Uh Oh ... Boring 6

Stocks v Wages

Stocks rose a lot on June 15. Why? Because there was a lot less inflation than supposed. The key fact, as seen by Wall St types, is:

"Energy and food prices aside, so-called core consumer prices were up 0.2%, slowing from a 0.3% increase in April. "

From the perverse Wall St point of view, there is less inflation because food and energy are excluded. Why would people think there was less inflation, when they have to exclude the ever-volatile food and energy components to make it so? Isn't this a self-serving definition?

Exactly. It doesn't suit market fundamentalists to talk about food and energy. Those are costs you and I pay. Here I give away half the secret of Wall St "inflation:" it doesn't mean the prices you pay. What's left after taking out prices you pay are the prices they - the capitalists - pay. Chief among those prices are wages, which is the other half of the secret.

For Wall St, the "core rate of inflation" means the cost of labor and the other materials used in production, which cannot be immediately passed on to you, the consumer. Capitalists don't care about what the other guy pays, only what they pay. Naturally, this is called the "core consumer price index" (or core CPI), in memory of that which it is not.

When Dr Greenspan headed the Commission charged with reforming Social Security in 1983, it was his idea and recommendation to cut Social Security by reducing the Cost of Living Adjustment (COLA). His argument was that recipients were getting more of an increase than they deserved. So, the COLA had to be "adjusted" to reflect "true" increases in the cost of living, instead of using the Consumer Price Index (CPI). Greenspan's idea was implemented; Social Security payments are much lower today than they would otherwise have been. For example, my Social Security payment increased some 1% last January, whereas in 2003 the CPI rose over 2%.

Thus, one man's "data" is another man's undoing.

"Inflation"

What does "inflation" mean? How is it measured? Who does it affect? These are key questions not often discussed, except by professional economists and statisticians. Everyone else naively assumes inflation is what they're told it is. Unfortunately, things are much trickier than accepting the word of authorities. What is "inflation" depends on your view of economics; it is not a value-free term.

According to monetarists, such as Prof Milton Friedman, inflation is a monetary phenomenon. That is, it only happens because we use money to represent economic value. The monetarist view discounts the possibility of inflation in barter or other non-currency economic systems. In the "pure" monetarist view, there can be no inflation without money. Thus, monetarists usually believe in "hard money" - money based on gold, silver or similar commodities - because they think such money cannot be corrupted, or is very difficult to corrupt.

Monetarism is a key component of modern market fundamentalism; i.e., the recent economic theory of capitalism. Market fundamentalists, and their entrepreneurial "ultra-capitalist" siblings, believe all economic decisions should be left to private interests. Government should minimize its role, and should perform its functions unobtrusively. One of those quiet functions is management of the money, which should have a stable value. Ultra-capitalists don't start by being monetarists, but end up in the monetarist camp because it simplifies their economic lives. Capitalists want to make a profit producing things of certain, definite value, and preserve their capital along the way.

Federal Reserve Chairman Alan Greenspan is somewhat of a follower of Dr Friedman. (I say "somewhat" because many of Greenspan's policies are hard to reconcile with official monetarist positions.) Fed policy under Greenspan has been heavily influenced by the monetarist goal of price stability, using interest rates as the lever by which to control market behavior. However, "pure" monetarist theory suggests the Fed do its work by controlling the money supply, not by fooling around with the discount rate. (Rates should be set by the "free market".)

What is agreed between pure monetarists and those who would invoke interest rate setting, is that everything will be A-OK if prices are stable. Their goal is price stability, not full employment or rising standards of living. The old Reich bank, reborn as the European Central Bank, are tied to this sort of policy, despite about 10% unemployment in Germany. Social problems are just ignored by those holding and administering these views.

In the pure monetarist conception, inflation (deflation) is entirely a monetary problem. Thus, the problem is solved by adjusted the money supply. Inflation implies the existence of too much money, while deflation occurs when there is too little. (One has to think of all prices being measured solely by money.)

Those who allow of using the interest rate mechanism, as well as controlling the money supply, seem to believe prices are not entirely set by the money supply, but reflect distortions of production (supply) and consumption (demand). Thus, rises in coffee prices may not be the result of excess money in circulation, but of natural disasters, an increase in coffee drinking or some change in transport and processing (e.g., increased oil prices). To the extent that coffee production is the result of investment or some form of borrowing, lower interest rates may encourage further production or distribution, while also increasing consumption (by making consumer credit cheaper). Of course, higher interest rates will have the reverse effect. A difficulty arises in the long time it takes for interest rate policy to take effect, which does not help short-term mismatches in supply and demand. The hard-nosed believer will say, however, that increased (decreased) prices solve the distribution and allocation problem. I don't know what those folks think when the mismatch is in water; say, due to a drought in Western North America. Malthus thought famine was the natural way to reduce excess demand due to the surplus population.

