Deflation Myth

by | Mar 22, 2003

U.S. Federal Reserve officials, including Fed chairman Alan Greenspan, and commentators in the financial media have been worrying about deflation (a rise in the purchasing power of a currency) in recent years and months. It’s hard to figure why. Not only is deflation non-existent, but if it did exist it would be bullish for the […]

U.S. Federal Reserve officials, including Fed chairman Alan Greenspan, and commentators in the financial media have been worrying about deflation (a rise in the purchasing power of a currency) in recent years and months. It’s hard to figure why. Not only is deflation non-existent, but if it did exist it would be bullish for the economy and the stock markets. The bearish results seen in world stock markets since early 2000 have been due, in part, to an acceleration in inflation — not to deflation.

The first sign of higher inflation came with the rise in the dollar-gold price that began in September, 1999. That decline in the dollar versus gold was followed by a persistent rise in broad commodity prices. In turn, that rise was followed (over the past year) by a depreciation of the dollar on foreign exchange markets and finally by accelerations in the rates of price inflation recorded in such backward-looking measures as the Producer Price Index (PPI), the Consumer Price Index (CPI) and the U.S. Import Price Index. In January, the PPI rose at an annualized rate of nearly 20%. You read that correctly: 20%. Yet Fed officials, Wall Street economists and the financial media continue to deny the evidence of inflation — and of higher rates of inflation. They persist in perpetuating the widespread myth that the United States is suffering from deflation. Worst of all have been the recent comments of Fed officials. When a chronic inflator — like the Federal Reserve — brazenly ignores the overwhelming evidence of ever-higher inflation and speaks of doing “everything in its power” to prevent deflation or inflate, you can be sure markets will expect even greater rates of inflation.

Financial publications of every variety have promoted the myth of deflation. Last November, just three days after the government released a PPI rate for October which showed an annualized rate of increase of nearly 9%, a reporter for The Wall Street Journal wrote that “When October’s Consumer Price Index comes out today, investors will be looking for signs of deflation.” But in the year ending January, 2003, the CPI rate was positive (2.6%), which means price inflation, not deflation. Moreover, the CPI rate in that period was 1.5 percentage points above the rate in the prior year (through January, 2002).

Thus there’s been both consumer price inflation and an acceleration in the rate of consumer price inflation. In the year ending January, the PPI rate was 2.8%, or 5.6 percentage points above the rate in the prior year (through January, 2002). Like the CPI, the PPI rate has been accelerating over the past year. Nevertheless, The Wall Street Journal two weeks ago wrote as follows: “Underlying inflation continues to recede in the face of slow economic growth and minimal corporate pricing power.” When rates of price inflation rise — and when they’ve been statistically registered as rising for at least a year — it is simply false to report that inflation continues to recede. When the gold price has been rising (with the exception of a month or two) ever since late 1999, that’s inflation — and it’s been bearish for equities.

Even in the face of accelerating CPI inflation, the Fed continues to speak of “further downward pressure” on prices and predicts lower inflation in 2003 compared to 2002. This will occur, it claims, because the economy is operating at a low rate of capacity utilization. Thus Greenspan believes inflation is other than a monetary phenomenon, that something about the use of factories causes rates of inflation to move up or down. In particular, he believes that when utilization rates are low (as they are today), inflation rates won’t accelerate.

Wrong again, Mr. Greenspan.

Periods in the United States since 1968 in which capacity utilization rates have been low have tended to precede higher (not lower) rates of price inflation (in this case the PPI rate). Utilization rates below 80% have preceded an average acceleration of 0.6 percentage points in the PPI rate, while utilization rates above 84% have preceded an average deceleration of 1.7 percentage points in the PPI rate. Given recent low utilization rates, Greenspan must be surprised that the PPI rate has been accelerating lately. But such an acceleration — while wholly inconsistent with Greenspan’s theory — is not inconsistent with historical facts.

In any event it’s evident that Greenspan is focusing on something other than the facts. Consider the more recent period (January, 1999 – January, 2003). In the graph (above), we see that the gold price has been rising, which means the dollar has been depreciating (inflating) in real terms. For much of this period the money supply has been rising, and at an ever-faster rate. Finally, we see that the PPI rate has been much higher, and has accelerated.

