Let it therefore be remembered (and occasions will often rise of calling it to mind) that a general rise or a general fall of values is a contradiction; and that a general rise or a general fall of prices is merely tantamount to an alteration in the value of money. . . .
—John Stuart Mill, Principles of Political Economy
Bret Swanson is a futurist based in Indianapolis, and a longtime collaborator with George Gilder. Swanson founded a research firm several years ago called Entropy Economics. “Entropy,” says Gilder, is “the process by which the entrepreneur translates the idea in his imagination into a practical form.”1 That is, entrepreneurs perpetually pursue the creation of high-entropy concepts that will transform our lives—cancer cures, computer tablets, or transportation innovations.
Entrepreneurs seek to improve our lives and usually hope to grow wealthy in the process. Translating their ideas into marketable form, however, requires an economic environment or background that is low-entropy—that is, steady, open, and predictable. That low-entropy setting is really what this book is about. Human beings have unlimited desires, and satisfying those desires is easier when politicians remove the barriers to production. In modern times, government has become a high-entropy barrier to production. I am trying to make the case for reversing our course on taxes, regulation, trade, and money. In all four areas, we need maximum freedom from government meddling to achieve maximum growth.
I have shown (1) that taxes are a penalty placed on work and investment in new companies. Moreover, government spending itself is a tax. It is the extraction of resources from the private sector that robs entrepreneurs of capital, and the average worker of wages. (2) Regulation can’t succeed because the less talented and informed are trying to anticipate what even the sharpest minds in a given field have a difficult time predicting. (3) Trade is the reason people go to work every day, to get what they do not possess. Taxes on imports are taxes on the purpose of work, and they impede the productive specialization that free trade fosters. Finally, (4) money allows producers to measure the value of what they are exchanging and investing in (more on investment in the next chapter). When it is unstable as a measure, the economy loses the honest price signals that organize economic activity.
Gilder and Swanson seek to make taxes, regulation, trade, and money low-entropy inputs to commerce, as unintrusive and as unnoticeable as possible. So do I. If government intervention in the economy were substantially limited, entrepreneurs could productively pursue the high-entropy concepts that will raise living standards. Some of the government’s worst economic mischief is the result of monetary policy based on a fundamental misunderstanding of inflation and deflation.
At a conference organized in 2009 by Applied Finance Group, with which I am professionally affiliated through their mutual fund arm, Toreador Research & Trading, Swanson displayed a 1989 ad for the Tandy 5000 desktop, the “most powerful computer ever!” Monitor and mouse were not included in the $8,499 price. This once great computer, of course, would not come close to passing muster now. Today’s most basic Dell desktop is infinitely faster, offers far more features, including the monitor and mouse, and is just $449.99. In the year 2000, a fifty-inch flat-screen high-definition television cost twenty thousand dollars.2 Today a fifty-inch flat-screen high-definition television sells at BestBuy.com for $549.99.3
Stories like this abound in market economies. The original handheld cellular phone, the Motorola DynaTAC 8000X, which we recalled in chapter seven, was rolled out in 1983 at a price of $3,995.4 As amusing as it is to look back on those technological relics of the ’80s, we know that it won’t be long before we’re scoffing at the iPhone 6, which will seem primitive and expensive.
In the 1970s, a Sony Betamax was a luxury item that cost over a thousand dollars. The VHS video format ultimately proved more appealing to consumers than the Betamax. Yet today’s consumers would surely laugh at popping a videocassette into a bulky VCR in order to watch a film. Now there are DVD players and streaming video. Sony’s HDMI DVD player is listed at less than fifty dollars at Walmart.com, and that includes the cost of delivery.
These stories are a reminder that today’s luxuries of the rich are a preview of what everyone will enjoy eventually, and sooner rather than later if government is a low-entropy input in the economy. They also show that the rich—who provide the capital for the entrepreneurial ideas of others—are consumer “guinea pigs.” Acquiring the latest innovations at high prices, they act as “venture capitalist” buyers, creating the incentives for entrepreneurs to figure out how to sell expensive goods at low prices. But what do all these stories about relentlessly falling prices say about inflation and deflation? Very little.
