The Money Supply Contracts – Good News?
I finally got around to reading Jorg Guido Hulsmann’s Deflation and Liberty (pdf) today, which put the news that Ireland and the UK’s M2 money supply had contracted in a different light. Ireland is but a small fraction of the entire Eurozone, but the inflation/deflation debate (not just in terms of prices, but also of the money supply) is front and centre now, so surely worth finding some clarity on. From page 26:
There is only one fundamental change that deflation brings about. It radically modifies the structure of ownership. Firms financed per credits go bankrupt because at the lower level of prices they can no longer pay back the credits they had incurred without anticipating the deflation. Private households with mortgages and other considerable debts to pay back go bankrupt, because with the decline of money prices their monetary income declines too whereas their debts remain at the nominal level. The very attempt to liquidate assets to pay back debt entails a further reduction of the value of those assets, thus making it even more difficult for them to come even with their creditors…
The point is that other people will run the firms and own the houses—people who at the time the deflation set in were out of debt and had cash in their hands to buy firms and real estate. These new owners can run the firms profitably at the much lower level of selling prices because they bought the stock, and will buy other factors of production, at lower prices too.
Therefore, deflation by the collapse of a fiat money regime is really a kind of spontaneous economic revolution. As Jim Rogers put it, the credit crunch is like a brush fire – it eliminates the rot which developed over time, allowing the forest to start all over again. Given that most political incentives are to do with maintaining the comforts associated with the status quo, then, it is clear why authorities would be absolutely determined to prevent it. Where is the great Henry Ford when you need him?
Failure is simply the opportunity to begin again, this time more intelligently.
Of course, Ford also said (of the US):
It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”