Is the problem with the economy inflation or deflation? If you are buying food, gasoline, or college tuition, you are seeing dramatic inflation. If you get an assessment on your home, sell your SUV or GM stocks or bonds, you are seeing massive deflation. How can these both be happening at once? How can such an economic disease be treated? What should this phenomenon even be called?
I call it simulflation, an historically rare phenomenon where massive deflations and inflations occur at the same time or in very rapid and overlapping series.
Simulflation: A theory of physics and history stating that at critical inflection points, reigning economic and even biological paradigms sow the seeds of their own overthrow by their eventually valuable inadvertent "waste products" aka "progress".
Examples of earlier forms of Simulflation:
- Stars generate helium as a waste product of hydrogen fusion. The star's outer boundary stays stable until insufficient hydrogen remains. The fusion reaction decays resulting in gravitational deflation of the star, and simultaneous massive inflation via shockwaves, and massive helium fusion inflation (the former excreta of the fusion process) that creates an entirely new "species" of star.
- Printing of indulgences ("Get out of Hell free" cards) used to finance capital projects for the church (the Vatican for instance) causes overprinting of indulgences causing "spiritual inflation", undermines and overthrows the political, spiritual and intellectual hegemony of the church over western Europe. Massive inflation of knowledge and alternate ruling species (nation state, parliamentary monarchy) and gross deflation of languages caused by printing of the Bible (death of welsh, gaelic, Flemish – rise of Frankish, etc) and language groups ensue.
- During the 2nd industrial revolution, mechanization led to vastly increased productivity resulting in too much freed up capital and inflation of paper assets leading to overinvestment in canals railroads and eventually internet bubbles which led to railways and dark fiber to nowhere. The overinvestment generated vast deflation in the cost to transport goods as excess capital freed up by the new productivity feeds on itself as these costs free up even more capital since they no longer need to be paid to move stuff. Everything becomes free-er and free-er and all that untethered cash sloshes around on the deck of capitalism like a loose cannon driving bubble after bubble until the ship (institutions, companies, markets, states) itself is torn apart. We are now in a place and time where Moore's Law is inexorably destroying industry after industry creating 3 or more orders of magnitude efficiency gains – freeing up so much cash competing for so little return that it has produced a brainless rush for returns in silly investments such as giving mortgages to people who have never had a hope or prayer of servicing these mortgages. Exactly what happened in the late 20's. Same movie. Exactly.
These simultaneous and inextricably related inflation and deflation events are caused by rare yet predictable socio-economic conditions as economic paradigms are replaced by their R & D offspring. I coined the term 'Simulflation' to better describe this increasingly more frequent phenomenon described below. Floods of money/savings/bubbles with simultaneous inflation and deflation are one of its key predictions.
I've been quietly predicting just this kind of phenomenon in the economy since 1992. As the progress of bits, light and nano continues cost deflations of 2 to 4 orders of magnitude, such collapses free up oceans of capital/cash no longer needed in formerly higher cost operational/capital/investment transactions (part of the deflation component of Simulflation) - such loose cash moves inexorably into financial and fixed assets ( the simultaneous inflation). All the while the financial powers that be are unaware of the underlying forces - driving the phenomena into further pathologic epiphenomenon in an attempt to restore the previous order by means of grotesque additions of money supply.
The best visual way to "grok" the phenomenon can be observed by imagining the simultaneous deflation/inflation as a star collapses at the same time it's outer shell grows exponentially in a "bubble" - leading to unstoppable blowoff). Simulflation happens in stars as they shift from one fuel to another (hydrogen -> helium) having exhausted one source of fusion, they collapse...as they collapse (deflation), the energy of collapse blows off (inflation) the outer shell of the star. This can happen many times in a star's life...until it reaches nova - or supernova (uh oh). I believe that this is not just a metaphor for what's happening, but is indeed a more basic version of the same phenomenon wherein information density is the substrate of various forms of instantaneously propagated effects such as gravity and consciousness.
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Capitalistic economies grow money supplies reasonably commensurate with organic economic growth such that a current stock of money reflects historical investment and production costs. An analogy is a dam where sufficient water (money) is allowed to flow through the generators to supply enough electricity (liquidity) to handle instantaneous, peak and peak projected demands (operations, historical investment rates and depreciation). If too much water is allowed to flow, the grid could overheat (inflation) or brownout (recession). Accelerating technological change (first a drizzle, then a storm, then a deluge) leading to globalization is changing investment and production trends and accelerating cost reduction and thus faster productivity gains. Again, by analogy, the dam is breaking, the power grid is becoming superconducting, and the engineers are trying to spill water as fast as possible - meanwhile, lights are blowing out (bankruptcies) all over the place, and liquidity is spilling into the streets.
