Sowell’s Basic Economics: Deflation, Part One

Note: Though there are still a lot of errors and misrepresentations in this short section (pp. 373-378), it is not nearly as convoluted as the one on inflation. So we are going to take our time and enjoy this.

On page 373 Sowell writes, “From 1873-1896, price levels declined by 22 percent in Britain, and 32 percent in the United States … output was growing faster than the world’s gold supply. While the prices of current inputs and outputs were declining, debts specified in money terms remained the same – in effect, making mortgages and other debts more of a burden in real purchasing power terms than when these debts were incurred.”

First, it should be noted that the Western world was on the Gold Standard and the money supply was not shrinking. In other words, no deflation was occurring. Inflation and deflation, in a technical sense, refer only to the supply of money increasing or decreasing.

The most important thing about the money supply is that, ideally, it does not change. If it does change, it should neither increase nor decrease by very much, very quickly. There is no real optimal supply level. If newer techniques of production and better tools are invented which push down the costs of production and thereby put downward pressure on the prices of consumer goods, this ought not to be seen as a bad thing as it demonstrates than man is making advancements in his struggle against scarcity.

Now let us address the debt issue. Over the 23 year period from 1873-1896, prices fell by 32% in the United States. That is an average drop in price of 1.4% per year and is far more stable than 2% inflation per year that we experience today.  The fact that prices were falling and the overall purchasing power of the dollar was increasing put pressure on debtors to make extra payments toward their debts and pay them off or avoid going into debt unless it was unavoidable. Contrast that with today’s economy where the money is losing purchasing power and most people are in debt as a lifestyle. Debt is now a cultural norm. With the dollar losing its value at about 2% a year, it almost makes sense to buy everything you can on credit.

Have you heard of time preference? The basic idea is that – all things being equal – supposing there is not any interest and the values involved are perfectly stable over the allotted time, a man will prefer a good sooner rather than later. It is more desirable to have a it all now: a candy bar today rather than a candy bar tomorrow, a laptop next week rather than a laptop next month, a new car next month rather than next year. As the saying goes, “There is no time like the present.” When the value of money is decreasing the way it is now, inflation magnifies the time preference and makes it even more acute. Not only would I prefer a new car next month – heck, right this minute – but why should I hold my savings in the bank where it is losing value while I continue to save toward the future purchase of a new car? Next year a new car will be more expensive than the one on the lot today and my money will be worth less. I would rather use any savings as a down payment and take out a low interest loan to cover the rest.

On the other hand, when the money is increasing in value relative to the price of goods and services this usually has a tempering effect on time preference. The consumer will look at the car market and determine that though he might like to have a car right this minute, the wise thing is to continue saving his money. The money saved will be worth more in a year or two and the price of the new car will be even lower than it is now. 

As far as debts being more of a burden, there is some truth to this, but those already in long term debt can always refinance to more favorable terms or buckle down and pay off their debts early. 

While something in the amount of the average mortgage would be a pain in such circumstances, it would also be much easier to save and buy a home with cash, or with a greater down payment than what anyone approaches today.  Besides, a fellow locked into a mortgage in a “deflationary” economy could be said to be paying more in real terms. We should not forget that everything else he has to buy is getting cheaper.

Sowell finishes off the paragraph by saying, “Farmers were especially hard hit by declining price levels because agricultural produce declined especially sharply in price, while the things that farmers bought did not decline as much, and mortgages and other farm debts required the same amounts of money as before.”  

There is only an inkling of truth to this. You need to consider the time that separates investment from return. A man might spend money today, in 2016 prices, to buy apple trees and then have to wait 4 years before his first crop of apples appears that he will then sell at 2020 prices. In a deflationary setting the farmer may be said to lose money, but apples may have been one dollar a piece when he planted the trees and only 90 cents a piece the first year he sold his crop. The purchasing power of the 90 cents was the same when he sold as one dollar was four year earlier when he planted.  When you look at what his money would exchange for on the market from one time to the next, not much has changed.

Nevertheless, times were hard for farmers in this era and that has to do with tariffs. Tariffs were extremely high in this era, and it was these tariffs and not an appreciating dollar that put a burden on farmers. I have written on tariffs in previous posts, but I think they will get covered again as we work through this book.

See you soon.

Inflation. Yes, again.

Note: I had written a whole play-by-play analysis of this section (pages 366-373) of Basic Economics by Thomas Sowell, but it is so boring and long I’ve decided it isn’t worth being put on a blog. 

We are going to whittle this down drastically and not trouble ourselves with all the different ways Sowell errs on inflation. I’ll try to simply give an explanation of what inflation is while keeping his errors in mind. There will be coverage of this section of Basic Economics in more detail in an eventual upcoming e-book and you can join The Mean Austrian email list for updates on that.

So, let’s get down to it: (Pry those eyelids open and try to not run away. It may sound familiar, but I promise it’s – relatively -short.) 

– The Mean Austrian

 

Scarcity is one of the key features of money and an important feature to keep inflation from drastically hitting an economy. When government has control over the money supply, and that money supply is paper backed by nothing of true worth – as the U.S. currency is today – there is nothing to stop the government from printing out more money. And more money. And more money still. This inflates the money supply (i.e., inflation).

The result is that as more gold comes on the market, it is valued less. The more there is of something the less it is worth. On the flip side, generally speaking, the less there is of something the more valuable it becomes. This is true of everything from bread to baseball cards. Pretty basic stuff.

