Darin: Is deflation good or bad? Is inflation good or bad?
Should an economy try to focus on a stable exchange rate for stability purposes? These are questions that many have their own opinions, while even knowledgeable people on the subject will find differences of opinion when referencing the economic theories.
Many of us, on this forum, may find ourselves as consumers so we will likely be biased on what we find is better. We would all like to buy more for less, acquire more with spending less of our own cash, I know I would.
There are two popular economic theories, Keynesian economics which believes inflation is good and Austrian theory that economics should work off of a free market society and that deflation is good and inflation is bad.
Keynesian economics is by far the more popular, as it is used all over the world.
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But, what if the we started to change our ways and saw deflation as a good thing? Would the economies across the world fail?
As many of us on this forum would likely be labeled as consumers, how happy would we be if we saw prices dropping? If our dollar gained value, we may see some prices drop consistently over time.
Imagine if the national average for gasoline was $4.00 per gallon and in a couple years it dropped down to $2.00 per gallon and had the potential to drop even further? Imagine the money you have put aside to save for a new car purchase took half the time you had expected?
Think about if your monthly grocery bill was $200 and dropped to $100? I can't imagine anyone really complaining about any of the above scenarios.
Your first thought would be that the companies selling the goods/services are the losers in this scenario. That is not the case, as they would likely remain profitable or in some cases may even see higher profits.
When we reference supply and demand, when prices drop, we can see a rise in demand. More demand may lead to more purchases, thus companies seeing higher sales volumes. To correctly determine the situation, they would have to look at units sold and not in terms of dollars. I will try and provide an example below:
Lets say that Company ABC sells mattresses. They only carry a queen size in one model (Trying to keep things simple here). Their costs of goods to acquire the mattresses is $500 per unit. They sell their mattresses for $1,000.
In 2010, Company ABC sold 1,000 mattresses. They had yearly sales of $1,000,000. The costs of goods was $500,000, thus their profit was $500,000.
Lets say in 2015, the dollar value increases which led to mattresses only having a cost of $250 per unit. If the company maintains selling their product at double its cost, we would see the price of the mattress in the stores at $500 per unit.
If in 2015, they sold the same amount of units in 2010, they would have a yearly sales volume of only $500,000, yearly costs of goods at $250,000 and only a profit of $250,000. This would appear they are not doing as good as they did in 2010, but that is not the case.
Their volume of units sold is the same and their mark-up was also the same. The costs of goods decreased due to a stronger valued currency, so the yearly sales volume they received is equal to what it was in 2010 on what it can purchase.
But, in this type of scenario, many would argue that it can be very likely that if they are able to decrease their prices accordingly that their volume of units sold would actually go up.
So right now you may be thinking, "Deflation seems like a great idea, why are we not implementing it into societies?
We looked at it from a consumer point of view, but we did not look at it from a debt holding point of view such as taking out loans. Lets say back in 2010 you took out a loan for $100,000 (maybe for a mortgage). If you had waited until 2015 to go buy that house, you would of only needed to take out a loan for $50,000 to buy the same house.
This may go beyond loans as items previously purchased and sold later such as houses. In this scenario, if you had purchased a house for $100,000 in 2010 and had it paid off by 2015... The value of your house would be cut in half while if we saw the value of the dollar drop in half instead of double, the value of your house would double.
But can we really view it as a major gain or loss as the purchasing power in amounts paid is equal to what it was in 2010?
If we could see the future and saw that the value of our dollar doubled, it would likely lead to hoarding of cash. This would not be a good things for an economy.
If everyone is hoarding, that means no one is buying. If no one is buying, companies are not making profits. Companies begin to fail and thus have to counter lower sales by layoffs or taking other drastic measures. Thus, a continuing domino effect as less employed people equal less people buying leading to more layoffs.
If we look at recent events and history, we would have seen that the central bankers see inflation as a good thing and have continued to have applied its economic principles as the value of our dollar has lost 95% of value since 1915.
Thus the good old phrase that we all may have heard by now that a Dollar today is worth more than a dollar tomorrow (Future value of money). If a dollar is worth more today than tomorrow, we are more likely to spend it today instead of tomorrow. We would only prefer to hoard our dollars with incentive (such as savings accounts or promising investments).
If we look to the dinar, we see that their currency exchange rate is stable. Their monetary base continues to expand as their country sees economic growth and population growth.
But, we see that demand is nearly non-existent and the market value is much higher than the official rate.
It would be my prediction that many people from that region do not want the dinar and may possibly not even accept it as a form of payment. This may create or further decrease the market price.
As the market price continues to fall, less and less merchants may look to accept alternative forms of payment (i.e., dollars, euros, etc).
As consumers pick up on this, even they will not care for the dinars that they hold and seek to convert them to other alternative currencies. It would be my opinion to reverse this effect by taking action on giving back reason(s) to demand dinars over dollars.
Deflation may actually be a feasible solution. I am not saying some significant value adjustment that happens overnight, but more of a pegged rate of exchange that slowly crawls and appreciates.
As the official rate slowly appreciates, the demand for dinars may return.. Too much deflation may cause hoarding, but just enough may maintain and or return previous demand to use it.
As merchants see its trending raising value, they will return to accepting it as a form of payment. As more places become accepting of it as payment, other merchants may follow suit.
I know that I have seen a similar trend in the BTC population, as the awareness increases, the demand for it has gone up along with those that accept it as a form of payment. It has slowly grown and value has appreciated.
If the CBI were to find that it has a high demand for its currency, it can exploit the demand if need be. The dollar is demanded all over the globe, thus we see that we continue to print due to the global demand.
If our demand dropped, our value would plummet as well. Global acceptance has helped maintain our value. But will the demand last forever? I doubt it..
Once the global demand starts to plummet, our value may plummet with it. I guess you can only kick the can down the road for so long.