Inflation, round 2

I have some more insights to share from Friedrich A. Hayek's essay Can We Still Avoid Inflation?. It too has to do with the distortion that inflation causes in a business's ability to forecast the future, and therefore distort the business decisions it must make.

I must deal with an argument that, ... seems to lie at the root of the view which represents inflation as relatively harmless. It seems to be that, if future prices are correctly foreseen, any set of prices expected in the future is compatible with an equilibrium position, because present prices will adjust themselves to expected future prices. For this it would, however, clearly not be sufficient that the general level of prices at the various future dates be correctly foreseen, and these, as we have seen, will change in different degrees.

A main part of the Austrian argument is that prices do not rise simultaneously throughout an economy. Elsewhere in the essays the adjustment of prices is described as a titled plane, where some commodities rise or fall in price before others. This is a way to visualize the fact that money does not flow equally throughout the entire economy. Despite our governments policies, there is only a limited supply of money available and it must flow through the economy. It takes time for inflationary effects to touch any particular segment.

With this background, the quote above is attempting to point out that future valuations will be flawed because the effects of inflation are not consistent and the different degrees by which these changes occur cannot be foreseen.

More important, however, is the fact that if future prices were correctly foreseen, inflation would have none of the stimulating effects for which it is welcomed by so many people.

Now the chief effect of inflation which makes it at first generally welcome to business is precisely that prices of products turn out to be higher in general than foreseen. It is this which produces the general state of euphoria, a false sense of wellbeing, in which everybody seems to prosper. Those who without inflation would have made high profits make still higher ones. Those who would have made normal profits make unusually high ones. And not only businesses which were near failure but even some which ought to fail are kept above water by the unexpected boom. There is a general excess of demand over supply-all is saleable and everybody can continue what he had been doing. It is this seemingly blessed state in which there are more jobs than applicants which Lord Beveridge defined as the state of full employment-never understanding that the shrinking value of his pension of which he so bitterly complained in old age was the inevitable consequence of his own recommendations having been followed.

But, and this brings me to my next point, "full employment" in his sense requires not only continued inflation but inflation at a growing rate. Because, as we have seen, it will have its immediate beneficial effect only so long as it, or at least its magnitude, is not foreseen. But once it has continued for some time, its further continuance comes to be expected...

Or in my own words, when the high wears off businesses realize where the growth came from and are able to adjust future valuations on the inflated prices.

But if prices then do not rise more than expected, no extra profits will be made. Although prices continue to rise at the former rate, this will no longer have the miraculous effect on sales and employment it had before. The artificial gains will disappear, there will again be losses, and some firms will find that prices will not even cover costs. To maintain the effect inflation had earlier when its full extent was not anticipated, it will have to be stronger than before. If at first an annual rate of price increase of five percent had been sufficient, once five percent comes to be expected something like seven percent or more will be necessary to have the same stimulating effect which a five percent rise had before. And since, if inflation has already lasted for some time, a great many activities will have become dependent on its continuance at a progressive rate, we will have a situation in which, in spite of rising prices, many firms will be making losses, and there may be substantial unemployment. Depression with rising prices is a typical consequence of a mere braking of the increase in the rate of inflation once the economy has become geared to a certain rate of inflation.

All this means that, unless we are prepared to accept constantly increasing rates of inflation which in the end would have to exceed any assignable limit, inflation can always give only a temporary fillip to the economy, but must not only cease to have stimulating effect but will always leave us with a legacy of postponed adjustments and new maladjustments which make our problem more difficult.

Let me repeat, only a temporary bump to the economy. I have some more from Hayek's essay to share, but I will leave them for another post.

Can We Still Avoid Inflation?

I really enjoyed the essays from the Austrian school of economic thought on the trade cycle. I have another point I want to mention, and a few more posts worth.

The essay Can We Still Avoid Inflation? by Friedrich A. Hayek was given as a lecture on May 18, 1970. I find this question interesting, as it seems to be a given in our time that inflation will always be with us.

In the elementary textbook accounts, and probably also in the public mind generally, only one harmful effect of inflation is seriously considered, that on the relations between debtors and creditors. Of course, an unforeseen depreciation of the value of money harms creditors and benefits debtors. This is important but by no means the most important effect of inflation. And since it is the creditors who are harmed and the debtors who benefit, most people do not particularly mind, at least until they realize that in modern society the most important and numerous class of creditors are the wage and salary earners and the small savers, and the representative groups of debtors who profit in the first instance are the enterprises and credit institutions.

I don't know if most of us really know that inflation is helpful in paying off debts, but the larger debtors (e.g. our government) I am sure do know. When you can use money worth less to pay off past amounts it makes economic sense in that transaction. Hayek moves on beyond this point, and this I find interesting given the little that I have learned about valuing companies. Again quoting from the essay.

