The American Enterprise Institute has now joined much of the Fed, Christine Lagarde of the IMF and the commentariat in warning of the imminence of deflation, and the dire consequences that would ensue from even a mild decline in prices. I frankly don’t believe a word of it. We are in uncharted waters of monetary and fiscal policy, but asset prices are still rising, and rapid inflation seems to me much more likely than significant deflation. However, let’s do a thought experiment, and suppose they’re right. Would the deflation experience be so very terrible?

There’s no question many of the beneficiaries from the last five years’ policies think it would be. The Fed is determined to avoid it, while the Bank of Japan is printing even more money than the Fed in order to avoid it. Those responsible for the large deficits in government finances (except for Germany’s) correctly see a period of higher real interest rates and stable or increasing value of outstanding debt obligations as the worst thing that could happen to them.

In general, naturally enough, those who would benefit from a period of rapid inflation and those who have benefited from the exceptionally loose monetary policies of the last few years would be major losers from a period of deflation. You can include on this list hedge fund managers, who would no longer be able to use cheap leverage and rising asset prices to disguise their fundamental lack of ability to beat the market. On the individual side, the overleveraged and the overspending would run into severe difficulties.

But there would be winners too. Since we haven’t had a period of deflation in the West since the 1930s (and in the U.S. at least that decade was an unhappy experience) we have no personal memory of who those winners are; in general they are people and sectors who have been oppressed for about three quarters of a century, although they had a brief period of revival in the 1980s.

In the United States, the 1930s were pathological, and included a fall in prices of 25% in four years, largely because of Fed ineptitude. Clearly deflation at that level is highly damaging to the economy, bringing huge numbers of bankruptcies and distorting price signals throughout the system. The problem was worsened however by Herbert Hoover’s insane decisions to sign the protectionist Smoot-Hawley Tariff bill and to raise taxes at the bottom of the recession, putting up the top rate of income tax from 25% to 63%, making the deflation very much worse.

However Britain earlier had a period of severe deflation over a considerably longer period, from 1814 to 1823. While figures are guesstimates that far back, one website calculation (Safalra’s) has British prices falling by 46% between 1814 and 1823, as the Napoleonic Wars ended and the government took the brave and ultimately correct decision to take the country back on the Gold Standard in 1819 at the prewar parity. What’s more the country at that time had government debt of around 250% of GDP, so combined the Great Depression’s deflation with today’s Japanese level of debt.

Needless to say, today’s Keynesians would recommend cheating the debt holders and inflating out of trouble, but Lord Liverpool, prime minister at the time, did the opposite, inflicting an average rate of deflation of 6.7% per annum on the economy for nine years. The result was a painful “double dip” recession in 1816-19, made worse by the “Year without a Summer” in which the crops failed after the 1815 Mt. Tambora volcano, but this was followed by an astonishing and unprecedented boom, which restored the government’s popularity and sent the Industrial Revolution into overdrive. Lord Castlereagh (Liverpool’s right-hand man and Foreign Secretary) said in 1821 “I am grown as popular now as I was unpopular formerly – and of the two, unpopularity is the more convenient and gentlemanlike.”

Needless to say, they don’t make governments like that anymore. But the Liverpool experience, and that of the United States after the Civil War (3.2% annual deflation in 1864-79 and a further 0.8% annual deflation in 1879-97, for a total price decline of 47% over 33 years) and of Britain in 1857-80 (0.8% annual price decline, for a total decline of 17%) shows that deflation can be combined with strong economic growth, and gives some pointers as to its effects. After all, both the U.S. Gilded Age and the British mid-Victorian heyday are remembered as periods of great prosperity, though in both cases life was hard for the heavily indebted and the speculators.

Finally, the British inter-war period, with a 38% price decline (3.6% per annum) between 1921 and 1934 was a period of generally improving living standards, with no huge slump as in the United States, although there were pockets of severe hardship and the overall picture is less positive than the nineteenth century deflations.

There are two directions in which a deflationary environment helps the economy. The first, and more obvious, is that it rewards savers at the expense of the spendthrift, thereby building up the stock of capital available for investment. It doesn’t hurt either that at this particular historical point in time, there are a host of baby boomers with inadequate retirement pots, who could very usefully benefit from a deflationary environment with increasing purchasing power for their limited pools of dollars and high real rates of return on their savings. Since these people tend to vote and younger people tend not to, a deflationary environment might meet with a surprising level of political support.