“Hold up, Mean Austrian! Might gold ever be affected by inflation?”

Yes, inflation can happen even with gold. Enter, History:

After the New World was discovered by Europeans, gold mines in America were opened and gold flowed back to the old country where this new money bid up the price of goods. But it was very minimal and happened gradually over the course of a century.

The difference between gold mines in the New World and printing presses in the U.S. is that to mine gold out of the ground and ship it across the Atlantic was a costly and risky venture. It took a lot of tangible resources to bring that gold into circulation and thus the inflation was limited by the pocketbooks of the entrepreneurs and their backers. Under the Federal Reserve, there is nothing limiting the the increase in money. It is little more than a matter of paper and ink. No risk, high “reward”.

While there can be inflation with gold-based currency, that inflation would never be runaway inflation. The only thing keeping us from experiencing the runaway inflation the Wiemar Republic went through, and that Venezuela is currently experiencing, is the relative good sense of Janet Yellen.

WHY GOVERNMENTS CAUSE INFLATION

Governments, in some sense, ultimately rest upon the acquiescence of the people. If the taxes get too high, people become unruly. The solution then is to tax as much as you can get away with, and for whatever expenditures remain unmet, simply print the money.

Yes, you guessed it: This inflates the money supply! It devalues the money already in circulation and it steals the purchasing power of every consumer in the country. This is a hidden tax and the most regressive tax. A sales tax may be at 8% of every dollar a poor man spends, but inflation takes 2% of every dollar the poor man doesn’t spend every year. This flat-out discourages saving money and if the man wishes to improve his current financial situation it makes it all the harder.

I’m pretty sure we’ll deal with other aspects of inflation as we move forward.  Deflation is right around the corner, so I’ll leave it here for now… I wouldn’t want to overexcite anyone all in one post.

I should also apologize for the delay. Blame my cows and computer. I know I do. For those of you who are still following along despite the delay, I really do appreciate you!

Technology as a Threat , And an Old Threat.

A familiar refrain has been raised a thousand times, from the dawn of the Industrial Revolution until now: more technology will throw workers out of their jobs, machines will do everything, and the common man will be left jobless with no way to provide for himself. Of course, this notion has been refuted a thousand times by economists, from Bastiat to Mises and Rothbard, even today where Tom Woods and Jason Stapleton have addressed the concern. (Their podcast episodes where they deal with this are linked here for Tom and here for Jason.)

Usually, I am critical of the economists who espouse errors, but here I have no problem with what anyone has said. I have read columns from Sowell on this, and he has it right as well.  My criticism here is for those who raise the complaint.

One of the best objections to this complaint thus far has come from the Jason Stapleton Facebook group, where a member asked about artificial intelligence rather than merely machines and technology. This is a much more challenging concept that deserves further consideration.

If for the sake of the argument we can set aside the morally repugnant nature of slavery, we might ask ourselves what was the impact of slavery on the “free” labor market in the Antebellum South?

Slaves were as close as we have gotten to artificial intelligence, and yet they had real intelligence. Importantly, slavery negatively affected the labor market for free laborers. This was the primary reason why Lincoln opposed the expansion of slavery into the western states, and not because he had a soft spot in his heart for the oppressed and downtrodden. Rather, Lincoln realized that where there were slaves it was much more difficult for free whites, who can vote, to find jobs.

So if I were sympathetic to argument, I would point to this as proof that it is possible for technology and AI to displace workers almost entirely. If it happened in the South, where slaves displaced free laborers, then why could it not happen again with technology? Slaves reproduced more slaves, and if AI reproduced more AI wouldn’t we be in the same position but even worse? If not what is the difference?

The key difference is costs. The slave costs less per labor hour than the free man, though the output was less. Mises famously argued in Human Action that slavery was inefficient and that the producer who used free labor would have higher profit margins than the producer who relied on slave labor. (chapter 9 of Human Action)

Really, it is all about costs. What is the cost of employing a machine versus a worker? The machine is at a disadvantage here. While it takes X dollars to purchase and maintain a machine, the human has the ability to compete and to cut his price (i.e. the cost of hiring him), barring any interference by the State. So where a fast food restaurant may consider installing kiosks to take orders from customers, men can respond to that by simply working for a little less (or in the real world just be contented with the wages they are getting for the work they are doing.)

Technology and AI are implemented to make existing labor more productive, and inadvertently make labor less intensive, and more valuable. Just consider the man digging a sewer line with a backhoe in 3o minutes compared to 2 men digging it out with shovels and spending all day at it. If there were enough men willing to work for $1.00 an hour, the backhoe would not have been bought and would not be in use. It is at least to some degree the workers who determine what new technologies come into the market. The fact that there are not enough men willing to dig with picks and shovels for $1.00 an hour suggests that no one will be long out of work with the introduction of the backhoe.

If it ever gets so easy to produce machines that can produce machines, and do everything for us, then the cost of these machines will necessarily not be very expensive at all, and perhaps each of us would have a dozen bots that we are able to employ to provide us with all our wants and needs. If not they would be restricted only to the industries with the highest return per input. In either case, it is something that really makes me think, but does not make me worry that much at all.

Even if it were a real threat, it is a real threat of the same sort as the Sun burning out and leaving us in the dark. It will happen millions of years from now, and either something else will get us in the meantime, or we will figure out a work around between now and then. I am much more concerned about government interference in our ability to provide for ourselves and their constant proclivity to make war.