This certainly does not illustrate a “deflationary” episode, despite what everyone claims. All the monetary evidence points to inflation — and to higher rates of it. But has this monetary climate been bullish for the U.S. economy — or stocks? Certainly not. It should be obvious that if the current affliction is misdiagnosed as deflation — and further, if the generator of inflation (the Fed) pledges to prevent deflation and cause inflation — that cannot be good for the U.S. economy or equities. To return to the bullish period of 1996-1999, the Fed must stop inflating.

The Fed has no intention of doing so.

Recent reports confirm that, if anything, Fed members have been obsessed about non-existent deflation.

Last December, Greenspan gave a speech assuring markets that he was worried about deflation and that he’d do everything possible to make sure it didn’t happen. He promised to fight deflation by increasing the money supply even further, if necessary. As he put it, “The expansion of the monetary base can proceed even if overnight rates are driven to their zero lower bound. The Federal Reserve has authority to purchase Treasury securities of any maturity, and indeed already purchases such securities as part of its procedures to keep the overnight rate at its desired level. This authority could be used to lower interest rates at longer maturities.”

Even though Greenspan admits that central banks in general — and the Fed in particular — have a long-standing reputation for generating inflation, and even though he hints (correctly) that this is the case because such banks abandoned the gold standard, nevertheless he feels the need to “assure” people that the Fed can (and will!) inflate again. Big surprise. What is truly ominous about Greenspan’s view is that the evidence today (and in recent years) points overwhelmingly toward inflation — and yet he thinks there’s deflation. As such he promises more inflation, if necessary.

Greenspan’s deputy, Ben Bernanke, also has been pushing the myth of deflation and pledging that the Fed will print paper without limit to ensure “it doesn’t happen here.” In a speech last November, Bernanke spoke boldly of that inflationist “technology” at the Fed’s disposal — the printing presses: “By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” The markets were so “reassured” by these irresponsible central bank pledges last fall that the gold price sky-rocketed still further.

The Fed’s obsession with non-existent deflation — combined with its recent, shameless commitments to print more paper — only makes the inflation worse. There is nothing more bizarre than a central banker straining to tell the world about his inflationary prowess — except, perhaps, a central banker’s refusal, simultaneously, to see the inflation signs that are all around him. Such people live in an unreal universe of their own making, but real investors are made to suffer for it.


Capacity utilization rates and wholesale price inflation

Averages for years when the U.S. industrial capacity utilization rate was:* Below 80%

Capacity utilization rate: 78%

Change in producer price index: Same year: 2.0%

Capacity utilization rate: Following year: 2.6%

Acceleration/deceleration PPI rate: +0.6%pts

Averages for years when the U.S. industrial capacity utilization rate was:* Above 84%

Capacity utilization rate: 87%

Change in producer price index: Same year: 8.0%

Capacity utilization rate: Following year: 6.3%

Acceleration/deceleration PPI rate: -1.7%pts

*The average utilization rate since 1968 has been 82%. The most recent low, in utilization, was 74.6% in Dec. 2001. The utilization rate in January 2003 was 75.7%

Source: Intermarket Forecasting, Inc.

Dr. Salsman is president of InterMarket Forecasting, Inc., an assistant professor of political economy at Duke University and a senior fellow at the American Institute for Economic Research. Previously he was an economist at Wainwright Economics, Inc. and a banker at the Bank of New York and Citibank. Dr. Salsman has authored three books: Breaking the Banks: Central Banking Problems and Free Banking Solutions (AIER, 1990), Gold and Liberty (AIER, 1995), and The Political Economy of Public Debt: Three Centuries of Theory and Evidence (Edward Elgar Publishing, 2017). In 2021 his fourth book – Where Have all the Capitalist Gone? – will be published by the American Institute for Economic Research. He is also author of a dozen chapters and scores of articles. His work has appeared in the Georgetown Journal of Law and Public Policy, Reason Papers, the Wall Street Journal, the New York Times, Forbes, the Economist, the Financial Post, the Intellectual Activist, and The Objective Standard. Dr. Salsman earned his B.A. in economics from Bowdoin College (1981), his M.A. in economics from New York University (1988), and his Ph.D. in political economy from Duke University (2012). His personal website is

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