Deflation Made Simple (Part I)

A falsely vilified phenomenon (Image 026)

Money debasement had been observed since Ancient Greece. Certainly it had been brought to the attention of the Catholic Church in the mid-14th century by a French Bishop named Nicole Oresme, ironically a close advisor to another Charles V named Charles, the Wise, of France.

Bishop Oresme made it clear to the king that a tainted medium of exchange would taint all transactions and thereby undermine the integrity of all commerce and society, as a result. The good king listened to his spiritual advisor and standardized the money of his kingdom.

What occurred in France and sporadically across Europe in the 14th century was not the same as the widespread surge in the real money supply on the Iberian peninsula and across the entire continent of Europe in the 16th century.

Yes, the newly coined metal now in circulation had surely been stolen — if not in the form of exotic art, then from the mines that produced the metal that made the art possible. This said, the metal itself had not been corrupted. The problem was that there was suddenly much more of it, and time would be needed to adapt to its presence.

When the supply of anything increases relative to its demand, its relative value to the other things against which it is traded falls. As there were no good substitutes for gold and silver as a source of real money, the price of everything else rose. Europe was experiencing widespread, general price inflation for the first time in its several hundred-year history under the rule of the Holy Roman Empire.

As with all occurrences of general price inflation — no matter its source —, there is a general transfer of real wealth from those who receive and spend the new money lastly to those who receive and spend it firstly. In other words, there is a general transfer of real wealth from the many to the few. The market mechanism for this transfer is an increase in the supply of money.

Today, we call the result of this mechanism an inflation tax, because it is generally government that receives and spends the new money firstly.

Well, governments have the right to tax, you might argue. So, who cares whether they take our wealth through direct taxation or indirectly by increasing the money supply and spending it into the economy? The effect is the same!

Such argumentation is at best partial, and at worst highly misleading, but unfortunately still much too early to explain. So, please be patient. I promise to discuss the matter at great length and with much clarity in the distant future. Remember, our first goal is to demonstrate that real money works well and to provide evidence for it having worked in the past. So, let us return to 16th century Spain and explain how the transfer of wealth occurred back then.

Those who receive and spend the new money first make their purchases before the prices of all goods and services have had a chance to adapt to the increase in the supply of money. Accordingly, those who receive and spend the new supply of money last must purchase everything at higher prices with the same amount of money that they had, before the new money now in circulation was introduced. Only when these latter are finally compensated for their effort with this new money does the inequity stop — what surely must happen, because no one works for nothing, and the demand for everything has now increased!

It is the damage that is caused until the last worker is paid that is the bitter pill for everyone, but those at the head of the line. What is worse, the pill becomes increasingly bitter the further that one is removed from the line’s head. The longest industrial supply chains are the hardest hit, and they tend — at least from an overall economic point of view — to be the most important.

In passing, keep in mind that all of these monetary adjustments are regulated by a market agent’s desire to hold liquid wealth (real money) as a proportion of his total wealth (Images 10-12). Further elaboration of this point will be saved for a more distant discussion, as well.

Since those who have only their labor to bring to market are always the last in line in any given industry or market, workers — both skilled and unskilled — are nearly always the hardest hit. Also, depending on how hard they were taxed by landlords faced with rising prices, even peasants in the 16th century were generally better off than paid workers. For, after all, they could simply raise the price of their produce in the market place with no additional effort.

Only when workers realized that the purchasing power of what they were paid had diminished would they begin to complain and demand more. Importantly, their labor was now in greater demand, and they were in a good position to bargain for higher wages. Indeed, more of everything was now in demand, and labor was no exception. Workers tended to be landless and mobile and enjoyed considerable clout as a result. They could change their employment and offer their labor services to the highest bidder.

But, what about those who were no longer bringing anything to market but their savings — namely, the single elderly. These people could never escape the perverse effect of price inflation unless they were invested in the production of others and were receiving the benefit of the higher price-adjusted incomes. Indeed, for the non-invested, everything was now more expensive, and there was no market mechanism for them to adjust to the general increase in prices. In the 16th century the Church was generally the first to learn about such hardship.

Church clerics were among society’s best educated people. So, these latter set to work in an effort to understand the phenomenon just described. As a result of this effort, an entire new school of economics developed at the Spanish Universidad de Salamanca located west of Madrid between the northern city of León and Seville. The name of the school was the Escuela de Salamanca. The School of Salamanca remains today, and it is from the writings of this school’s 16th-century scholars from which you can obtain the best understanding of what was occurring in the economies of Spain and Europe at the time of King Charles V, the Emperor of the Holy Roman Empire.

In closing, inflation is a more complicated issue in today’s society in which the entire global money supply has been corrupted. So, please be patient until we have reached that stage of our discussion.

See you tomorrow!

In liberty, or not at all,
Roddy A. Stegemann