The Blessing of Falling Prices
The DVD player crashed last night. The disc wouldn’t load. Clearly, the player had gone the way of all flesh. With great reluctance, it was off to Wal-Mart to replace this appliance for the first time in perhaps 10 years. While I was there, I figured I would get a case for my iPhone.
Much to my shock, I paid about the same for both. The DVD player — and I didn’t get the cheapest one — was a startlingly low $28. I’m pretty sure that I paid $150 for my last one. Looking this up, it turns out that these were $1,000 and up in 1997, and the price has been falling ever since. The price deflation has been relentless over these 14 years, and yet, somehow, the companies that make them have survived and thrived.
And the falling prices of such hardware are nothing compared with the price of the memory used in your laptop. After 15 years of falling, prices this year have dropped completely off the cliff, to the point where the 8 gigabytes I once thought unaffordable are now practically free. By year’s end, the homeless will enjoy more access to DRAM (dynamic random-access memory) than soup.
Falling prices are a great gift to the consumer, and the whole experience of the digital revolution has demonstrated that they are no threat to free enterprise as we know it. Far from having killed technology, this sector is the main source of economic growth, jobs, innovation and productivity. Thank goodness that technology did not enjoy the same treatment as real estate after its price crash in 2008…
We tend to realize this when we look at specific sectors like technology, but somehow, when it comes to the larger macroeconomic pictures, confusion sets in. In truth, there is no reason to fear falling prices. The greatest period of economic growth in American history took place during the Gilded Age, when average prices were falling 3.8% per year, even as economic growth marched onward at 4.5%.
Today, however, the fear of deflation is pushed by the Fed at every possible opportunity. Just last month, Ben Bernanke, speaking in Fort Bliss, Texas, called falling prices “both a cause and a symptom of an extremely weak economy.” Bernanke would clarify that he means deflation induced by deleveraging and liquidation, not falling prices in response to increased productivity and innovation.
The problem with that distinction is that it is purely theoretical; it means nothing from the point of view of producers and consumers who face the same reality, whatever the cause. What’s more, even in cases of an economic bust, market prices do not lie; they are there to reveal truths about resource allocations that not even central bankers can sweep under the carpet.
So in his mind, falling prices, even of the sort that we’ve seen in the technology sector, can be seen not only a sign of weakness (which is, obviously, untrue), but also an actual cause of weakness (which is even less true). This view seems like a leftover from the Great Depression, when economists wrongly concluded that deflation was the reason for the persistence of weakness. Murray Rothbard, nearly alone, has disputed this and pointed out that falling prices are the one saving grace of a depressed economy, something to cheer, not jeer.
Afflicted with this dogma, the Fed, the Treasury and nearly everyone else set out to stop the fall in real estate prices starting in 2007. This has been a central concern of economic policy ever since, and trillions have been wasted in this endeavor. But it’s all for nought. Prices have a mind of their own, an amazing pigheadedness that disregards the wishes even of the world’s mightiest military power. The price system is the ultimate resistance force in the universe, more effective than all the insurgency operations in the world combined.
Why might the Fed be so interested in propagating the view that falling prices are a disaster? Because its main business is creating money, which always ends up watering down the value of the existing money stock, in addition to distorting production structures. Inflation is its main product. Or in our times, when the Fed’s attempt to do this has been frustrated by the banking system’s lack of cooperation, it can at least claim that it does the good of preventing deflation.
In 2009, consumer prices as measured by the CPI actually fell for the first time in 50 years. Thanks to the Fed’s intervention, this trend came to a halt and prices in general have marched upward ever since, despite the downward pressure in housing and technology. The main movers here have been the sectors where the state has the most control: education, utilities and medical care.
Counterfactuals are always speculative, but one does wonder what the world would look like today had the Fed not pushed its inflationary agenda after 2008. Would the price declines have continued? And if so, how much cheaper might everything be today after the global deleveraging that took place? It would have been wonderful for the consuming public and posed new challenges for capitalist producers to solve. It would have been thrilling to see how this would have led to a much-needed upheaval across the corporate world.
So let us speculate here. Given the efforts that the Fed has undertaken to manufacture high inflation, how can we account for its seemingly slow rate today? Why is the inflation taking the the form of a slow burn, rather than a roaring bonfire? One possible way to look at this is that it has taken the form of the absence of the price deflation we otherwise would have enjoyed in absence of the Fed’s actions. If prices might have fallen 10%, but instead rise 2%, perhaps we should include the boon foregone as a cost of the Fed’s monetary policy.
We can see, then, why the Fed has every reason to push this view that deflation is the worst possible hell in which we can find ourselves. This claim stands against all human experience. When I encountered stacks of DVD players at Wal-Mart, I experienced the right kind of sticker shock. Broaden that model to all goods and services and we would be living in a beautiful world of rising prosperity, rising value for our money and relentless innovation.
Perhaps someday, even iPhone4 cases will be reasonable.