What these stories do tell us is that falling prices, far from being deflationary, reveal new wants. As Mill wrote, “life is highly favorable to the growth of new wants, and opens a possibility of their gratification.”5 Flat-screen televisions available for a few hundred dollars indicate that consumers are now searching for the next big thing. Ultra-high-definition televisions have now reached the market, retailing at around twenty-five thousand dollars, but it’s a fair bet that within a few years that price will be dramatically lower.
Falling prices by themselves are not deflationary, because no act of saving ever subtracts from demand. Plummeting television prices merely free up money for new, previously unattainable wants, sending those prices up. And if the money saved on televisions isn’t spent on other consumer goods, it will be available, through savings, to someone else—either a consumer with short-term demands or the entrepreneur who has figured out a way to make ultra-high-definition televisions that can be sold for five hundred dollars.
News about the Federal Reserve today often concerns central bankers who fear deflation. Their constant focus on consumption makes Fed officials worry that falling prices will cause consumers to delay their purchases, driving prices down further and weakening the economy. But this is a mirage. To save is not to not consume, as the Fed believes. Saving simply shifts consumptive ability to others. As we saw in chapter six, banks “borrow” money from savers in the form of a deposit, or liability, and they immediately turn that liability, in the form of a loan to someone else, into an asset.
Falling prices are normal in a market economy, and they do not deter consumption. The first Apple iPhone retailed at around five hundred dollars, but consumers can now buy a much more advanced model from their wireless service providers at a fraction of that cost. Consumers are well aware that prices have a tendency to fall, particularly in the highly competitive world of technology. Yet despite the history of falling prices, consumers lined up to buy the first Apple iPhone, as they lined up, more recently, to buy the iPhone 6.
The price of admission to the first Super Bowl, played in 1967, was twelve dollars.6 In 2014 the face value of a Super Bowl ticket was one thousand dollars, but the average price actually paid was $3,552.7 Is this what economists mean by inflation? Many economists probably do think it is inflation, but it is not.
If the demand for certain goods, like Super Bowl tickets, becomes so strong that the price rises substantially, consumers have less money to demand other goods, driving the prices of those goods down. Prices are constantly adjusting to a multitude of factors, such as consumer preferences and enhanced productivity. Rising and falling prices, therefore, tell you many things about the market, but they don’t tell you much about inflation or deflation, which is a change in the value of money.
If oranges are discovered greatly to reduce the possibility of heart failure, then demand for oranges will skyrocket. But if people are paying more for oranges, then they’ll have less money to spend on other goods, the prices of which will decline. There is no inflation here, just a change in what consumers desire. You can buy a VHS recorder for next to nothing nowadays because no one wants it, but no one would call that deflation. Furthermore, markets always adjust to changing demand. If soaring demand for hotel rooms in Las Vegas drives prices up, the market is signaling entrepreneurs to build more hotels in Vegas. Prices, regardless of their direction, are a poor measure of inflation or deflation.
What about globalization, or the arrival of the less developed world into the global capitalist system? The most dramatic manifestation of globalization has been China’s turn away from dogmatic collectivism and its embrace of a market economy. Shouldn’t the entrance into the world market of hundreds of millions of Chinese consumers, hungry after decades of deprivation for the goods we enjoy in the West, drive up prices? Ben Bernanke, the recently departed chairman of the Federal Reserve, seems to think so.
In a speech before the Stanford Institute for Economic Policy Research in March 2007, Bernanke opined that “there seems to be little basis for concluding that globalization overall has significantly reduced inflation.”8 His point was that all those new workers would increase demand for goods and services and consequently drive up prices.
What Bernanke missed is that all demand is a function of supply. A visitor to China beholds the beautiful sight of formerly poor people enjoying an increasingly middle-class, and even upper middle-class, way of life, with all the consumption that comes with it. But Chinese demand for goods and services is a result of Chinese workers themselves supplying commensurate goods and services to the world economy. The increased supply and the increased demand balance each other, neutralizing the pressure on prices from these entrants to the labor force.
Quite comically, some economists argue that the Chinese don’t consume enough,9 showing how fraudulent the economics profession has become. It cannot be emphasized enough that savings provides capital for entrepreneurs and that the act of saving shifts consumptive ability from one person to another. It is the purest form of wealth redistribution, a fact almost totally lost on economists.
