A Journal for Western Man-- Issue VIII
Dr. George Reisman
Falling prices due to increased production, however, do not constitute deflation. They do not signify any reduction in the average rate of profit, that is, the average rate of return on capital invested. Nor do they signify any greater difficulty of repaying debts. Yet a plunge in profits and a sudden increase in the difficulty of repaying debt are essential symptoms of deflation/depression.
Indeed, as I show in my book, the modest increase in the quantity of money and volume of spending that goes on under a one-hundred- percent-reserve, precious-metals monetary system serves to add a positive component to the rate of return and to make debt repayment somewhat easier, not more difficult. The falling prices caused by increased production do not interfere with this. When prices fall because of increased production in the face of an increase in the quantity of money and volume of spending, the average seller is in the position of having a supply of goods to sell that is larger in greater proportion than prices are lower and thus to be able to earn more money, not less.
Genuine deflation, the accompaniment of depression, is financial contraction—that is, a decrease in the quantity of money and/or volume of spending. This is what wipes out profitability and makes debt repayment more difficult. But such contraction is precisely what a one-hundred- percent-reserve, precious-metals monetary system prevents. It prevents it because once precious-metal money comes into existence, it does not suddenly go out of existence, as occurs with fiduciary media when the banks that issue them fail. And because its rate of increase is modest, it does not lead to any substantial, artificial reduction in the demand for money for holding, which then must be followed by a reversal when the increase in the quantity of money stops or slows.
Nor do the continuous saving and capital accumulation that go on under capitalism operate to reduce the rate of return on capital. The nominal saving that takes place out of money income, takes place largely out of a rate of return that is elevated by the increase in the quantity of money and volume of spending, and, so long as the quantity of money and volume of spending go on modestly increasing, that saving does not reduce the rate of return.
If there were no increase in the quantity of money and volume of spending, the rate of return would be lower, but stable at the lower level. Capital accumulation would proceed simply on the basis of falling replacement prices, with unchanged expenditures buying progressively larger quantities of capital goods.
As I show in my book, in such a context, the role of saving exists entirely at the gross level, where it determines such vital matters as the degree to which the economic system concentrates on the production of capital goods relative to the production of consumers' goods and the length of the period of production. The essential elements in capital accumulation then stand revealed as a sufficiently high relative production of capital goods, and sufficiently long period of production, together with technological progress and anything else that serves to increase production, above all, economic freedom.
Here, for lack of time. I must close. I'd like to do so by saying that if you've found my talk today to be of interest, I hope you will explore the matters I've discussed, at greater length and in detail in my book. Its entire sum and substance can be understood as a systematic exposition of the benevolent nature of capitalism.
(C) 2002 George Reisman. All rights reserved.
George Reisman is professor of economics at Pepperdine University’s Graziadio School of Business & Management in Los Angeles, and is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996). His book is available through Mises.org or Amazon.com. His web site is www.capitalism.net. You may contact Dr. Reisman by MAIL. See his Mises.org Daily Articles Archive, and read his interview in the Austrian Economics Newsletter.
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