There is, however, another more devious aspect of this process [inflation] which I must at least briefly mention at this point. It is that it upsets the reliability of all accounting practices and is bound to show spurious profits much in excess to true gains. Of course, a wise manager could allow for this also, at least in a general way, and treat as profits only what remains after he has taken into account the depreciation of money as affecting the replacement costs of his capital. But the tax inspector will not permit him to do so and insist on taxing all the pseudo-profits. Such taxation is simply confiscation of some of the substance of capital, and in the case of a rapid inflation may become a very serious matter.

My short summary, inflation is bad. Savings are a much healthier form of growth, if only we could have more discipline in these matters. I am curious what the arguments for inflationary policies are, how do they defend what I view as corrosive practices. More to come shortly.

Mises

I have been trying to follow the economic news and ideas being tossed around lately. I was curious about the Austrian school of economic thought that has been mentioned by many writers. These theories have been placed in contrast to the ideas labeled as Keynesian. I read a compilation of essays on the Austrian theory of the trade cycle published by the Mises Institute. Mises was an economist to whom, among others, the foundations of the Austrian theories have been attributed. The published essays provide a brief introduction to these theories as well as the history behind them. I recommend these essays to anyone interested in our present economic situation. They are available in pdf form from the Mises Institute website.

The basics of the theory are that manipulation of interest rates lead to misallocation of capital throughout the economy. Forecasts that appear profitable under these conditions lead to projects and enterprises that would not otherwise have been considered prudent. Depressions are the natural correction of the economy as it reallocates capital in line with sustained demand. In the essay Economic Depressions: Their Cause and Cure by Murray N. Rothbard are the following recommendations on how to react to such a depression.

Mises, then, pinpoints the blame for the cycle on inflationary bank credit expansion propelled by the intervention of government and its central bank. What does Mises say should be done, say by government, once the depression arrives? What is the governmental role in the cure of depression? In the first place, government must cease inflating as soon as possible. It is true that this will, inevitably, bring the inflationary boom abruptly to an end, and commence the inevitable recession or depression. But the longer the government waits for this, the worse the necessary readjustments will have to be. The sooner the depression-readjustment is gotten over with, the better. This means, also, that the government must never try to prop up unsound business situations; it must never bail out or lend money to business firms in trouble. Doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease. The government must never try to prop up wage rates or prices of producers' goods; doing so will prolong and delay indefinitely the completion of the depression-adjustment process; it will cause indefinite and prolonged depression and mass unemployment in the vital capital goods industries. The government must not try to inflate again, in order to get out of the depression. For even if this reinflation succeeds, it will only sow greater trouble later on. The government must do nothing to encourage consumption, and it must not increase its own expenditures, for this will further increase the social consumption/investment ratio. In fact, cutting the government budget will improve the ratio. What the economy needs is not more consumption spending but more saving, in order to validate some of the excessive investments of the boom. [emphasis added]

Thus, what the government should do, according to the Misesian analysis of the depression, is absolutely nothing. It should, from the point of view of economic health and ending the depression as quickly as possible, maintain a strict hands off, "laissez-faire" policy. Anything it does will delay and obstruct the adjustment process of the market; the less it does, the more rapidly will the market adjustment process do its work, and sound economic recovery ensue.

The Misesian prescription is thus the exact opposite of the Keynesian: It is for the government to keep absolute hands off the economy and to confine itself to stopping its own inflation and to cutting its own budget.

What I find most striking is that this essay was originally published in 1969. I realize it is naive to hope that our government will take the recommended approach of this essay, but I was glad to find the words that echo my own thoughts on the matter.

I realize that these are theories, and we can argue about theories all day and it will make little difference. Real people feel the pains brought on by economic upheaval, and the economic theory being pushed at the time is of little consequence. That said, I hope that we can look further toward the future and act to place our economy on a more firm foundation rather than sacrificing that future to relieve the current, and I feel temporary, pain of the moment.

Goodreads

Thank you to Nate for pointing me towards goodreads.com. I should have known that a community existed on the world wide web to meet my needs to share what I have been reading and thinking about.

I still plan to continue publishing here, but we will see if the content shifts away from books.

Orson Scott Card and technology

I had some more thoughts about Ender’s Game that thematically deserved a separate post.

I read some science fiction as a teenager (not any Orson Scott Card as I admitted previously) and perhaps I knew too little to realize some of the foresight the authors had. Reading Ender’s Game however I am amazed at the technical aspects that we are beginning to see today that Card wrote about in the 1970’s.

It may be that I view the 1970’s as long ago because of my age, but as I understand things this was before the personal computer was a part of even the most tech savvy home. Ender’s Game is full of things that are just now becoming a part of everyday use. They studied on personal, laptop computers connected together in a giant network. They played simulation and computer games, some of which they interacted directly with.

Perhaps we haven't come as far as I think since the late 1970's and we have been this close for a long time. Even if there were visionaries then talking about these things I am impressed with Card’s ability to understand how technology can be used in our lives and how it will affect our lives.

