An optimistic error in the meaning of deflation (Published 4/12/06)
Other analysts have consistently made the point that inflation and deflation can only be measured in terms of increases or decreases in the quantity of money supply. Although I must agree philosophically, my concern is how much things cost and how little I have left after paying the ever higher costs of rising bills. Rather than argue with others about definitions of inflation and deflation, the Optimist chooses the more productive path of defining the new terms of inflatuation and deflatuation to mean what seems intuitive to him. Note to readers: This is a serious discussion, and the Optimist will not take kindly to odiferous puns about FED inflatuation in handling the nation's money.
Deflatuation is the answer, and now is the time
The Optimist confesses that in his youthful and less experienced past, he considered that deflation (which he thought of as paper money buying more essential stuff than it did previously) was possible only if the FED made a decision to push the U.S. economy into a deflationary recession worse than the 1930s. Since the political pressure would increase at least as fast as the nation's economic pain, the Optimist concluded that our fearless leaders would not be cowered into a deflationary retreat to honest money when they could continue to boldly advance by simply printing more paper at a faster rate. Although that is still the way that he wants to bet, the Optimist has reexamined the terms he has used a little too loosely, and he has come to a new conclusion. The newsletter writers who talk endlessly about deflation (for example, see Y.Y. comments at the bottom of Is Silver or Gold Better?) are right, sort of, but their projected timing is too far in the future. The correct answer is that the real money gas is exiting financial bubbles now as we speak, and that deflatuation is not only our destiny, but it is our inescapable present as well!
Deflatuation and inflatuation defined
Come on, guys. We are trying to have a serious academic discussion here. Let's leave the snickering thoughts about deflatuation gas exiting the financial bubbles behind. The Optimist thinks it stinks to make puns about a subject as pungently intense as deflatuation. Since inflatuation and deflatuation are my own made up words, I can conveniently define them to mean increases or decreases in the real money costs of essential items. If that sounds too simple to be useful, take another look at the microscopic print. What are essential items, and why not just consider everything? How does one measure costs? What is real money? Great! We are finally beginning to get into meaningful content. The Optimist considers essential items to be food, shelter, energy, medical, clothes, and transportation. The millions of other goods (ranging from computers and electronic toys to expensive imported cars and caviar) and services (from mega store greeter to mud bath massager at exclusive resort spas) are all relevant to the overall price environment, but differ from essentials in one very significant way. People must buy essentials regardless of the price, but people can choose to do without a few of the non-essentials, many of which did not even exist a decade or two ago.
How has the USA measured costs for the last hundred years?
Stupid question, right? The obvious answer is that goods and services have been priced in dollars for more than a century. Well, hopefully those who have previously read the Optimist's work will not be too surprised to see a different perspective here. The USA has actually used three different currencies during the last century. Until 1933 when FDR confiscated gold, everything was priced in gold and silver. Paper certificates really were as good as gold and silver since paper was freely interchangeable with the real precious metal which backed the value of the paper. Think of those dollars (which were interchangeable with gold and silver) as colored green for good paper. Between 1933 and 1971, everything in the USA was priced in a different type of dollar. Although Americans could still exchange the new breed of dollar for silver, only foreigners could get gold for the dollar. Those transition dollars should have been colored yellow for questionable value. After Nixon slammed shut the foreign gold window in 1971, the Federal Reserve Note (FRN) was only a piece of paper which people continued to accept in payment, but only because they had no alternative to doing so. The current FRN notes we are required to accept as payment should be colored a bright red to match the rage that people will feel when they find out the truth that those government IOU Nothing notes have no intrinsic value.
What is an ounce of gold worth?
So what happened to the value of gold during the transition from a dollar that was as good as gold before 1933 to today's FRN that is just printed paper? The Optimist's viewpoint may surprise some people, but his answer is that nothing happened to the value of gold over more than the past two centuries. An ounce of gold in the 1800s was still an ounce of gold in the 1900s. An ounce of gold today continues to be worth an ounce of gold, and it will likely retain that same value for the foreseeable future. Despite the deterioration in the value of paper since 1933, the fact that an ounce of gold is always worth the same precious and desirable ounce of gold is one of the most enduring aspects which makes gold (and silver, for the same reason) real money that preserves purchasing power and truly provides a store of wealth.
The price of gold in dollars
Quickly before the mutiny gathers momentum, let me assure all readers that I am aware that gold is priced in dollars (or another comparable paper currency), and that the dollar price frequently fluctuates. Here we begin the journey that convinced the Optimist that deflatuation is our present and our inevitable future fate. Gold and silver are not alone in being priced in paper dollars. The simple fact is that all of our goods and services are also priced in FRNs, and those prices similarly change substantially over the years. As shown above, however, the value of an ounce of gold or silver has remained constant at exactly one ounce of gold or silver over centuries. So the price of gold and silver measured in dollars changes substantially but the value remains constant? Although that sounds reminiscent of the Zen riddle about the sound of one hand clapping, the statement is true and the explanation is very simple.
The price of everything in gold
We cannot directly compare the dollar prices of gold, silver and all other goods and services over centuries because we are measuring prices the wrong way. Instead of calculating the number of dollars it takes to purchase an ounce of gold or silver, or any good or service, we need to use the stable value of gold to determine the changes in the prices of everything. For example, the current value of an average house is a little less than 400 ounces of gold and a share of Microsoft stock is around 0.05 ounces of gold. Gold has the constant value that we need to make meaningful comparisons over time. The price of the FRN changes significantly when measured by the yardstick of gold's constant value. Indeed, the full concepts of inflation and deflation are directly attributed to changes in the quantity of FRN paper available to push dollar prices higher or lower, while an ounce of gold stubbornly retains exactly the same value of one ounce of gold.
Changes in the amount of essential stuff gold buys
The easiest way to see whether we are in inflatuation (so that it takes more gold to buy essential things) or deflatuation (where less gold buys more significant stuff) is to look at charts which show the trends over time of prices measured in the constant value of gold. Since those charts are not readily available, the Optimist created a few example charts by dividing the FRN cost of things by the FRN cost of gold. The charts below show that the price when computed in ounces of gold of houses, stocks, oil, and most other commodities (measured by the CRB Index) may have risen in the past, but are solidly declining now. The currently declining prices (measured in ounces of gold with constant value) across the board demonstrates that we are now in a state of deflatuation, where real prices of essential things are consistently being reduced over time.