While monetarists disavow fiscal policy, in practice Greenspan seems to accept that fiscal policy is sometimes necessary in managing the economy. Thus, he worked closely with Pres Clinton and Treasury Sec Rubin during and after the tax increase of 1993. He also gave the wink and nod that allowed Pres Bush to go ahead with the 2001 tax cuts.

In the 1970s, Dr Friedman's monetarism was put into practice, but it simply didn't work. In the face of the OPEC Oil Embargo and other catastrophes, the government was forced to adopt "other measures." Despite the failure of monetarism, and its abandonment by influential proponents such as Dr Greenspan, conservatives, especially market fundamentalists, still hail their mentor, Dr Friedman.

Intrinsic Value

Those who believe in hard currency, and the weakness of paper or "fiat" currency, usually posit some enduring value in the commodity of their choice. Like their gods, the currency is preferably absolute in its value and authority in order to regulate men's lives. But, what reason would anyone have for recognizing that value? And, is it always the same?

John Kenneth Galbraith has discussed these issues in his book, Money: Whence It Came, Where It Went. I recommend the book, because I think it shows there never has been any "absolute" currency standard.

When the Spaniards arrived in the Western Hemisphere, and got the first case of (White Man's) American Gold Fever, they confronted natives who failed to appreciate the significance of gold. There are a number of surviving commentaries on these encounters stating that Indians perceived White Men as crazed by gold. This is not the only case of native, primitive populations who did not understand the value of gold.

The Europeans themselves used silver, not gold, in their currencies. This is indicated by the French word, argent [from the l. argentum], and the English pound sterling, which are silver treated as money. The gold standard was seldom used until late Victorian times, probably because of the scarcity of gold until the various North American gold rushes. I haven't read anything indicating that Livres (₣) and Pounds () had some absolute value, some constant international reference other than their weights, over long periods of time. While it is true Medieval Kings and their descendants settled debts in silver (or sometimes in gold) weighed out on scales, it is also true that the price of salt, sugar and butter varied from time to time. As nearly as I can determine, prices have always varied.

If there have been periods of inflation or deflation since ancient times, regardless of the basis of the money or the actual money used, then the value of money is not a constant. There is just no evidence that the prices of commodities were always constant with respect to "hard money." Ancient Rome, for example, persistently debased the currency in order to pay its debts. While confusing because of the debasement, there appears to have been no constant assessment of the "intrinsic" value of gold or silver. What a Roman soldiers' pay could buy varied from time to time.

So, unlike Dr Friedman and his monetarist followers, and contrary to "gold bugs" generally, I prefer to believe that there is no common or intrinsic monetary value. My theory is simply that it is all in the eye of the beholder, and different beholders see different things. This view justifies floating currencies, and currency trading. Today's barrel of oil is tomorrow's lump of coal.

Changing Values

If inflation and deflation go on regardless of money, then what are they? Dr Friedman is right, that inflation is a "monetary phenomenon," minimally meaning that we use money (of whatever sort) to measure inflation. If milk fetches a higher and higher price, then its value is inflating. How do I know that? Because I pay more and more of whatever it takes to possess the milk. When the Narragansett tribes were in charge of the money supply, by making wampum from certain sea shells, increasing milk prices would have been measured by the increasing amounts of wampum I would have paid for it.

Note: There is a difference between measuring inflation or deflation with a currency, and alleging that the currency causes the phenomenon.

There is another way to look at it. The value of milk may have been constant while the value of wampum devalued. Thus, increasing milk prices can be the inverse of monetary deflation. Whether an entire economy is suffering inflation or deflation is relative to one's standard of value. At any time, it can be looked at either way.

I realize most people aren't prepared to deal with negative interest rates, but we deal with credits and debits all the time. The American economy is built on owing, a negative. Those who owe pay interest on their debts. Those who don't owe, receive interest on their credits. Whether the interest is positive or negative simply depends on your reference point. Generally, the same is true of inflation and deflation. If the prices paid in the market keep going higher and higher, meaning it takes more and more of whatever currency to pay them, either the currency is deflating or the goods are inflating. It is all relative, in the relationship between money and the things it buys.

Hard Work

There are those who believe value resides in the labor which produces the products; i.e., they hold the labor theory of value. It is true one can measure the price of milk and butter by the number of hours worked in exchange for those items. But, how does one measure the value of work? In the offices down the road, they pay some people huge amounts of money for sitting around and talking to other people, or talking to computers, but they pay very little for someone hustling trash cans and piles of paper. So, in the same workplace, there are people who think milk is cheap, and others unlikely to agree. Their beliefs about the cost of things depends on their wages, which depends on their positions in society.