Ender - Orson Scott Card

I came to the Ender series late. I never did read any of Orson Scott Card’s books as a teenager. I finally read Ender’s Game recently and was very impressed.

The copy of Ender's Game that I read had questions at the back to be used in classroom discussion. The questions had the potential to elicit very serious answers and yet were directed at young adults. These questions echoed many of the thoughts I had as I read and pondered the book.

I have been reading some of the other books in the Ender saga. Card has the ability to draw me in quickly with each book. A real part of the satisfaction is not simply the good story and approachable delivery; I enjoy the deep potential thoughts that are brought up throughout each book.

I also came across Card’s Alvin Maker series and feel the same way. This series is a historical fantasy set in an alternate colonial North America. This series is directed at a more mature audience because of the themes, but it is undergirded with deep issues to think about.

I don’t know if Card intends his works to be as deep as I read them, but it is wonderful to enjoy a book not only for the story but also for the things it makes you think about.

John Madea and Simplicity

The Laws of Simplicity by John Maeda


I loved this book and the concise presentation of powerful ideas. He has collected the principles to drive toward simplicity and makes the case for the power behind simplicity. This can be applied in so many circumstances.

Madea’s background coming from both computer science and design is especially intriguing to me. As I sit on the technical side of things I am often fascinated by the design world. The more I learn and observe I see many corollaries between the two worlds. I was able to see the application of the principles in this book both to design as well as the technical world.

The Alchemist

When I began this short book by Paulo Coelho I was skeptical. I felt as I did while reading The Richest Man in Babylon by George S. Clayson. I did not agree fully with the motivations of the individuals in the story, but as I continued to read both books I found lessons that I could easily apply to myself and my own experience.

For those unfamiliar with these books they discuss ways to achieve goals and are set in times long ago. The Richest Man in Babylon is specifically about paying yourself first to provide financial freedom. The Alchemist is about following your personal dream. I recommend both books and the overall messages that they have to share.

The sticking point for me that I had to get past was that I saw much of the individual motivations based on selfishness. I know that I have many selfish desires myself, and probably many I don’t realize, but I have spent a lot of energy trying to curb many of those selfish desires.

Perhaps we all need a certain amount of healthy selfishness in our lives. I find motivation a much friendlier word, and this is how I view healthy selfishness. We need the motivation to get out and do productive things and build worthwhile relationships.

The side of selfishness that bothered me the most in the story was the lack of commitment to other people close to the main character. Granted this may only be my perception, but in comparing these characters to myself they had very few if any obligations to others. I feel that it is natural for us to take upon ourselves obligations that should determine decisions we make in the future. With a family it is not appropriate to leave or force your family into a difficult situation. I don’t mean to say that family commitments restrict our dreams, these commitments just add another layer of things that must be considered before major actions are undertaken.

I believe that our lives are more meaningful when shared with others. If we expand self to include family and others important to us then acting upon selfish motivation for this expanded self will bring more happiness to our lives.

Stumbling On Happiness

I listened to this book after listening to Malcolm Gladwell's Blink, which in hindsight was a good fit. This book addresses more of things that our brain does without us realizing it. In this case Daniel Gilbert dissects some of the ways our brain may deceive us and specifically why it can be so difficult to understand what decisions will bring us the most happiness in the future.

The analogy that Gilbert uses is the optical illusion. An optical illusion is the corruption or confusion of our vision. Our past vision (memories) also becomes corrupted in a way similar to optical illusions. In the same way our future vision is also imperfect, seen through bias of the present. This means that our decisions are tainted by the present moment. Our thoughts and feelings now are poor predictors to how we will feel in future situations that we have not yet experienced.

Daniel Gilbert leaves the reader with an antidote to overcome our inability to accurately predict future happiness, and it is surprisingly simple. He makes the point however that it is also tremendously difficult. His recommendation is to ask someone else who has gone through a similar situation how they felt and how the experience went. It has been found that even if we feel our situations are unique they are not nearly as unique as we think. The best projection of how we will feel in a situation we have not experienced can be found in the experiences of someone who has gone through a similar situation.

I have my own reluctance in counseling with others, but I can also see the power in turning to others to help guide our decisions. We are not as different as we may think. Part of the difficulty in following this advice is knowing the best person to ask. This is a good argument to be socially active, as those with a wider circle of friends and acquaintances will probably have an easier time than the recluse.

2009 Update

I intended these posts to try and present some of the thoughts I had while reading the books I enjoy. Unfortunately I have let too much time elapse since reading these books and my thoughts have turned into vague impressions. Compounding the problem is the fact that I haven't stopped reading other books, so I hope ideas don't become muddled. I will try and do some catch up so that I can post my thoughts more quickly, but no promises.

If anyone has read any of these books and would like to discuss them let me know. Also, if you think of any books that I may enjoy, please let me know and I will add them to my ever growing list of interesting books to read.