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Beer…is there anything it can’t do?

Explain deflation?  Why yes it can!

On the heels of this report that British pub drinkers have been warned about higher beer prices next year due to a poor barley harvest and higher taxes on the brew, many a raconteur has advised the masses to drink heavily now.  You know, as a hedge against inflation.

Amusing as this might be, it provides an apt analogy for the false specter of deflation.  We are told by many a mainstream economist that deflation is far worse than the alternative of inflating the money supply, and that it will even lead to economic armageddon.  Except that it doesn’t.  Inflation favors persons and institutions which load up on debt and are run inefficiently, such as governments and highly-leveraged companies.  After all if you borrow $100 today and only have to pay back the equivalent of $90 next year, you’re ahead of the curve.  Because of this, many who would otherwise be far more prudent are incentivized to take on debt, leading to cataclysmic results when bubbles burst and bottoms drop out of the market.

Deflation on the other hand does none of this.  It incentivizes savings, and it encourages people to invest their money rather than rush out and use it for consumption right this very second.  Those people and institutions that are well-suited for deflationary times are those which are not reckless. 

So how does beer help explain the difference?  Remember that the standard refrain of deflation-doomsayers goes like this:

  1. When prices fall, people put off spending money in anticipation of further price reductions.
  2. When prices for their goods and services fall, companies’ profits fall.
  3. When companies’ profits fall, companies lay off workers.

 

The problem with this is the fact that people cannot and will not put off most of their purchases.  Just like it is ridiculous to suggest that drinking several kegs of beer all at once is a good way to avoid drinking higher-priced beer through next year, it is ridiculous to suggest that people are interested in underconsuming due to deflation – at least to the point that the economy collapses.  Not to mention the fact that the effects of putting off spending take into account only the effects of spending!  Where people are incentivized to invest rather than spend, the aggregate total of consumption spending will certainly go down by some measure, but it does not logically follow that money is sitting idle.

Likewise, if one were to define deflation without reference to the money supply, say, as the condition under which prices fall, it would not logically follow that people would buy less.  When prices fall, people find themselves able to afford what they previously could not, and they are thus more likely to buy it.  This is a form of deflation that is seen over and over again in the free market.  Whereas HD televisions were well over $10,000 when they first came out, you can pick one up for a few hundred now.  Are people buying fewer?  Even in medical care, where the government does NOT intervene, prices fall.  The average price of LASIK surgery in 1999 was over $2000 per eye.  Now you can get it done for a few hundred per.  Are fewer people having LASIK surgery?

Deflation is not really that scary of a prospect.  What is scary is having all of your savings and investment cut out at the knees by inflation.  Economists ought to know that it pays off in the long run to incentivize responsibility.  Raising the alarm on inflation does the opposite. 

Perhaps they’re all just drinking massive quantities of beer?

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