When I was living in Australia I witnessed a discussion between two professionals about how much money they thought they should accumulate before entering permanent retirement.
On the one hand you had the banker who argued that one million dollars was enough to retire on. On the other hand you had the accountant who argued that five million dollars was enough to retire on.
Both amounts of money seemed absurdly over the top to me and grossly exceeded my own then-savings goal of accumulating $100,000 to retire to the Coromandel to live as a writer. What was more, I could see how, having saved one million dollars, or even five million dollars, you could talk yourself into believing that the amount would not be enough. It would be too easy to just keep working forever.
The truth remains, however, that no matter how much you plan to save for your retirement, your savings targets will always be affected by inflation. If you are not wholly familiar with the concept of inflation, then you are to be forgiven. I believe that ‘inflation’ is one of the most poorly described terms in all of economics, and the poverty of its definition only leads to the continuation of a set of tools applied at the macro level that are at best occasionally ineffective and at worst counter-productive and even causative of long term economic and environmental drama.
A common definition of inflation follows:
‘Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.’
With the definition, however, must come the questions.
- Why look at a ‘general level of prices for goods and services’ rather than specific price changes for specific products and services? What does this bundling of goods and services conceal or obscure?
- Who gets to determine what goods and services are included in the bundle? Whose purchasing habits do these bundles of goods actually reflect?
- What are the geographical limits of the region where the ‘rate’ of inflation is calculated across? What is the impact on the effectiveness of central bank policy if prices go up at different ‘rates’ within these limits?
- If inflation (and also the methods used to control it) affects different parties within the economy differently, who are the winners and losers and to what extent do they win or lose?
- How much do we really know about the causes of inflation?
- What is the best strategy to limit one’s own exposure to inflation? What are the benefits to doing so?
I will explore these and other questions over the course of this blog, with particular focus on the last two questions.
I have a number of hypotheses that will be confirmed or denied as we explore these topics further:
- Inflation creates winners and losers. Some parties will profit substantially off inflation using specific economic strategies. Other parties will suffer heavily.
- A regressive tax system (where nearly a third of the total tax take comes from a single source, GST) will further amplify the effects of this schism.
- Applying inflation-control measures to a geographical region such as a country fails to curb inflation in some areas just as it stifles economic growth in other areas.
- A micro analysis is far more useful than a macro analysis in determining how (and even if) we should combat inflation.
We’ll start by looking at the micro, the smallest of the small. I believe that rather than being a single event, inflation is actually a process driven by many billions of minor transactions, shifts and adjustments made between buyer and seller. The only useful way to study inflation is to pay attention to the details of these minor transactions. That’s why I’ve taken the tagline ‘Everything Micro Nothing Macro’.
On occasion, we will have cause to talk about the macro stuff, but we’ll generally get there by relating it back to the micro, ie the impact that macro policies have on individual transactions.
Going back to the example of the two professionals arguing over when they should retire – the answer is that in each case, neither of them are safe, because of inflation.
Even if you accumulate five million dollars in wealth, there is no guarantee against a general increase in prices that may lead you to eventually run out of money. The rate of increase of prices makes all estimates regarding retirement uncertain, especially where the sudden costs associated with old age are concerned.
Inflation creates uncertainty that gets worse as you go into the distance. In both cases, if one is ‘to be safe’, the only answer is to go on working indefinitely. The corollary of this is that many resources will be used unnecessarily to support a productive lifestyle that is ultimately driven by fear.
I also believe that inflation is to some extent a self-causing phenomenon. When an entrepreneur puts her prices up, she does so not only out of the fear that her current prices will be unable to cover her increasing costs, but also out of the perception that costs will increase further in the future. This in turn creates a chain reaction that accelerates as the general level of uncertainty increases.
Inflation creates a reasonable fear that you will never have enough.
