; it actually rose between 6 percent and 16 percent. 

"This was nearly a full-employment deflation. Nor are economists at any loss to account for this widely disparate performance. The American economy of the 1930s was characterized by prices, especially wages, that were rigid downward, whereas in the 1840s, prices could fall fast and far enough to quickly restore market equilibrium.”

-“Martin Van Buren: The American Gladstone” by Jeffrey Rogers Hummel

Even mainstream MIT former Economics Department Chair Peter Temin, himself a fairly left-leaning mainstream quasi-Keynesian cites the 1839-1843 experience:

“As some detailed estimates by economic historian Peter Temin show, the contraction in the money supply was even greater in 1839-43 than in 1929-33. The fall in the price level was substantially greater: -31 percent in 1929-33 and -42 percent in 1839-43.

"But consumption in real terms, which decreased by 19 percent in 1929 to 1933 increased 21 percent from 1839 to 1843. More dramatically still the real gross domestic product, which decreased by no less than 30 percent from 1929 to 1933, increased by 16 percent from 1839 to 1843.”

-“The Rise and Decline of Nations” by Mancur Olson

To add color to Professor Hummel’s contrast between the price and wage policies of the 1839-1843 and 1929-1933 periods, the Correspondent would like to add that during the Hoover years of the Great Depression the top federal tax rate was raised from 25% to 63%, taxes on the middle classes raised by over 100%, an international trade war was launched by the Smoot-Hawley Tariff, and federal government spending more than doubled in real terms.

So while the Economics Correspondent doesn’t want to test the theory of 10% annual deflation anytime soon, the stark contrast between the 1839-1843 and 1929-1933 periods suggests free market economies are more resilient to rapidly falling prices than mainstream economists believe. 

An over 40% fall in prices during the 19th century failed to produce a Great Depression because market prices and wages were freely floating and allowed to adjust rapidly.  And 19th century America was free from the crushing government tax and spending hikes, inflexible labor regulations, and global trade wars of the 1930's.


However there is a “good” kind of deflation too, and it dominated the 19th century with the exception of several banking panics that occurred on average every dozen years.

Good deflation occurs when the economic output is growing faster than the money supply. 

During the 19th century the United States was on a bimetallic (gold and silver) standard until 1879 when it joined the industrialized world on the monometallic classical gold standard. But in both cases, the money supply was closely linked to precious metal reserves and the pace of new mining discoveries thus limiting the rate of monetary expansion.

If, for example, the economy produced 5% more goods and services one year but the money supply, constrained by the gold standard, grew by only 4%, then assuming constant velocity the price level fell roughly 1% (104 units of new money divided by 105 new units of product = 99.05% the previous price level).

Quite the opposite from the bad deflation scenario, good inflation is associated with strong economic growth. Clearly the faster the economy grows the further prices will fall provided money growth remains restrained, or in the Equation of Exchange mv = py, rising output ( y ) results in a lower price level ( p ), all other variables being equal.

In real world practice this produced benign, gentle deflation during the Gilded Age. Annual prices fell a little slower than 1% on average from 1865 to 1914, and far from a half-century Great Depression America experienced the fastest half-century of economic growth in its history.

Unfortunately most economists are taught in school that depression is simply associated with deflation, particularly the Great Depression. They also look at the recessions and depressions of the 19th century and notice an accompanying fall in prices—a trend present throughout the entire century, not just during slumps—and conclude deflation must have caused those downturns.

Well correlation is not causation, as deflation was the norm during both economic booms and economic busts during the pre-Fed era.

And one mustn’t underestimate the impact of living in an academic and media echo chamber, where large numbers of intellectuals and reporters simply recycle the myth among themselves. 

The myth, repeated enough times, becomes the truth, although the Economics Correspondent doesn’t let academia in particular off the hook. It’s their job to thoroughly research the theory and history before opining. Too many don’t.

====OK, stop reading here unless you are an econ nerd seeking a more detailed (wonkish) analysis.====

ps. See attached visual model of good vs bad deflation.

Model 1 (“Falling AD”) is a graph of bad deflation resulting from a sudden demand shock, usually the result of a banking crisis and contracting money supply. The quantity (x-axis) of demand represented by curve AD1 shifts left to lesser demand curve AD2. Thus the intersection with long-run aggregate supply curve LRAS moves down the price or y-axis from P1 to P2 resulting in lower prices.

Model 2 (“Lower costs of production”) is a graph of good deflation resulting from capital investment and higher productivity which raises output of goods and services per unit of labor. The quantity (x-axis) of aggregate supply represented by curve SRAS1 shifts right to greater supply curve SRAS2. Thus the intersection with aggregate demand curve AD moves down the price or y-axis from P1 to P2 resulting in a lower prices.

There is absolutely nothing wrong with Model 2 as it was the real-world norm during the spectacular growth periods of the Industrial Revolution and American Gilded Age. In fact good deflation would be the norm today were it not for central banks producing new money at a rate faster than the growth of goods and services in a deliberate policy of eternal price inflation.

In the “bad deflation” environment, government intervention has historically made things much worse. If the government forces prices back to P1 (price and wage floors such as those during the Great Depression) a gap or “surplus” in quantity appears between new demand curve AD2 and supply curve LRAS. That gap—follow dotted-line P1 between AD1 and AD2—in quantity applies to both goods and services and particularly labor. 

Hence as aggregate demand fell during the Great Depression and the government forced wages up to old price level P1, the supply of labor at LRAS/P1 exceeded the demand for labor at AD2/P2, and the surplus was manifested as double-digit unemployment for a decade that peaked above 25% in 1933.