Sowell’s Basic Economics: Deflation, Part One

Note: Though there are still a lot of errors and misrepresentations in this short section (pp. 373-378), it is not nearly as convoluted as the one on inflation. So we are going to take our time and enjoy this.

On page 373 Sowell writes, “From 1873-1896, price levels declined by 22 percent in Britain, and 32 percent in the United States … output was growing faster than the world’s gold supply. While the prices of current inputs and outputs were declining, debts specified in money terms remained the same – in effect, making mortgages and other debts more of a burden in real purchasing power terms than when these debts were incurred.”

First, it should be noted that the Western world was on the Gold Standard and the money supply was not shrinking. In other words, no deflation was occurring. Inflation and deflation, in a technical sense, refer only to the supply of money increasing or decreasing.

The most important thing about the money supply is that, ideally, it does not change. If it does change, it should neither increase nor decrease by very much, very quickly. There is no real optimal supply level. If newer techniques of production and better tools are invented which push down the costs of production and thereby put downward pressure on the prices of consumer goods, this ought not to be seen as a bad thing as it demonstrates than man is making advancements in his struggle against scarcity.

Now let us address the debt issue. Over the 23 year period from 1873-1896, prices fell by 32% in the United States. That is an average drop in price of 1.4% per year and is far more stable than 2% inflation per year that we experience today.  The fact that prices were falling and the overall purchasing power of the dollar was increasing put pressure on debtors to make extra payments toward their debts and pay them off or avoid going into debt unless it was unavoidable. Contrast that with today’s economy where the money is losing purchasing power and most people are in debt as a lifestyle. Debt is now a cultural norm. With the dollar losing its value at about 2% a year, it almost makes sense to buy everything you can on credit.

Have you heard of time preference? The basic idea is that – all things being equal – supposing there is not any interest and the values involved are perfectly stable over the allotted time, a man will prefer a good sooner rather than later. It is more desirable to have a it all now: a candy bar today rather than a candy bar tomorrow, a laptop next week rather than a laptop next month, a new car next month rather than next year. As the saying goes, “There is no time like the present.” When the value of money is decreasing the way it is now, inflation magnifies the time preference and makes it even more acute. Not only would I prefer a new car next month – heck, right this minute – but why should I hold my savings in the bank where it is losing value while I continue to save toward the future purchase of a new car? Next year a new car will be more expensive than the one on the lot today and my money will be worth less. I would rather use any savings as a down payment and take out a low interest loan to cover the rest.

On the other hand, when the money is increasing in value relative to the price of goods and services this usually has a tempering effect on time preference. The consumer will look at the car market and determine that though he might like to have a car right this minute, the wise thing is to continue saving his money. The money saved will be worth more in a year or two and the price of the new car will be even lower than it is now. 

As far as debts being more of a burden, there is some truth to this, but those already in long term debt can always refinance to more favorable terms or buckle down and pay off their debts early. 

While something in the amount of the average mortgage would be a pain in such circumstances, it would also be much easier to save and buy a home with cash, or with a greater down payment than what anyone approaches today.  Besides, a fellow locked into a mortgage in a “deflationary” economy could be said to be paying more in real terms. We should not forget that everything else he has to buy is getting cheaper.

Sowell finishes off the paragraph by saying, “Farmers were especially hard hit by declining price levels because agricultural produce declined especially sharply in price, while the things that farmers bought did not decline as much, and mortgages and other farm debts required the same amounts of money as before.”  

There is only an inkling of truth to this. You need to consider the time that separates investment from return. A man might spend money today, in 2016 prices, to buy apple trees and then have to wait 4 years before his first crop of apples appears that he will then sell at 2020 prices. In a deflationary setting the farmer may be said to lose money, but apples may have been one dollar a piece when he planted the trees and only 90 cents a piece the first year he sold his crop. The purchasing power of the 90 cents was the same when he sold as one dollar was four year earlier when he planted.  When you look at what his money would exchange for on the market from one time to the next, not much has changed.

Nevertheless, times were hard for farmers in this era and that has to do with tariffs. Tariffs were extremely high in this era, and it was these tariffs and not an appreciating dollar that put a burden on farmers. I have written on tariffs in previous posts, but I think they will get covered again as we work through this book.

See you soon.

Inflation. Yes, again.

Note: I had written a whole play-by-play analysis of this section (pages 366-373) of Basic Economics by Thomas Sowell, but it is so boring and long I’ve decided it isn’t worth being put on a blog. 

We are going to whittle this down drastically and not trouble ourselves with all the different ways Sowell errs on inflation. I’ll try to simply give an explanation of what inflation is while keeping his errors in mind. There will be coverage of this section of Basic Economics in more detail in an eventual upcoming e-book and you can join The Mean Austrian email list for updates on that.

So, let’s get down to it: (Pry those eyelids open and try to not run away. It may sound familiar, but I promise it’s – relatively -short.) 

– The Mean Austrian


Scarcity is one of the key features of money and an important feature to keep inflation from drastically hitting an economy. When government has control over the money supply, and that money supply is paper backed by nothing of true worth – as the U.S. currency is today – there is nothing to stop the government from printing out more money. And more money. And more money still. This inflates the money supply (i.e., inflation).