Maynard Keynes tried to euthanize the rentier but in reality rentiers are the core of a successful economy. The early industrial fortunes built up during the Liverpool period, the gigantic industrial empires built up during the Gilded Age, the explosion of economic activity in the mid-Victorian period, all depended on deflation to build the wealth that fueled them. Long-term inflation, destroying the value of accumulated savings, is correspondingly destructive.

However the most important virtue of a deflationary environment is its huge incentive to cut out costs and increase efficiency. In an inflationary system, companies can always increase prices, because there are always people who have recently gained additional wealth and will happily bear the additional cost. In a deflationary environment, money is expensive and buyers know there is no more coming in, and that borrowing for purchases will endanger their survival. Hence they force sellers to cut their prices, and sellers in turn remove overhead and wring costs out of the system.

You can see the effects of this in our historical periods of deflation. In Lord Liverpool’s time, government operations were cut to the bone, in order to service Britain’s massive debt. Transportation links were rapidly improved, by turnpike road, rail and steamship, to reduce logistics costs, and widen the circle of buyers for the new factory-made goods. Manufacturing methods were standardized and running speeds improved, to cut costs. The result was an explosion of productivity and wealth.

In mid-Victorian Britain the most important statesman was William Gladstone, who led a crusade for economy in government, as did Neville Chamberlain in the 1930s, cutting civil service salaries by 10% because their job security was an additional benefit in a recession. You can see the benefits of this approach in Latvia, Greece and Spain, where localized deflation caused by euro membership (or in Latvia’s case, link) has forced costs out of the system and forced down bloated wages. This has allowed the economies to rebound economically far more quickly than anyone had thought possible. The Greek unions are very unhappy, but the Greek people have been forced into competitiveness, for the first time in a generation.

You can also see this effect in Japan since 1990, even though their deflation has been very mild. Tokyo was by far the most expensive city in the world at the end of the 1980s, whereas greater efficiencies in retailing and real estate usage have now made it cost-competitive with other cities, and much cheaper than London, for example.

One glance at the U.S. economy will thus tell you that a burst of deflation is sorely needed. Infrastructure costs about five times as much as it should. Since the middle 1960s, with one short interlude in the 1980s, money has been cheap and inflation has been pervasive. This has resulted in regulation and delays being piled onto large infrastructure projects, with the cost increases being assumed as natural and critics blasted for not caring about the poor state of U.S. infrastructure. The reality is that we could not replicate the Interstate Highway System, the 1960s space program or the nuclear reactor grid without driving the country into bankruptcy. Deflation would force the U.S. to hack away at this morass, until a simple tunnel under the Hudson River could once again be had for $1 billion instead of $9 billion and a high speed rail link between San Francisco and Los Angeles could be had for $10 billion instead of $80 billion – and both completed far more quickly than is currently thought possible.

The public sector has added cost, but it’s not the only place. The financial services sector has doubled its share of the economy in the last generation, and it’s almost entirely rent-seeking and greed, as the new products such as high speed trading add nothing to real wealth. In the 1930s, Merrill Lynch was only kept alive by Charles Merrill’s mother’s trust fund, while in mid-Victorian Britain, merchant banking was a business of short hours, modest returns and gigantic, splendiferous lunches. As a result, the necessary financial business of the world got done much more cheaply. More enjoyably, too; nineteenth century merchant bankers had time to enjoy their modest country lodges and become experts on haute cuisine and fine wines, whereas their 21st Century financial sector successors have time only for vulgar excess.

Then there’s the tech sector. The Chinese company Huawei has introduced an $80 smartphone, with no contract attached for the African market – undercutting Apple in the same way that Chinese garment manufacturers undercut the dozy Western operations in the 1990s. With deflation, the Huawei approach will enter the U.S. market also, and tech will become commoditized, much to the benefit of tech users. There will be fewer arrogant twenty-something tech billionaires and better designed, cheaper tech for the rest of us.

No, deflation is not heading our way anytime soon. More’s the pity.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)