Tuesday, July 13, 2010

On Uncertainty

When a downturn occurs, the anticipated fails to materialize, our expectations are dashed, and uncertainty increases. The old verities have become less true. We become less sure of our beliefs and of what to believe. Our plans are drawn in, focusing less on the future and more on the present. The good times have gone and we struggle, not knowing how bad times will get, how long they will last, or how fast good times will return. What is uncertain is the future.

With stability and time, our anxieties recede and we become more confident of what tomorrow will bring. It is difficult to believe in the end of the world forever. As our worst fears fail to be realized, we become more sure of our position and its possibilities.

Stability and time can be hard to come by though. Since we were taken by surprise by the downturn, and uncertain about the cause, condition, cure, and what will happen next, we steel ourselves for more surprises, and if they materialize our uncertainty is redoubled. People will seek out uncertainty and take note of it at times like these as justification of their uncertainty and to avoid taking actions, but the real uncertainty is always the future. The search for new truths, for reassurance of familiar patterns, will continue until a new stability and a new time is made.

Monday, July 12, 2010

On Deflation

Deflation is rare but has occurred occasionally through history. As experience with it is very limited and much of common experience fails to apply, many of its features are counterintuitive. Existing theory is heavily flawed as a result. These are critiques of it.

As inflation is a signal to flee money and seek (fixed) debt, deflation is a signal to seek money and flee debt. Commonly, decreasing the price increases demand, but under deflation demand for money is stronger and falling prices allow the conservation of money, so lowering the price reduces demand.

Sticky prices lead to unemployment, but they also lead to, that is, preserve, employment. The problem is flexible prices would not lead to equilibrium in general, but to instability and swings due to everyone trying to anticipate and exceed everyone else's expectations. The problem is not that they are sticky but that they are not uniformly sticky for if everything changed in the same proportion it would be as if they did not change at all. It is really that this is not true initially that creates deflation and the reestablishment of this feature that ends deflation.

As prices fall, real balances rise, but the expectation they will continue to fall induces delay to purchase, not advancement. If you were becoming wealthier at an increasing rate, you would be more inclined to delay, but while sellers may be willing or forced to sell inventory below cost, they are not likely to produce below cost, so eventually price declines reach a limit of wage declines and real balances cease to increase. The duration of the production cycle would throttle the rate of decline. At this point, there is no more incentive to delay. If prices fall, wages also fall, and attempts to save more fail as they do so. It is not rising real balances that turns deflation around but that they cease to rise, or equivalently, it is not that real wages rise but that they eventually cease to rise.

Falling prices do not lead to increased output. Flexible prices would not lead to equilibrium. Rising real balances are the result of deflation, not its end.

Saturday, July 10, 2010

On Barter and Money

Under barter, economic actions are linked, production with consumption, savings with investment, wages with prices. One can trade for mutual benefit or accumulate assets and inventories but that is the only way to separate these functions, speculate, or store wealth. There may be excess or shortages of specific goods but never all goods at the same time. The hazards are vicissitudes of life, nature, and the market.

With money all these actions may be separated and wealth accumulated more conveniently. For these benefits, there is a price to be paid, and that is an shortage or excess of money. A shortage results in deflation while an excess in inflation. Both impair the function of money as a medium of exchange, deflation by elevating its function as a medium of storage at the expense of trade and the economy, inflation by lowering its function as medium of storage diverting it into assets and inventory. Money largely works through interest rates and credit, making investment more or less risky. This has real effects when investments fail or succeed, though they may fail due to the underestimation of risk as well as its increase and succeed due to the overestimation of risk as well as its decrease. Deflation can destroy money by credit contraction, bankruptcy, and making otherwise profitable investments unprofitable. Inflation can create money by credit expansion and making otherwise unprofitable investments profitable, some of which may only be profitable with inflation though these will be realized over time. These can amplify themeselves over time, but if not allowed to do so, economies can adjust and neutralize them over time. Otherwise it can lead to a return to subsistence and barter.