Why do prices go up?
published on 17 July, 2024. Adding it to this blog
Almost everyone I know is finding it harder to make their income last longer than the month.
Grandma's advice of "spend less than you earn and save", reliable for generations, no longer works.
So why do prices go up?
Well, because of inflation of course.
But what is inflation?
Inflation is where the general level of prices for goods and services rises, typically as measured by the Consumer Price Index (CPI), Producer Price Index (PPI) or Core Inflation.
Keynesian economists and modern money theorists will tell you that inflationary causes are demand-pull (demand for goods and services exceed supply), cost-push (increase in cost of production) and built-in (workers demanding higher wages to keep up with living costs).
The Austrian school of economics, unsurprisingly less popular in the age of central banking, argue the axiom that the natural state of a free market is deflationary. Prices fall to the marginal cost of production. The calculator on my phone has more capability than my expensive HP calculator from university days, and it is free!
When I studied engineering, it was always drummed into me that a number without a unit is meaningless. So what is the unit for inflation? It is expressed as a percentage and is a measure of the number of additional units of money required in exchange for the same goods and/or services over a period of time. So it is a measure of the loss of purchasing power of the monetary unit over time.
The primary functions of money are threefold, a store of value, a medium of exchange and a unit of account.
Since 1966, the unit of account where I live, has been the Australian dollar. The benefit of a unit of account is it provides standardization, divisibility and fungibility. Thus, just like any other unit of measure, I can make meaningful comparisons and calculations. It used to be somewhat physically constrained by gold via the US dollar under the Bretton Woods agreement, however since 1971 when Nixon temporarily suspended convertibility of the US dollar for gold, it has been untethered and is issued by the Australian central bank (RBA) by decree (fiat). The mechanics of how that is done is a topic I leave for another day.
In the metric system the meter is the unit of account which allows me to measure length. If I have a property of 100m x 100m, I know that the area of the property is 10,000 m2. If someone on the other side of the world has a property of 10,500m2, I know it is larger than mine without having to visit. Now imagine that the International Bureau of Weights and Measures (BIPM), responsible for the length of a meter, decided for good reasons which they need not explain, that we needed to reduce the length of a meter by 2% each year. That would mean that at the end of the first year my same property would be 102m x 102m and the new area 10,404 m2. I am ecstatic because I now have an additional 404 square meters of property! The other property, if under the same authority, is now 10,924 m2!
In fact, after 36 years at 2% annual reduction in the length of a meter, we both will have doubled the size of our properties - hooray! What if they had their own central authority with a different policy?
The absurdity is obvious. Why? Because the map is not the territory. The number of square meters (map) is an abstraction of the size of my property (territory) and is useful for comparison. If the length were to be arbitrarily adjusted by the BIPM each year by decree (fiat) it would create chaos. The unit (map) is an abstraction representing reality, but since the definition of the unit is attached to reality the illusion is immediately exposed. A meter is the distance that light travels in a vacuum in 1/299,792,458 of a second and nobody, no matter how powerful, can change that. That is what makes the length of a meter reliable, it is governed by physics and not by any human authority.
Because I know the length is constrained by physics, when the other person tells me they now have 20,000 m2 of property, I can reliably know that they have actually extended the size of physical property. Absent an incorruptible standard, I would have no way of knowing whether or not the increase was due to a larger property or an impaired unit of account.
In the same way, the number of monetary units is an abstraction (map) representing the total stock of goods and services within an economy (the actual territory, or wealth). If, as is natural absent war, pandemics, etc., the stock of goods and services within an economy increases then this will be reflected in the increased purchasing power of the unit of account to the benefit of all holders of the unit (savers). Of course, this is not evenly distributed across all goods and services and can also be dampened by policies like mass immigration, however any short term price increase signals demand and a free market, being an adaptive control system, will respond by increasing supply which in turn continues to drive the price towards the marginal cost of production.
It is said that where incentives align, no conspiracy is required. The free market is incentivized to produce increased value at lower cost. Countervailing this is a debt based system with incentives to maintain inflation in order to fund government expansion and deficit spending while cheapening the debt. These forces are mutually exclusive and history is unanimous that the end result is hyperinflation and collapse into a reset, most typically in a kinetic war.
We forget that the map is not the territory and that increasing the supply of monetary units is not the same as increasing wealth. If it were, Zimbabwe and Venezuela would be the wealthiest nations on earth.
There is another solution, and that is to return to honest weights and measures. No government, central bank or electorate is going to do that voluntarily, the advantage afforded by the ability to create for free what others have to work for is simply too strong.
However, in the words of Friedrich Hayek, an economist of the Austrian school and writing in 1979, "I don't believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can't take it violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can't stop."
I am persuaded that bitcoin is that honest measure that cannot be stopped, against which measure all prices are falling over time. Those who understand and adopt it early will reap an asymmetric advantage, as we are already seeing play out in El Salvador, the first country to adopt bitcoin as legal tender, and MicroStrategy, the first company to put bitcoin on its balance sheet, and the ONLY company currently outperforming Nvidia. It is also seen in individuals, whose hope of a better future grows together with their conviction and purchasing power.
In the words of Satoshi - "you might want to get some in case it catches on".