There are others who argue that China’s embrace of capitalism will cause deflation. Bernanke’s predecessor as Fed chairman, Alan Greenspan, asserted as much in his 2007 book, The Age of Turbulence, writing that “the rising rate of worker migration to the export-oriented coastal provinces imparted an ever-increasing wage (and price) disinflation to the developed economies.”10 No doubt the Chinese are producing all sorts of goods for us to enjoy, but they are not doing so in order to remain poor. The Chinese, like anyone else, are producing in order to consume. Their production brings with it commensurate demands, whether through their own consumption, or through their shifting of consumption to others through savings.
Every day that the Chinese go to work, Americans get a raise. But as I have emphasized, falling prices of certain goods (including those made in China) are not deflation. Instead, falling prices give rise to new demands that previously did not exist. The prices of consumer goods are a poor measurement of inflation pressures.
It is widely believed in the economics profession that economic growth is the source of inflation. This theory is easily disprovable, but it is very popular, particularly at the Fed, so let’s examine it further.
The theory that inflation is the result of total demand’s outstripping total supply is expressed in the Phillips curve. In a speech given in 2008, former Fed vice chairman Donald Kohn said, “A model in the Phillips curve tradition remains at the core of how most academic researchers and policymakers—including this one—think about fluctuations in inflation.” Kohn added, “Bringing overall inflation immediately back to the low rate consistent with price stability could be associated with a much higher rate of unemployment for a short time.”11 Get it? The Fed thinks that when unemployment falls too low, its job is to engineer an economic slowdown to keep inflation in check.
Kohn is correct that he is hardly alone in believing that growth is the cause of inflation, and that’s a serious indictment of both the Fed and the economics profession. In The Age of Turbulence Greenspan repeatedly states that a growing economy and falling unemployment are the source of inflation. “[G]ood growth, high optimism, and full employment,” he observes, are “all reasons to be leery of inflation.”12
Bernanke is singing in the same choir as Kohn and Greenspan. In a 2003 speech made while he was vice chairman at the Fed, Bernanke spoke about the possibility of future inflation, warning that “the effective slack in the economy may be less than we now think, and inflationary pressures may emerge more quickly than we currently expect.” In a Wall Street Journal column published in July 2005, a few months before his nomination as Fed chief, Bernanke asserted that we had the “highest level of employment that can be sustained without creating inflationary pressure.”13 But is any of this true?
The best place to start is employment. Bernanke, Greenspan, and Kohn are all on record as believing that if unemployment gets too low, inflationary pressure will result. At first glance, this makes sense. If there is a labor shortage, employers presumably have to offer higher wages to current and prospective workers, and higher labor costs will push up the price of goods.
But these assumptions do not hold up under further inspection. First, the number of prospective workers is not static. If rising demand for workers sends wages up, workers on the sidelines will be more willing to offer their services. Recently, for example, rising wages in oil-patch states such as Texas and North Dakota14 have drawn able-bodied workers from other states.15
The Fox Business News host Lou Dobbs has made a second career out of criticizing American companies that have moved jobs overseas. In chapter sixteen I made the case that “outsourcing” or “offshoring” results in better and higher paid work in the United States, but leaving that argument aside, as long as U.S. companies continue to find an abundant supply of labor around the world, a tight labor market at home won’t put pressure on American wages. Simply put, when policymakers suggest that falling unemployment in the United States is inflationary, they ignore American companies’ access to a worldwide labor force.
Markets, moreover, innovate their way around labor shortages. Most Americans no longer encounter another human being when they buy movie and airplane tickets or when they make bank deposits or withdrawals. More and more big-box retailers and grocery stores offer self-service checkout lines requiring no cashiers. In addition to these adaptations, the American labor force increases through immigration.
After Bernanke became chairman of the Fed in 2006, a stream of press releases from the Federal Open Market Committee offered variations of the following statement: “While the Fed expects inflation to moderate, a high level of resource utilization has the potential to sustain those [inflationary] pressures.” The Fed’s thinking here is that if the economy really starts growing, excessive demand might exhaust producers’ manufacturing capacity, causing prices to rise.