But surely wages depend on productivity, labor scarcity and technical skill? Not exactly. It still irks me that trolley car drivers make far more than I ever did programming computers. My work allowed hundreds of others to have a job. The trolley car does get thousands to work, but creates few new jobs. Who is worth more: the San Francisco Muni driver, or some techie-whizzie nerd? Regardless of my feelings, I don't know. Moreover, I don't know anyone who can answer such questions with any certainty. I do know I would have got paid a lot more, had I the power to screw up the City by going on strike. (Blackmail works.)

Labor creates things which we value, but it is not at all clear that labor creates the standard of value. There is a difference. So, unlike Marxists and some socialists, I do not subscribe to the labor theory of value.

What I do know is that hungry and thirsty people are far more willing to pay 'an arm and a leg' for food and drink that others would shun. Value depends in some way on perceived need or want (desire), but it is not easily calculable. The hot dog stand waitress might get a big tip out of some hungry people, but nothing from others, for almost identical services. People may not be willing to pay as much for some hot dogs as for others, by reason of taste, convenience, toppings, etc. Even the location and appearance of a hot dog stand affects the price of what's served. So, what people are willing to pay for a hot dog depends, and depends deeply, on inestimable factors.

My best guess at settled economic values is simply that they are the result of improving estimates. Maybe I paid too much for the last hot dog, so try to pay less for the next one. Maybe, even as I write, I can savor the taste of a delicious hot dog, and would pay at least as much for another. Somewhere in the range of choices, I will settle on a price, what a hot dog is "worth." The same sorts of ideas are put to work in neural networks. I call my notion of value, the "training theory," or "system training theory." Maybe it could be called a "network theory."

Apples

Neural networks and training theories have a way of upsetting a lot of apple carts, thereby making a lot of people unhappy.

For example, (neo-)conservative economists assume prices are measured in constant currency. That constancy makes their supply-demand curves work as classically described. The economic argument is analogous to classical physics, in which it is assumed gravitational acceleration is constant, that there are no meaningful derivatives of motion beyond the 2^nd.

Suppose gravitation is susceptible to a calculation that depends on factors like mass, relative speeds, etc. After a few experiments, one soon arrives at General Relativity, which is a complex set of partial differential equations (technically, tensors). One has to "get into" higher dimensional spaces and all sorts of things to understand "motion.". The seeming simplicity of Newtonian Mechanics disappears, except as a special case.

It's the same in the economy as soon as money isn't a constant. What's an Apple "iPod" worth? How much should Apple's assembly line workers be paid? What about the value of intellectual property? What interest should a tentative bondholder be willing to receive from the Company? How much is the stock worth, considering all that Apple contributed to the economy?

I've never bought an Apple computer, mostly because the IBM compatibles have always been cheaper, faster and more appropriate for the work I do. So, for me, Apples have always cost too much. That doesn't mean they are worthless; after all, one man's byte is another's worm. Who's right about Apples? Everyone and no one. There is no way to decide as long as someone is willing to make them, and someone is willing to buy them.

Non-Linear Money

When the value of money spirals around, it becomes difficult, maybe impossible, to determine whether one's business will succeed or fail. There is no simple productivity curve, or marginal value curve. Supply and demand don't meet neatly at an intersection of straight lines. If value itself is a relative variable, the entire production function is at least as complex as a recursion, and all the factors are dimensions of multi-dimensional spaces. Solutions to economic problems are, then, only estimates, and only arrived at by complex computations.

This should be obvious from the fact that many industries have to solve the "traveling salesman problem" in order to run their business and sell their products. For example, breweries schedule ingredient purchases, and ferment batches of beer, ale and other beverages, based on best guesses about price and availability calculated by super-computers using leased software. The lease is really expensive, as it represents some of the best efforts of leading mathematicians and research scientists on optimization problems like the "traveling salesman."

Coors and Anheuser-Busch donate millions to conservative causes that try to sell you simple-minded solutions to complex economic problems. They don't run their businesses that way; they would go broke if they did. The truth is, not even a Republican business can be run by the Eco 101 book.

The best we can do about inflation and deflation is make a guess, just because values are ever changing. Economic values - prices - depend on a myriad of factors that not only change over time, but the inter-relationships of the factors changes as well. Thus, at a very basic level, everything economic is risky (uncertain); economics is about the management of risk. I am sure Dr Greenspan will concur with that statement.