Why deflationary currencies are ok

Q: Didn't the gold standard fail because it was deflationary?

No. England was forced off of the gold standard in 1931 because they ran out of gold. In the first half of the 20th century, countries on the gold standard usually only had 40% of the gold needed to back the currency they issued. When there was a run on the reserves after WWI, they ran out of gold and were forced off gold standard.

More info on this: Various societies have had and left the gold standard over the years. But when most people think 'exist from the gold standard' they're referring to the European powers and America in the 1930s. On this topic, I recommend The Lords Of Finance which outlines in detail what happened around 1900-1940 with central banks and This Time Is Different which outlines historical metal-standards and monetary policy.

Q: But didn't countries leave the gold standard because it caused unemployment?

Yes. According to John Maynard Keynes, a leading economist at the time and widely revered today, workers don't leave their jobs if the *value* of the money they get goes down. They leave their jobs if the *amount* of that money goes down. So when the value of the dollar goes up (deflation) workers quit rather than take a pay cut. In this way, deflation can lead to unemployment. By contrast, if the dollar is worth less (inflation) workers who were not working will start working when they perceive they're getting paid more, even if that money has less value now.

In modern times, this is supported by various incarnations of the Phillips Curve which is essentially a correlation between unemployment and inflation.

More info on this: I recommend reading Keynes himself on this one. His seminal work The General Theory of Employment, Interest, and Money explains his position well and most of modern money policy is based on it.

Q: So isn't it bad that workers will be unemployed?

Yes. But solving it is not impossible; workers will have to learn to look at the *value* of their money instead of the number of currency units they're getting.

Q: If there's deflation, what's the incentive to invest? Couldn't people just keep their money instead of putting that money to work?

Only projects that yield a rate of return higher than the rate of deflation will get investments. In practice, this will be any project expected to yield returns greater than the average rate of return for all investments. Which is reasonable because investments that are expected to be worse than average are by definition a poor choice. Instead of being forced to pick any investment, people will have an easy asset (the currency itself) save in until a good investment comes along. By contrast, our current system encourages almost *any* investment with low interest rates and inflation.

Q: Currencies work best when they're value-stable over time. Deflationary currencies are by definition not value-stable. Isn't this bad?

Yes. But there is no known way to create a value stable currency and having a lightly deflating currency is better than having a potentially highly inflating currency. Fiat currencies we use today have central banks that are in charge of keeping the value stable, but none of them succeed at this job forever. Historically, people who can print money always end up printing more of it and destroying the currency. This is why gold is an long-used deflationary currency; people tolerate the minor level of deflation rather than risk abusive inflation.

More info on this: I recommend reading When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany. It's an excellent account of the risks of currency abuse. In almost all cases it doesn't get that bad, but it's worth remembering why the Germans are so hesitant to print more Euros just to get out of what their forefathers would see as a minor recession.