2) Capitalism targets and promotes the destruction of costs as well as creation of value. The inexorable destruction of costs and then industries by the orders of magnitude improvements in communications and information technology has made so many business models fall apart, (travel agents? Long distance and wired phones? Print magazines and newspapers? Songs on CDs? Etc etc etc. that the current paradigm is collapsing and has been for the last 20 years at least.
3) There are inflection points where technological progress causes the (pick a word - collimation, conflation, synergistic) destruction of costs through substitution effects of one order of magnitude or greater ( i.e. teleconference instead of airplane ticket).
4) The result of wholesale substitution of stable industries with new methods creates A major source of surplus money and causes a relative reduction in investment in the stable industries and reduced pricing power, thus releasing the money that used to be needed to grease the wheels of the old industry in such quantity that it creates a defacto increase in the money supply. Additionally, governments see significantly greater revenues from apparent sustainable expansion, financial industry proliferation, productivity improvement and thus, the surplus moneys then goes to governments through taxes. As governments find their need of borrowing is reduced, the absolute and prospective supply of debt (treasury bonds) is severely constrained - resulting in inflation of prices of the debt paper, and drastically lower interest rates creating a secondary boom in primary debt asset inflation. An inverse result of increasing/inflating bond prices is a massive decline in bond yields, further reducing the apparent cost of investments of governmental, commercial and personal investments (real estate, stock, bond bubbles and rampant frauds).
"When a flood of new inventions gives opportunity to make more than the current rate of interest there is always a tendency to go into debt, in order to make money out of inventions, and to the ordinary investor this comes in the form of investing in common stocks. At such time, the rate of interest should be high, embracing as it does the opportunity to invest for a high rate of return over cost. If there is a great discrepancy between the rate to be realized to the investor from his investment, and the rate of interest on which he can borrow, he will be inclined to borrow all the more." Paul Warburg The Theory of Interest, New York 1930
The flood of money made redundant by a new paradigm seeks its highest return by over investment in the new paradigm (railroads, fiber optics etc etc) further driving the deflationary phenomenon undermining older industries and indeed, even the new industry as a surplus of competitors lower prices to compete. Globalization has accelerated this element to an even more severe degree as the simulflation phenomenon no longer stops at national boundaries.
Reduced interest rates then encourages governments, enterprises and individuals to increase spending. Cash seems to be trash. During such periods, the very meaning of money can become quite confused as new and bizarre species of financial analogs of money appear-anything from tulip bulbs to derivatives to - yes - stock in companies that make nothing and give even that away.
But, fundamentally, money has UTILITY because it is a low friction medium of exchange with the power to coerce behavior in strangers, both locally and halfway around the world. Its true NATURE and justification and source of legitimacy (i.e. Why some money is not counterfeit) is that it is believed to be a reliable proxy for human trust. Money's legitimacy arises from its ability to project trust into the future (this is similar to the utility, value and legitimacy of LAW) and thus most importantly can COERCE people and institutions into behaviors that they would otherwise not engage in (waking up at 6 am for the 10,000th time to have fun in traffic to go to a job you despise to pay the mortgage) as surely as gravity keeps folks feet planted on the ground. In order for the number of goods/services to grow much beyond "my tribe", there is a requisite need for an increase in trust...for example, I would only build a house on spec if I have supreme belief/faith that there will one day (soon) be a willing buyer if there is enough "trust/money" in a system. This is how I am coerced into investing huge efforts to build a good for a future currently anonymous buyer who today doesn't even know he wants a house. Without a surrogate for my trust/faith in the future of transactions, I cannot rationally produce goods in advance of their instantaneous demand. Thus, a supply of trust surrogates (money) must increase when actual growth of (in-demand) goods and services grows.
When the prolapse cycle begins, Governmental and real counterfeiting proliferates as systemic moral hazard grows and eventually reigns. Recent examples are the 1929 worldwide prolapse, 1980's East Asian thru 1995 - today's serial financial scandals, corporate lootings, bankruptcies and get rich quick through debt or market speculations accelerate ad - nauseum. small lies, accumulated with compound interest over decades, led to mammoth deception on Wall Street. earnings reporting gave way to earning management to earnings manipulation to earnings misrepresentation to outright deceit. As accounting firms sold more lucrative consulting services to audit clients, their professional integrity came into conflict with revenue, and guess which side won. The accounting industry's reputation for professional caution and for dullness led the investing public to believe massive fraud was impossible as Enron, Tyco, et al stole investors blind.
