We all understand what we mean by inflation. We buy a loaf of bread this week for £1.00. Next week we go to the shops and the loaf is £1.10. Soon enough we can’t afford the bread so we demand a pay rise. Due to pressure the boss agrees but as soon as we get the rise the whole process starts again. Sadly, the person at the end of the chain is the worker, the last in the queue to get his share of inflation in his wage packet. Inflation is clearly bad for the worker, initially.
But what about deflation? To continue the bread analogy, this week it costs £1 but next week we buy our bread for £0.90. Happy days indeed. Soon however, the boss begins to demand a wage cut because his factory gate prices are going down. The worker agrees but the boss realises that the whole process will begin again. This time the boss is at the end of the chain, deflation is bad for the boss but good for the worker, initially.
Both of these situations are highly destructive when they reach extremes. When inflation becomes extreme no one wants to keep any money, why would they when next week it buys less? This fuels further inflation so we see rapid currency destruction which is bad for everybody. When deflation becomes extreme no one wants any goods, why buy an item for £10 this week when that item will be £5 in a few weeks ? So we see rapid destruction of consumption which leads to further price falls and factory closures, resulting in huge unemployment.
Clearly, in an ideal world the inflation figure would be zero with small fluctuations on either side. Price stability becomes the norm. Good for planning, good for savers, good for workers and bosses.
The other big effect of these twin evils is their effect on debt especially on the large scale. Imagine a country that owes out 100 percent of GDP and where inflation is high, doubling prices every five years. Well after five years, without paying a single penny off the debt, that debt has magically reduced to 50 percent of GDP. The government is happy. On the other hand, imagine this same government lives in a deflationary environment. After five years the debt has grown to a massive 200percent of GDP and the government will be in crisis with bond investors refusing to buy government debt.
Governments that run large deficits (and as a result end up with huge debts) are terrified of deflation. These governments are unable to target zero inflation, instead they have to target at least a few points of inflation to avoid disaster. Inflation may well be good for an indebted government but it’s bad in general for the masses. In this scenario the government is trying to create a situation that is actually bad for its own citizens and has become the enemy of its own people in a sense. Inflation used as a tool by reckless governments punishes those who have saved, those who have been sensible, by reducing the value of their savings. Conversely, those who have been reckless, and have spent all their money, over borrowed and spent that as well, are rewarded.
The bigger the government, the bigger the deficits in general. The Eurozone is a zone of big government and even bigger deficits and is currently tipping into deflation. The people in charge are terrified and rightly so because the effects of high deflation on those countries in the EU which are mired in huge debt could be catastrophic. So what is their answer? Negative interest rates. Yes, it only applies to banks leaving overnight deposits with the central bank at the moment, but the message is very clear. Savers in Europe are going to be punished and probably for a long time to come.
Any sensible person can clearly see that lowering taxation would see increased business activity and with it GDP growth. Deflationary forces can be overcome by increased business activity but of course because the governments in the EU are so deeply mired in debt they dare not reduce taxes. Like the fangs of giant vampires the EU superstate is going ever deeper into the bloodstream of its citizens.
The conclusion is that if you want to live in a world of big government with big debt:
• A world where savers and people who have been sensible get punished long and hard
• A world where people who borrow and spend and then spend again get rewarded
• A world that is hell bent on trying to create inflation at all costs to cover its own debts
• A world of high taxation
then the thing to do is be a full paying member of that elitist club called the European Union.