The Alleged European 'Deflation' Threat Is Y2K Silly

In the 1970s IBM's first mainframe computer would have set you back $1.5 million. Today, the cost of an exponentially more powerful and functional computer operated on your lap can be measured in the hundreds of dollars.

In the early ‘80s the very rich could access the first handheld cellphone, all for the princely sum of $3,995. Nearly four grand got you a heavy phone with battery life of ½ hour, roaming charges, and annoyingly bad sound. Today, the cost of a phone that fits in your pocket, plays movies and TV, sends messages, and that easily guides you to your desired destination is a two figure purchase.

Flat-screen televisions? Twelve years ago a 46 inch cost $25,000 and up, while today you can have one for less than $500. Remember the Apple iPod? It used to be sold on a stand-alone basis for hundreds of dollars, but now iPod technology is so prosaic as to be included in the price of Apple iPhones that continue to decline in price.

All of which brings us to recent headlines in the major business press about the economic situation in Europe. One in Saturday's Wall Street Journal ominously warned "Falling Prices Threaten to Sink Fragile Recovery in Europe." You can't make this up. The aforementioned headline gives life to the famous Mark Twain quip about readers of newspapers being misinformed.

Indeed, not only do the reporters who presume to understand the European continent's economy not have a clue about what deflation is, they also are seemingly blind to the growth-enhancing tautology that is falling prices. The two are very different. To be clear, it's when prices are not declining that an economy is recessing. Yet, I digress.

Deflation is a monetary phenomenon, not a pricing concept. If deflation were about falling prices, then it would certainly be true that the U.S. economy has been in a crushing depression for much of its history. Falling prices are the norm in economically advanced societies.

Deflation, like its opposite in inflation, is once again a monetary phenomenon. Inflation signals a currency value in decline, while deflation points to a currency's value that is on the rise. And since currencies have been floating in value since 1971, it's not credible to measure them against one another. Yes, the euro has soared against the dollar since 2001, but since the dollar has been mostly weak during that time, the euro's relative strength isn't very telling. In that case, many use an objective measure of value like gold.

Looking at the euro in gold terms, the yellow metal has risen 239 percent against the euro since 2001. Over the same timeframe, gold has risen 375 percent against the dollar. Reporters and economists who don't understand what deflation is mistake limp growth for deflation, but if they understood what they're vainly trying to define, they'd be talking about an inflation (decline in the value of money) problem that has beset much of Europe in the new millennium.

To see why inflation always correlates with weak growth, we need only remember that investment is the author of all economic progress. Investors are of course buying future dollar, euro, and yen (to name but three currencies) income streams when they commit capital, so when the value of money is in decline, so is the investment that powers any economy forward.

Not only has the euro been weak since 2001, but it's also been soft since 2008. Over that timeframe gold has risen 72% against the euro. Weak currency, lighter investment, and then slower growth. There's no deflation problem in Europe, but with the euro having rallied since 2013 against gold (when the dollar strengthens it's a global event, and vice versa), it's a fair bet that the European economy is set for revival. European stock markets certainly think so.

Back to prices, the fact that they're constantly falling in growing, vibrant economies is almost a redundancy. Of course they are. Falling prices signal copious amounts of competition and innovation as various economic actors compete for the business of economically productive consumers; all while searching for ways to produce a lot with as little in the way of labor inputs as possible. This is beautiful, and it explains why we can buy an infinitely more powerful computer today for a microscopic fraction of the price paid for one that didn't work very well back in the ‘70s.

What needs to be stressed about this is that what's described above - falling prices - is not deflation. If the cost of a flat-screen TV is in freefall (as it has been for years), the fact that we're spending less for televisions means we have more money to demand other goods once out of reach; thus driving up their prices. Short of stuffing it under a mattress, there's no such thing as idle money in an economy. If we're saving on flat screens, our demand migrates elsewhere; that, or it migrates toward new investment concepts.

Indeed, that's the other beauty of the very falling prices that confuse pundits and economists (think Ben Bernanke) alike. When prices are in decline as producers innovate, the reduced cost of goods signals with near certainty that investment is on the rise such that new wants can be fulfilled. The $25,000 HDTV can now be had for $250, and the money saved means that soon enough there will be massive amounts of investment in pursuit of rendering the Ultra-HDTV (prices in the $25,000 range) similarly ubiquitous and cheap. If prices aren't falling, there's not only no marketplace competition or innovation, the latter also signals a lack of investment necessary to fulfill our infinite unmet needs.

The previously mentioned Journal article that oddly tied Europe's woes to "deflation" also made the laughable assertion that "business leaders" are the most notable victims of "falling prices." Can they be serious? Apple Computer is the living, breathing definition of ferocious innovation whereby it's constantly lowering prices for its customers. This doesn't drive them away, or cause them to "hoard" their money (the latter a logical impossibility as it is) as they wait for prices to fall; rather they buy Apple's brilliant products well aware that their prices will either fall, or the product will be rendered superfluous by further Apple advances. Apple's share price is up over 13,000 percent since 1997 despite plummeting prices being the norm in the technology space that the Cupertino, CA companyoperates in.

Comical about the above is that anti-trust lawyers resist mergers out of fear that combined entities will raise prices. Were the anti-trust types among the sentient, they'd realize that no investment bank or investor would ever fund a presumed price gouger. He wouldn't simply because high prices are like blood in the water for sharks. Innovators gravitate toward them with an eye on winning the customer over with a cheaper, better product. "Falling prices" aren't something business leaders suffer, rather business leaders are able to lead precisely because they're constantly searching for ways to stay ahead by lowering prices.

Looking at Europe, there are many fathers of its presumed economic weakness, but falling prices isn't one of them. Furthermore, price declines speak to dynamic growth, not depression. As for "deflation," that was more of a ‘90s thing when global currencies were on the march upward. It has nothing to with the present despite the musings of hapless economists and their enablers in the media.