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Summarizing Jorg Guido Hulsmann's Lecture on Deflation

Summarizing Jorg Guido Hulsmann's Lecture on Deflation

by Alex Merced

Listen to his Mises U Lecture on Deflation

One of my favorite topics and debates is the Inflation/Deflation debate, of Hulsmann has written extensively about putting him in my top 5 misesians (Murphy, Block, Woods, Hulsmann, and Salerno). This year his lecture was recorded much better than last years, so I was able to gleem much more of the finer points. Ok so let's sum up his argument about why growth can occur during deflation...

Three Examples Of This Good Deflation in the US:
1839-1843: Had Deflation in which unemployment remained near full employment
1870's: Where you had sustained deflation, and the most steady and robust growth in American History
1920's: Where the country went into recession, and allowing it deflate led to a speedy recovery unlike 1929.

(NOTE: In his lecture Hulsmann consciously decided to stick to the current mainstream definition of deflation as drops in the price level, not the typical austrian definition as a drop in the money supply, there is a difference.)

How do Prices Drop from Productivity Gains:

A pully system makes accomplishing a task easier by extending the distance of which I must exert force. So for example to pick something up 3ft I may have to use a force of 10, but if I use a pully and pull 10ft worth of string and only need to use a force of 3, so now with a force of 10 I can pull the block up 9.3ft. As you can see, by extending the distance the productivity has increases, and the structure of production works the same.

For Example Let's Use Hulsmanns Example of the Farmer

Structure One - The Farmer Plows the Field by Hand

Structure Two - Someone Raises the Horse -> The Farmer Uses the Horse to Plow the Field

Structure Three - Someone Mines Steel -> Someone Assembles Parts from Steel -> Someone Assembles the Parts into a Tractor -> The Farmer Uses the Tractor to Plow the Field

So looking at these three it should be obvious structure one would be the most expensive structure of production. In this scenario the farmer would either lose a lot of time plowing the fields himself, or money having to hire many worker to plow for him, so the end good would be more expensive. Although, in structure three, the farmer may be able to plow the whole field by himself in little time with the tractor so his goods would be cheaper. So as the structure of production grows, production becomes more productive, which means the goods can be cheaper, this is the kinda of productivity based price deflation we see in technology all the time.

Next Point: What if deflation occurs cause changes in the supply or demand for money? (IE people want to save more)

In an Equity Based Economy (people + businesses pay cash, little to no debt in the economy) - Producers who do not anticipate the price deflation with lose money when they can't sell their goods at the previous market price. In order not to lose money again the producer will renegotiate the costs up the structure of production making the whole structure nominally cheaper to adjust to the deflation to maintain the same profit margins. If the producer does anticipate, he may stay out of the market to not lose money and wait till some people have in order to negotiate the costs of structure of production. At the end of the day, after adjusting the structure the producer and all the higher stages of production will still have a similar margin of profit after adjusting.

In a Debt Based Economy (people+ businesses incur debt to purchase goods) - This is more painful since the debt's nominal value doesn't automatically go down with prices, so it's difficult to service the debt on the slimmer profits. Although, just like the structures of production, if the lender and borrower both want to continue on they'll renegotiate the principal (original money lent) of the loan probably at a higher rate of interest so it can be serviced in the equilibrium price level. Although not all lenders have the foresight to renegotiate so there will be a period of massive bankruptcy of borrowers and lenders purging the non-sustainable debt leaving the economy with a sustainable foundation. In the end though, new market entrants will surface with the lower costs of business to continue the structure of the production.

Final Point: Why do the elites and powerful fight so hard against deflation?

People need resources to gain power, those who are most powerful and elite in society more than likely have incurred lots of debt in the process of attaining that power. If deflation takes hold, while it doesn't change the overall structure of the economy it does ravage the elites and powerful as they go bankrupt not being able to maintain their large debts, and brings upon a proverbial political power shift to those who saved and acted responsibly under their reign of power.


Not only does deflation not destroy an economy, it actually can make it more robust as seen by historical evidence linked to at the the top. Deflation truly threatens the elite who's policies and reign causes the massive inflation that the deflation corrects, so it plays a very healthy role in making sure young fresh responsible people move up the power ladder while the old corrupt irresponsible power of old is punished for their mis-use of power and leverage.

Posted Aug 07 2010, 10:53 AM by Alex Merced