As these large pools of free cash seek returns, Asset inflation takes off, resulting in compartmentalized thinking that somehow increases in asset prices are somehow NOT a symptom of inflation. As this inflation continues it creates an euphoric air in the civilization resulting in less rigorous investment criteria, easier provisioning of and increased amounts of available credit and a gravitational attraction to seek phenomenoligically profound apparent returns from the process of asset inflation (growing toward blowoff). As the gravitational mania proceeds, it becomes clear that following the prudent rules of the stable period becomes confoundingly the cause of failure such as those that short stocks because they've gone nuts. Those following the old wisdom are either economically destroyed or become marginalized due to poor returns relative to the "new paradigm".
The old wisdom really is wrong during this period. As the impossible inflation of wealth proceeds, more and more generational savings is pulled from now low yielding vehicles (CDs) for what appear to be highly speculative vehicles that create trust by continually seeming to defy gravity - these are the new paradigm technologies, techniques and methods. The freed up money from newly allocated savings, surplused cash from productivity improvements, and increased credit availability all tend to focus on the new technology - but since the new technology is from 10 to 100,000 times more efficient than the previous paradigm, it will occur that these new areas will quickly become supersaturated with cash, creating many multiples of competitors all vying to dramatically increase the already dramatically increased productivity/utility of the new paradigm.
When trust is counterfeited, then money goes thru bubble/evaporation phases during which the decades long formations of trust are squandered. When the gross "capital" formation of trust (again, trust being an outgrowth of consciousness - itself an outgrowth of immense informational density) is in process of collapsing, no amount of physical/fiat money (utility) can replace trust. Until trust (human integrity) is restored, then no firm basis for the growth of money comes into being. In this model, even gold may hold no value unless there is human trust available to support the specie.
In normal times such phenomena are too small to have significant macro effects - but from time to time there are so many of these events happening simultaneously that it has a huge and ongoing effect - initially causing asset inflation and gross capital misallocation to the "new thing(s)", while the industries that formerly in aggregate WERE the economy become unviable and collapse in flames (think Railroads, airlines, AT&T Long Distance, the future collapse of the PC industry) along with the profits and taxes that these enterprises once generated.
As the cycle proceeds, goods and services directly affected by the new methods/paradigm enter a deflationary cycle wherein prices drop repeatedly...thus preventing the apparent need to increase interest rates to stop "price inflation". However, all items not significantly impacted/improved by the new methods will paradoxically increase in value commensurate with their actual and perceived scarcity such as real estate and financial assets (up till now anyway). This creates a situation of simultaneously positive feedback where the inflation and deflation promote one another such that they accelerate "away" from each other like two ice skaters releasing one another after a high speed spin - Thus inducing an accelerating prolapse.
If one looks at stellar fusion cycles, it is almost identically the same process (I assert this is not a coincidence).
Over time the conflation cycles proceed at a more and more frequent pace - from printing press - to shipping/exploration - empiring - industrial rev I, industrial rev 2 railroads/telegraph, Airplanes/refrigeration/electrical grids/cars/machine guns/telephones/movies/radio.
I don't really need to talk to you about the black hole effect that Moore's law is having today. It is self evident.
The well-understood causes of inflation are unfettered printing or debasement of currency and relaxation of credit requirements via fractional reserve banking.
History shows there is another source of de facto inflation that is growing in frequency, magnitude and prominence as technological cycles accelerate. Before recent times these events happened either before the appearance of humanity, or more recently, beyond the typical human life span and therefore the beyond the ability of a single generation to experience, observe and describe. With the advent of the printing press and more widespread and reliable historical records of the last 500 years it has become possible to see this phenomenon in action such that it can be theoretically described and therefore falsified by predictions that either succeed or fail.
Capitalistic economies grow money supplies reasonably commensurate with organic economic growth of the central economic engines represented as an "economic era" such that a current stock of money reflects historical investment and production costs. An economic era is the collection of socio-economic drivers that provide the thematic fuel of economic activity – all or most other activities being subservient or supportive of the main theme(s).