The result is that as more gold comes on the market, it is valued less. The more there is of something the less it is worth. On the flip side, generally speaking, the less there is of something the more valuable it becomes. This is true of everything from bread to baseball cards. Pretty basic stuff.

“Hold up, Mean Austrian! Might gold ever be affected by inflation?”

Yes, inflation can happen even with gold. Enter, History:

After the New World was discovered by Europeans, gold mines in America were opened and gold flowed back to the old country where this new money bid up the price of goods. But it was very minimal and happened gradually over the course of a century.

The difference between gold mines in the New World and printing presses in the U.S. is that to mine gold out of the ground and ship it across the Atlantic was a costly and risky venture. It took a lot of tangible resources to bring that gold into circulation and thus the inflation was limited by the pocketbooks of the entrepreneurs and their backers. Under the Federal Reserve, there is nothing limiting the the increase in money. It is little more than a matter of paper and ink. No risk, high “reward”.

While there can be inflation with gold-based currency, that inflation would never be runaway inflation. The only thing keeping us from experiencing the runaway inflation the Wiemar Republic went through, and that Venezuela is currently experiencing, is the relative good sense of Janet Yellen.


Governments, in some sense, ultimately rest upon the acquiescence of the people. If the taxes get too high, people become unruly. The solution then is to tax as much as you can get away with, and for whatever expenditures remain unmet, simply print the money.

Yes, you guessed it: This inflates the money supply! It devalues the money already in circulation and it steals the purchasing power of every consumer in the country. This is a hidden tax and the most regressive tax. A sales tax may be at 8% of every dollar a poor man spends, but inflation takes 2% of every dollar the poor man doesn’t spend every year. This flat-out discourages saving money and if the man wishes to improve his current financial situation it makes it all the harder.

I’m pretty sure we’ll deal with other aspects of inflation as we move forward.  Deflation is right around the corner, so I’ll leave it here for now… I wouldn’t want to overexcite anyone all in one post.

I should also apologize for the delay. Blame my cows and computer. I know I do. For those of you who are still following along despite the delay, I really do appreciate you!

When Do People Not Want Money?

When do people not want money? The question arises from a passage of Basic Economics found in chapter 17, pages 365-366, that reads, “Usually everyone seems to want money, but there have been particular times in particular countries when no one wanted money because they considered it worthless. In reality, it was the fact that no one would accept money that made it worthless […]”

If we are referring to natural and unmolested money that hasn’t been debased, the answer is never. However, there is another kind of money we haven’t covered yet: What about fiat money?

Fiat money isn’t the sort of money that develops naturally and spontaneously between market participants like anything Tom Sawyer and his cohorts might have considered money amongst themselves.

Fiat money is, and can only ever be, backed by law. Our money, which started out as bits of gold with inherent value, is nothing today but government issued paper.*

Just suppose gold was money and people decided they didn’t want to use gold anymore. They could still melt down their gold and reform it into jewelry. Your options with dollar bills, should they become unwanted on the market, is limited to either birdcage lining or tiny pieces of origami. Fiat currencies are pretty good at being divisible and fungible, but scarcity is another matter.

With something along the lines of gold (or silver, salt, cattle, et cetera) as money, anyone may enter into the “production of money”. The idea is, if you can bring in more precious metal (or salt or meat) for society, then you’ve earned your reward and good for you. Of course, there are some risks in this. Cattle can catch plague and be wiped out, and the expenses of mining might exceed the amount of gold or salt that you can obtain. When we have a fiat currency, not just anyone can produce money. Because it is far too easy a production, there are no risks and with virtually no costs or limits of paper and ink, one could invest a miniscule amount in paper and ink, and print out a million fiat dollars.

Thus, it becomes necessary for one entity to have the power to produce money, and thereby control the supply. They can print out new notes faster than old notes wear out and flood the money supply with them. This is the essence of inflation. Alternatively, they can stop printing notes altogether. As notes wear out, and they fail to replace them, this will cause the money supply to deflate. It is no longer a market operation, but a command and control operation. This is the same sort of thing the Kremlin did with bread and coats. Sowell seems to be critical of this inefficiency, yet the Central Banks continue to do the same thing with money today and all we seem to get are a few protests from Sowell saying  that the power they hold isn’t the problem – it’s their failure to wield this power wisely.

Sometimes the entity in control of the money makes really poor decisions, doubling and tripling the money supply by the day. As this new money enters into circulation, the value of the money plunges (i.e., inflation at work). There has never been a time in history when the economy was fine and the money was stable, and the next day the money is worthless. There is always some lead time where the money is still accepted, but at a discount. The value of money will always follow the laws of supply and demand. When money is first discounted, and then later not accepted at all, it is because the quantity of money has been drastically increased and is expected to increase significantly more in the near future.

In summation:

  1. Sowell is saying people not accepting money is what causes it to be worthless.
  2.  We of the Austrian school say that the money is being made worthless by inflation, followed by hyperinflation, and this is what causes people to not accept it.
  3. It isn’t a disastrous error in and of itself, but this is a proposition that rests on fundamentals and it’s important to have clarity as we move forward.

