Blogger “Lord Keynes” (LK) posts on inflation, savings, and Keynesian stimulus. There are a lot of different things I could say — and then I would have to agree with his criticism of “Rothbardians” who oppose fractional reserve banking on the basis of fraud or instability —, but I want to focus on one particular argument he makes in his post,
The alternative system favoured by some Rothbardians – a system of perpetual deflation – would impose a “tax” on producers and businesses that take on debt to expand output and increase employment: the deflation tax would penalise productive businesses and individuals who must pay back their debts with money of higher purchasing power. The economy would also experience debt deflationary effects.
There is no theoretical basis for this, and there is no empirical basis for this. There are two types of deflation that free bankers like to talk about: secular and monetary. The first they consider benign, and it results from output increasing at rates faster than the supply of money (the second free bankers consider malign, and I disagree, but this is a topic I have discussed elsewhere). A free banking system “deals” with monetary deflation, not secular deflation.
We actually saw a period of secular deflation between 1879–94 (what a lot of economic historians like to term the “long depression”), and none of the problems that LK describes came up. In fact, this period was amongst the most productive in the history of the United States (if not the most productive).
One of the best histories of this period is provided by Robert Higgs, in his book The Transformation of the American Economy — I review the book here. As I note in the review, during this period, moneylenders actually allowed for a dynamic interest rate, which would let the rate on loans fall with prices. So, it turns out that the market, through competitive forces, deal with that “issue” (an “issue” we must be neutral on, because there are always costs on the market — is it fair to call these “penalties?”). EDIT: It seems to pertinent to remind that the supposed problem with interest and a rising value of money is not with producers, who do not see a fall in profits (since they are selling more output).
I feel that LK is confusing deflationary “problems.” The issue with monetary deflation, as best described by Leland Yeager in A Fluttering Veil, is a fall in the price of outputs before the price of inputs adjust. This, according to the theory of monetary disequilibrium, would lead to a disruption of entrepreneurial action, since it would throw production into disarray. I disagree, and I have voiced my opinions in an article published at the Cobden Centre, and reproduced on this blog.
But, let one thing be clear: there is no problem with secular price deflation, and a free fractional reserve banking system would not stop secular deflation from occurring.