For instance, immediately prior to the advent of the printing press (in the West) the main economic theme was to avoid hell and get into heaven. There was a monopoly on this economic theme held by the Roman Catholic Church – while there were many other economic activities, this was the overriding theme, and the church held vast control over economic activity. In addition to various forms of hard money, a key currency of the day was in the form of indulgences – or "get out of Hell free" passes. As the fear and horror of certain death followed by payment for sins was realized by a typical wealthy individual of the time, the church was able to do a lively business in selling its "bonds" aka indulgences. Over time the church used proceeds from these transactions to extend its secular power through conquest and political intrigue as well as a vast building program of palaces, cathedrals and commissioning of great artworks. In this effort, the church began to exhaust its (moral) fuel in that it debased its justification for holding the spiritual monopoly over spiritual outcomes – how could it be the arbiter over the next world when it was seen as immoral and secular as the buyers of the indulgences? But, things went along until the printing press was invented. The key question should be WHY DID THE CHURCH ALLOW this disruptive technology to survive? There is no way they did not understand the potential consequences of this machine – certainly they did understand. So WHY on earth did they allow the machine to continue? Because they had become totally absorbed in maximizing financial return in order to supply funding for huge building works such as St. Peters. The church had the idea of using the printing press to print indulgences instead of being required to use a scribe to manually produce each and every one of them. This was just to good to be true. The church could now print indulgences to its hearts content at near zero cost. Resulting of course in an inflation in the world of the spirit of massive proportions now, EVERYONE could get out of hell if they had the coin…but that's off topic here. The main point is that the printing press – the VERY THING THAT WOULD undermine and eventually destroy the church monopoly on the western world was kept in existence BY the church to improve its financial yield by reducing labor costs and increasing cash flow.
As another data point to illustrate the process, we turn to the airline industry. In order to generate greater passenger yield per plane trip, American Airlines funded the first networked real time computer system - SABRE - it is this very investment which has planted the seeds of the destruction of business passenger traffic. We are now seeing the growth of teleconferencing and telecommuting as the direct result of this investment by airlines...thus planting the seeds and creating the fertile soil of their own destruction (deflation). Just like a star, the main economic theme collapses and the next theme "ignites".
We discussed the Papal "Indulgence inflation" phenomenon and its monetary component as a severe dilution of spiritual credibility both of doctrine and the church institution. Both of which sowed the seeds of the reformation and the enlightenment. However, what about the deflationary component? Was there a simultaneous deflationary phenomenon attendant to and made possible by the printing press? Yes – over the course of decades, the primary barrier to commerce – too many languages – was significantly affected.
With printing taken out of the hands (literally) of scribes paid exclusively by the church, the Bible began to be printed in non-Latin languages. However, it was very life threatening to translate the Bible, required great skill, time, devotion and stealth – thus, not all of the multiplicity of regional dialects and languages received translation. For example, in the region we now call France , there were at least 3 major languages. The Bible was translated into the language of Parisians only – which then became "French". The deflation then was the extreme reduction of languages caused by some languages being left behind and losing critical mass while other languages achieved escape velocity - monopoly market shares. That is why so very few speak Flemish – Romani - Welsh – or Gaelic now.
Sadly, in the course of this Simulflation a large number of wars were fought – these wars are in my view a shock wave phenomenon attending the simulflation as economic, political and social winners and losers promote and/or attempt to prevent the course of history.
This language deflation then created ignited the new fuel for the next "socio-economic" theme. By reducing the number of languages within a geography it increase the potential market for book sales, raised therefore the general education level of the wealthy and middle class, created a desire for novelty in books (I'm sick of Plutarch – how about a "novel") and in general. Finally, it created more easily united and larger populations – resulting inexorably in The Nation State – first in the form of National Monarchies, and eventually – the western secular Nation State as it exists today.
Just as a stable star maintains equilibrium between collapse and blow-off through normal transaction (economic) activity – energy released through the conversion of hydrogen to helium, so economies reach dynamic equilibria – while at the same time burning the fuel of the current paradigm and creating the fuel for a future paradigm.
Interestingly, today we have another form of language deflation. In 1950 hardly anyone on Earth spoke binary (through a digital intermediary such as a computer)…after only 50 years, nearly everyone speaks binary through a digital intermediary (cd, cell phone, PC, internet, DVD). English has been the beneficiary of this binary carrier…and we can see the beginnings of all sorts of boundary dissolving (deflation/inflation) phenomenon as we sit here today.