Disclaimer: Here be dragons!
In our map we laid out three core concepts which would form the water in which we swim. The chance that I write out a perfect explanation of inflation is low. So instead of worrying I’m going to lay out an argument so we have something on the map and we’ll assume there is more to be laid out later which i’ll deal with in future posts - in much the same way that early maps would flag here be dragons to denote areas of the map where there was more to be discovered.
Part one of our bitcoin map.
First lets lay out some statements:
Inflation: The price of goods and services are going up and things you want are getting more expensive.
Deflation: The prices of goods and service are going down and the things you want are getting cheaper.
I think most people probably prefer the idea of number 2.
An interesting thing to learn though is that our economy is built on the idea that inflation is preferable.
The way that this is traditionally argued is that inflation is an outcome of growth and it is therefore good to observe!
I’d summarise the argument here as follows.
If the economy grows then there is a greater demand for goods and services which drives up the demand of labour and as such wages.
This in turn drives up the cost of goods and services as individuals in the economy have more money available to spend. A positive feedback loop!
So if we see inflation in prices, this can be interpreted as a positive sign of a strong economy with rising wages and prosperity.
As such we orientate economic policy around the idea that we should target 2% of inflation and that this would be good.
This mental model suffers from three key issues:
It takes an observable output metric and uses it as an input metric to policy.
It ignores other aspects of the system, which arguably have much bigger impacts on inflation in a modern globalised world.
It doesn’t really deal with the real world reality that, like the pigs of Animal Farm, not all goods and services are created equal.
OK. Number 1!
This should be kind of obvious to anyone who has been micromanaged in a company to the detriment of their performance.
An obsessive focus on a single output metric tends to lead to gaming of that metric without getting any of the benefits you hoped for.
This is helpfully summarised with the picture below.
In this case we’re saying we’d like to see inflation as this could indicate higher wages and growth. But we’re focusing on trying to hit the metric, whilst ignoring the mechanism that was supposed to generate it.
On point 2, Jeff Booth (did you front run the homework on this one) in the awesome book The Price of Tomorrow lays out a case for the overwhelming impact of technology as a deflationary force.
Put simply the role of technology brings prices down. It drives costs to zero and makes products and services more widely available to all.
What’s more it compounds, as new technologies build on the network effects of those before them in order to further drive down prices.
When we consider our model for why “inflation is good” we should perhaps put on our critical thinking trousers (the smart blue ones with the turn ups) and ask ourselves a question.
What if the growth in the economy was actually due to technology that can scale without a corresponding increase in labour and therefore wages?
Well seemingly in that situation you would get growth in the economy, greater wealth in society (increased access to low cost goods and services, increased productivity etc) but without an increase in wages.
Ahem…
Which begs the questions - if wages aren’t going up due to economic growth then why would we want inflation of prices, if we’re not getting paid more then we’re actually getting poorer right… which dovetails nicely to point 3.
To point 3, Michael Saylor of Micro Strategy has been pretty forthright in pointing out that not all inflation is created equal.
Check out this great podcast from TIP or the video version below.
It’s worth the time to listen / watch this one, but to summarise:
Inflation doesn’t exhibit itself equally across all goods. Some things will naturally get cheaper and tend towards to zero cost. Others will not.
For example anything which can be “digitised” (delivered via phone or computer) is going to get cheaper as there is a very low additional cost for each new unit produced. As such the incentive is to produce it once and replicate globally in order to drive a profit.
Alternatively some things can’t be digitally copied and made available and seem to go up in value over time.
The way to approach this is to think about the sort of things you’d like to have one day in the future (bigger house, boat, retirement, surgery?) and understand which bucket they fall into.
Netflix, streaming stuff etc should get cheaper. That house you want in the 500 metre stretch by the sea, less so.
If we revisit point 2, then we can see why this might be the case.
Short term some things are more easily digitised and improved by technology than others and we’d see it here first (digital products, information, educational materials etc).
Long term is no different though, it would be reasonable to see falling prices across the board in food, energy, services, potentially even land (Dubai??) etc as technology improves.
So in conclusion we’ve learnt that…
Focusing on inflation whilst ignoring the mechanism is probably a mistake;
Technology can drive growth without a corresponding increase in demand for labour which might undermine our inflation model;
Inflation is not evenly distributed across all goods and the ones we want might be getting more expensive even whilst others fall.
With this framing is seems reasonable to expect prices to fall over time in many goods across the economy and that that should be a good thing as they would be cheaper for us to buy.
As such the question I’d like to sign off with is.
If the price of goods should naturally fall, but we do our level best as a society to drive prices up, (in an environment of falling real wage).
Is that good for society and where did all those cost savings go?
This was a bugger to knock out in an evening so if I’ve messed up or could do better let me know in the comments!