We’ll continue exploring inflation and deflation in the next few pages of Basic Economics. For more on this topic, help yourself to a free download of  The Ethics of Money Production by Hulsman head over to for a hardcopy.

*5/1/16 ETA: In the comments, Dan Bonin brought up a good point that neither gold, nor anything else for that matter, has inherent value. Though gold does have inherent qualities which are almost universally considered valuable.

Gresham’s Law

On page 364 of Basic Economics, Thomas Sowell makes a few remarks about cigarettes circulating as money in P.O.W. camps. He writes, ” […] cigarettes from Red Cross care packages were used as money among prisoners, producing economic phenomena long associated with money, such as interest rates and Gresham’s Law.”

A footnote reads, “Gresham’s Law is that bad money drives good money out of circulation. In the P.O.W. camp, the least popular brands of cigarettes circulated as money, while the most popular brands were smoked.” This isn’t exactly right.

For Gresham’s Law to be in force, legal tender laws need to be in place, which fix an exchange rate between two monies. If the law designates 1 ounce of silver to exchange for 1 ounce of gold, but the market exchange rate is 20 ounces of silver for 1 ounce of gold, a man will hold his gold—which is undervalued by the law—and spend only silver, which is overvalued by the law. Gold will be pushed out of the market, not because silver is a bad money, but because of laws that overvalue silver and undervalue gold.

As far as the P.O.W. camp goes, we’re talking about 2 different goods when comparing the high-quality cigarettes with the low-quality cigarettes. Remembering from yesterday’s post that a desirable money is fungible (i.e., mutually interchangeable), one unpopular brand of cigarette is just as good as another is, but is not as good as a popular cigarette. While either a high-end or a low-end cigarette may circulate separately as money under P.O.W. conditions, they may also circulate simultaneously such as gold and silver have done on the global market in the past.

I speculate the reason the market chose one grade of cigarettes over another to circulate had more to do with the ease of divisibility. For example, a pair of socks might exchange for 3 low-grade cigarettes or 1.5 high-end cigarettes as a matter of pure convenience. At the end of the day, it’s just plain easier to pass around 3 cigarettes than 1.5 cigarettes.

If you want to delve into this more, see Hulsmann’s  “The Ethics of Money Production”.

What is Money?

We got into the topic of money a little bit yesterday—mostly how it developed and its humble origin as a run-of-the-mill commodity.

Money is a commonly used medium of exchange. Money has certain characteristics, which you might think would be found in a book titled “Basic Economics”,  but most economists seem to neglect this all important subject.

Money must be valuable: It is wealth, like a herd of cattle, a barn full of tobacco, a storehouse of salt, or a vault filled with gold. All of the above have been used as money at different times and in different places. Money has to be something of some value before it can ever be considered a commodity.

Next, it needs to be relatively scarce. There is a reason coins were made out of gold and silver, not iron. Today our coins are only token money, but were we to actually trade iron on its value, that would come out to about $50 per ton. For a young man taking his date to dinner and a movie, he would want to bring along at least one ton of iron and maybe a few hundred pounds change. Well, what about something along the lines of diamonds? Most simply, diamonds are too rare. Rarity is a problem. There simply are not enough floating around to be used.

Diamonds also are not fungible. That is to say, every diamond is unique. It’s impossible to consider a pricing system with diamonds—not only do you have size and carat, but also clarity. It truly boggles the mind…or mine, anyway. However, something like gold is fungible. One 1/2 ounce of gold is just as good as any other 1/2 ounce out there.

Another very important feature of a money that either allows for a more complex economy, or is brought about by a more sophisticated economy, is durability. The quality of not being used up over time is very desirous. This is why gold and silver have won out over time whereas cattle, salt, tobacco, and animal skins have finally reverted to regular old commodities.

Diamonds are durable, cattle are not—not over 15 years, at best, anyway—but neither are divisible. This is another essential to a more complex economy.  If I want to buy only 1 goat, but the going rate is 5 goats per 1 cow, what should I do with the other 4 goats? Now I’m back to bartering around to get rid of them. I only want 1 goat, I cannot trade 20% of my living cow, now can I? I can take either 5, or none. This isn’t good.  The same problem would arise with the diamond example above.

About the only things that seem to work are gold and silver, with copper making a guest appearance from time-to-time for extremely small exchanges.

I will deviate from some Austrians and add that bitcoin and crypto-currencies seem to be sound and meet all of the above criteria. Their inherent value being found in their ease of moving value through space without 3rd party participants. It’s possible to easily send any amount of value of bitcoins from a farm in Montana to a village in central America, so long as both people have internet, and with the bonus of no transaction fee. To send money through Western Union it would cost upwards of 10% of the amount sent.  That is the value of bitcoin, and had I caught upon this 2 years before I did, I just might be a rich man today.

But that should do it for the properties of money.

They are:
1) Value
2) Durability
3) Divisibility
4) Fungibility, or homogeneity
5) Scarcity

If you want a quick resource page, I recommend checking out:

It has a good, quick little run down on money, as well as plenty of resources.