March 10, 2006
Today's [Thursday's] trivial action by the BOJ has the media
proclaiming an official truce in Japan's war against deflation.
However, waging a war against falling consumer prices is the
policy equivalent of committing monetary hara-kiri. Far from
being the menace they are portrayed to be, falling consumer prices,
often incorrectly referred to as deflation, are in reality the
natural and beneficial results of rising productivity inherent
in a free market economy. They result in real increases in the
value of wages and savings, and therefore lead to rising standards
There is no doubt that Japan has suffered its share of economic
problems, but falling consumer prices, in reality one of the
lone bright spots in an otherwise cloudy picture, are certainly
not among them. Japan's economic problems result mainly from
monetary and fiscal policies designed to slow the liquidation
of the mal investments accumulated during the bubble years. The
sooner these misguided polices are abandoned, the sooner Japan's
economy can properly rebalance.
If Japan's economy faltered during an environment of falling
consumer prices, imagine how much weaker its economy would have
been had consumer prices risen instead. What about Japan's unemployed?
Would their lots have really improved if they were confronted
with a rising cost of living as well? If Japanese consumers were
reluctant to buy products even as falling prices made them more
affordable, imagine what the effect would have been had rising
prices instead made them more expensive. If Japanese companies
found it hard to generate adequate profits with their costs declining,
imagine how much more difficult the task would have been had
their costs been rising instead.
Take a step back and think about the whole subject of falling
consumer prices rationally. Suppose health care were to become
more affordable, if the cost of educating our children became
less expensive, if necessities such as food, energy, clothing,
and shelter consumed a smaller fraction of our family budgets,
if it became cheaper to travel, buy a car, appliances, or toys
for our children: wouldn't these be good things? Do central banks
really need to save us from this peril?
As far as I can tell, there are basically four flawed arguments
advanced for why falling consumer prices are bad:
1. Consumers will defer spending in anticipation of lower
prices. This argument is ridiculous on its face. First of
all, most purchases such as food or energy cannot be put off.
After all, consumers cannot refrain from eating while waiting
for lower food prices. Other purchases, such as those for televisions,
VCR's, DVD players, digital watches, personal computers, or cell
phones can be postponed. However, since prices for all of these
items have been falling for years on increasing sales, our real-world
example of the way consumers respond to falling prices disproves
2. Businesses will have their profits squeezed because of
falling prices for their goods. This argument ignores the
basic fact that costs are themselves prices. If a business' costs
are falling in line with its prices, its profit margins are not
affected. In fact, as falling prices lead to increased sales,
the net effect on profitability in such circumstances it to enhance
and not diminish it.
3. The United States had falling prices during the Great Depression,
and Japan had falling prices during its recent contraction therefore
falling prices must be bad. This is basically false logic,
because a causal relationship is assumed between two unrelated
elements. The argument goes as follows. The economy in Japan
is bad. Japan has falling prices. Therefore falling prices must
be bad for the economy. This is a false conclusion. During the
Industrial revolution, which saw the most rapid economic expansion
in American history, consumer prices fell consistently. In fact,
for the 120-year period which spanned from 1790 to 1913, U.S.
consumer prices fell. The brief exception was during the Civil
War, when for the first time the United States government issued
paper money (Greenbacks) to finance the war. This expansion of
the money supply (inflation) resulted in rising consumer prices.
When the war ended, the government discontinued the issuance
of Greenbacks, and over the years they were gradually withdrawn
from circulation. Prices resumed their downward trend, which
remained intact until 1913, with the introduction of the Federal
Reserve. It was the continuous expansionary monetary policy (inflation)
of the Federal Reserve that reversed the downward trend in consumer
prices which had prevailed since the birth of the republic.
4. Falling prices hurt debtors by increasing the real burden
of their debts. This is the one argument that has some merit.
Falling prices benefit creditors while rising prices benefit
debtors. Since most governments are debtors, as is certainly
the case in Japan, it is no wonder that inflation is the path
down which central banks chose to travel. However, since savings
make possible the capital formation vital for true economic growth,
a monetary policy designed to discourage savings cannot possibly
by considered beneficial for an economy.
In summation, falling consumer prices are the economic equivalent
of manna from heaven. By continually debasing their currencies,
central bankers routinely rob their citizens of this bounty.
The fact that they do so under the pretense of sparing them from
suffering the ravages of a falling cost of living does not alter
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March 9, 2006
C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
Barron's, Investor's Business Daily, The Financial Times, The
New York Times, The Los Angeles Times, The Washington Post, The
Chicago Tribune, The Dallas Morning News, The Miami Herald, The
San Francisco Chronicle, The Atlanta Journal-Constitution, The
Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange
Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in
finance and accounting from U.C. Berkley in 1987. A financial
professional for seventeen years he joined Euro Pacific
in 1996 and has served as its President since January 2000. An
expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial
newsletters and advisory services.