2.8 Supply of Gold Problem - Fear of Deflation
 |
| Gold |
In light
of the above, it is argued that countries which transition to a Gold Standard
would clearly not be able to maintain current prices and the realignment of
prices would occur leading to significant levels of price deflation across all
sectors of the economy. After this initial drop, then relative stabilization
would occur.
At the
heart of this criticism of the Gold Standard is the aversion and irrational
fear of deflation. To refute this dogma, an analysis of the supposed harms of
deflation will be discussed along with an alternative view of how deflation can
be a positive force in the economy, not being a trigger for recession and also
a positive force behind the distribution of wealth in an economy. Deflation is
argued as a bigger evil than inflation for numerous reasons including the
following:
- It increases the burden of debt as debts increase in real terms as money is worth more when prices are falling.
- It is suggested that people will delay purchasing goods and services in anticipation of prices falling further with an attendant fall in demand thereby leading to a vicious spiral towards recession and ultimately depression.
- It renders monetary policy ineffective as there is no incentive to borrow and therefore no way that central banks can instigate a self-sustaining recovery. Some theorists such as John Maynard Keynes called this phenomenon a liquidity trap.
In
response to this charge it is clear that many products have experienced rapid
sales growth during prolonged phases of deflating prices due both to
technological advancements such as the growth of ecommerce, or periods where
growth in output has outstripped the supply of currency. The former would cause
prices to deflate in specific sectors of the economy whereas the latter would
cause a general decrease in the prices of all commodities as the ratio of money
to goods and services would fall and a smaller quantity of money would need to
cater for a larger volume of trade and hence each unit of money would be worth
more in real terms (manifested in a drop in prices).
Trade and
investment is not inhibited by prices that fall as a result of increasing efficiency.
The growth as a result of the industrial revolution is ample evidence of the
case where entrepreneurs can effectively anticipate and predict price and cost
trends and make informed decisions in the present time to ensure maximum
benefit. Had this not been true, then the declining cost of communications
technology would have seen many technology companies go out of business instead
of an increase in growth and market presence as new market participants can now
afford such products thereby increasing sales even further.
One of
the reasons cited by the Keynesian school for deflation being a precursor to a
recession is that while the selling price of goods and services are falling,
cost prices, especially wage costs, are resistant to a corresponding fall and
as such business start to increase redundancies which has an effect of lowering
the overall level of demand in the economy which further exacerbates the fall
in prices into a perpetual downward spiral until the government steps in to
break the process and starts to exert its own demand through starting projects
to compensate for the private sectors shortfall in demand.
The
challenge here is to demonstrate how the costs of production can fall to enable
businesses to remain competitive in such a deflationary climate and thus not
suffer the ill effects described above. If businesses were able to drop their
input costs and by so doing preserve their profitability, they would be
relatively immune from the effects of declining prices.
Price
inflexibility especially downward cost price movement can occur in areas such
as labor costs where it is referred to as ‘wage stickiness’, or in other
factors of production such as rent on land, due to long term leasing contracts
which are hard to renegotiate. Wage stickiness can occur due to psychological
factors as individuals look to the nominal rather than the real value of money.
This concept is known as ‘money illusion’ as the phenomena where workers will
be less inclined to accept lower pay despite the fall in prices than they will
argue for their wages to rise when prices rise. If workers realized the
contradiction they would be less likely to resist wage cuts especially if they
saw the wider implications on their job prospects and on the wider economy.
Flexible labor
markets are therefore a necessary condition to counter the negative effects of
falling prices in product markets. In Islam there are various concepts such as
the notion that Allah provides the sustenance and also a clearer concept
towards value, in this case the value of money as defined by its purchasing
power, to ensure the market does not suffer from such inflexibilities.
In
contrast to this notion of measuring utility as a standalone feature of a
commodity, the early Capitalist theorists (the Marginal School) adopted a
concept of value called the theory of diminishing marginal utility which
defined the value of a commodity as its utility at the point of consumption
when satisfying the weakest point of need; this level of utility enabled the
comparison of commodities for the purposes of exchange.
Money
naturally became the universal good which acted as this scale for the
measurement of the value of all things. The problem however was that with this
ratio (called ‘price’) people started to measure the value of objects through
the prism of price instead of the inherent utility of the object. Hence if the
price or absolute amount of their pay is reduced, the implication being that
this must be a bad thing.
The
implication of this confusion of looking at value through price is clearly
demonstrated in the example of the phenomena of money illusion were workers
cannot see the real value of their wages. Instead workers think about their
wages in nominal terms measuring their pay through a nominal construct in the
form of an absolute monetary amount devoid of real value, in this case real
value would be through the purchasing power of money.
Had
market participants been operating in an Islamic economic environment with
clarity over these concepts (in the case of value became confused by early
classical economic theorists) and thus been able to see value in real terms,
then the correct view of the worth of ones wage in a deflationary phase would
have resulted in workers more likely to accept lower wages knowing that the
purchasing power and hence value of their pay would not be affected as a
result. Furthermore the constant fear of inflation associated with the Fiat
system exacerbates this fear and further discourages workers to accept pay
cuts.
Furthermore,
a 1999 study in North America entitled “Why Wages don’t Fall During a
Recession” by Truman Bewley [published by Harvard University Press], which was
based on interviews with over 300 businessmen union-leaders and recruiters,
found a huge disparity between the theoretical modeling of wage stickiness and
actual causes.
The study
cited reasons such as employers fear or lowering worker morale out of fear that
lower nominal wages would lead to a lower standard of living. The study found
that employers would fear an increase in staff turnover and this is very
costly. The implication being that employers would rather lay off a percentage
of workers as a means of reducing labor costs to counteract this effect instead
of dropping wages. Clearly if the reality of money illusion was clarified, and
the view towards value was understood, then the reluctance to lower wages would
be minimized and so would the negative effect on morale which acts as an
impediment to lowering wages.
In
conclusion to this point, it can be said that wages and other input prices
would need to fall to help the market readjust to new equilibriums necessary to
avoid the downward spiral towards contraction of the market towards recession,
high unemployment and ultimately depression. However if the underlying
investment were not robust enough to withstand such shocks then it would be
better for the business entity to fail instead of being bailed out by the
taxpayer.
Finally
as far as people delaying making purchases, this is an argument which is blown
out of proportion to justify the Quantitative Easing (QE) programs that target
the creation of inflation to counteract the deflation described above. If wages
are more flexible as shown in the preceding analysis, then the incentive to
delay a purchase when wages will fall, potentially before the drop in the price
of the good or service in question negates this false dogma.
It must
be noted that advocating a bimetallic standard that’s gold and silver providing
the monetary based. The bimetallic standard will augment the money supply, as
it would not rely upon gold alone.
0 comments:
Post a Comment