This concern might seem reasonable at first, since supply and demand certainly affect pricing. But capacity, like the labor force, is not static. Looming capacity shortages are a signal for producers to increase the very capacity that the Fed assumes is fixed. Manufacturers, moreover, constantly enhance their production techniques to get more out of their existing assets. Compare a Ford factory from the early twentieth century with one today. Production becomes more efficient.
Finally, American companies have access to world capacity to make the finished products that their customers want. When the Fed worries that domestic capacity is a source of inflationary pressure, it assumes that American manufacturing capacity is limited to the fifty states. It is not.
The assertion that economic growth, which allows people to work and prosper, is the cause of inflation is based on the assumption that the U.S. economy, or any country’s economy, is an island. But the world economy is so interconnected that wage and capacity pressures do not drive prices up. Even if they did, rising prices in one area simply reduce demand in other areas. After that, economic growth is about production. The idea that productive economic activity could be inflationary defies the basic economic law that all demand originates from supply.
What about the Consumer Price Index, the most familiar “measure” of inflation, calculated by the U.S. Bureau of Labor Statistics? The CPI measures changes in the price level of a market basket of consumer goods and services purchased by households. Of course, that description shows why it fails as a useful measure of inflation. If people are paying more for Super Bowl tickets, then they have less money to purchase clothes or cigarettes. And if improved productivity makes flat-screen televisions cheaper, there is more money to purchase Nike sneakers and the next new thing from Apple.
If the CPI is heavy on technology products like computers and cellphones, the index will be lower than it would be if it were weighted toward gasoline and ground beef. Even more distorting is the so-called “Core CPI,” which leaves out food and energy. Those commodities, priced in dollars and therefore priced minute by minute in commodity markets, are the most sensitive to changes in the value of the dollar. Yet they are left out of the inflation calculation.16 A CPI heavily weighted toward gasoline and food alone would tell an inflation tale over the last dozen or so years that computers and phones would not.
Worse, producers can raise prices without actually raising prices. In 2009, Skippy peanut butter jars were indented, reducing the contents by 9 percent, but the price of each jar remained the same. Steve Forbes, who makes a daily visit to Starbucks to buy their pastries, observed back in 2009 that while Starbucks had held the line on pastry prices, the size of the pastries had shrunk.17
And then consider the Tandy 5000 computer, priced at $8,499 in 1989, and today’s vastly more powerful Dell desktop that retails for under five hundred dollars. Since there is no reasonable way to compare the two computers, the idea of using consumer prices to chart inflation becomes rather difficult. Likewise, the gadgetry in a 2015 BMW 535i will be substantially advanced beyond that in a 2012 model, let alone a 2009. Using a basket of goods to gauge pricing pressures raises far more questions than it answers.
After that, the CPI is whatever federal bureaucrats want it to be. The Wall Street Journal reported in 2011, “Food accounts for 47% of the basket of products that make up India’s consumer-price index and 34% of China’s.”18 Rest assured that if the U.S. CPI were that heavily weighted toward food and gasoline (“the things we all buy,” as is often said), CPI inflation in the United States would be very high at the moment.
Prices of goods and labor move up and down all the time for all manner of reasons. Trying to “divine” inflation or deflation from the price of computers and televisions, from levels of unemployment, from globalization, or from baskets of goods selected by the federal government is a fool’s errand. Worse, it can be dangerous. It is widely known that the Fed, ever focused on consumption, wants CPI inflation of 2 percent per year. Really? So the Fed wants prices to double in thirty-six years? People should ignore it.
Inflation is a decline in the value of the dollar—nothing more and nothing less. The best measure of the dollar’s value is the price of gold simply because it is priced in dollars and is the commodity least influenced by supply and demand. Gold is the constant, and that is why market actors happened on it as the best way to stabilize the value of money.
In July 2001, a dollar bought roughly 1/266 of an ounce of gold.19 In the fall of 2014, a dollar bought roughly 1/1200 of an ounce of gold. The dollar has been substantially devalued these last thirteen years, meaning we’ve had serious inflation. In the next chapter we’ll see why that’s a problem.