The Digital Revolution vs. Inflation
There are constant debates over whether we are in an inflationary or a deflationary environment in the United States.
I argue, and I have been arguing for a decade, that we are in a mildly inflationary environment with respect to consumer prices. Obviously, with respect to the monetary base, we have been in a wildly inflationary environment. But because the Federal Reserve, in October 2008, began paying interest on the excess reserves deposited with it by commercial banks, the fivefold expansion of the monetary base has not converted into a comparable increase in M1. Also, there's been a sharp decline in M1 velocity.
For over a decade, I have used the Median CPI rather than the CPI as the best measure of price inflation. It is published monthly by the Federal Reserve Bank of Cleveland. I use it because it is far more stable than the CPI: month to month and year to year. I want to see the trend of price inflation. Wild fluctuations makes this difficult to see.
This year offers evidence of why I prefer the Median CPI. Here are the data: January (0.2%), February (0.2%), March (0.2%) April (0.2%). They were 0.2% for November and December.
In stark contrast, here are the figures for the CPI: January (-0.7%), February (0.2%), March (0.2%), April (0.1%). November and December were both deflationary (-0.3%).
What the Median CPI reveals is this: no change in the trend in 2015.
What about the previous 12 months, month by month? The Median CPI shows no change: 2.2% in every month, November through April. What about the CPI? November (1.3%), December (0.8%), January (-0.1%), February (0%), March (-0.1%), April (-0.2%). These were reported on May 22.
The standard response to this by people who really do not understand the problem of assembling price indexes is this: "The indexes are being jiggered by the government." The correct answer to this is simple: "So what?" The indexes are not jiggered with often. Maybe once a decade there are alterations, but this is necessary in every price index. This is inherent in the very theory of a price index. If somebody doesn't jigger with the index, then we would still have buggy whips as a component of the modern price index.
Because certain consumption goods fall out of favor, they have to be dropped. Every index in history has this problem, whether we're talking about the Dow Jones Industrial Average, the Standard & Poor's 500, or any other index. History changes, and the indexes have to change with it, or else they become irrelevant. But this obvious fact is never discussed by the people who have this knee-jerk response: "The government is jiggering with the statistics." The question is this: "Is this jiggering justified by changes in the economy?" The critics of price indexes never bother to discuss this problem. It is a fundamental problem of epistemology in economics. It is not easily solved.
So, I am interested in the trend. I want to see whether we are moving into higher rates of price inflation, or fairly standard rates of price inflation. In the case of the CPI, we are actually in a mildly deflationary environment, and we have been for over a year. But, as I said, I pay attention to the Median CPI, not the CPI.
MOORE'S LAW AND METCALFE'S LAW
I am a firm believer in Moore's law: the doubling time for computer chip density. I am a firm believer in the fact that the cost of information continues to decline sharply, and the cost of communicating this information also continues to decline.
I regard the declining cost of information as the most important single indicator of productivity in the modern economy. If the cost of information is declining, and the cost of communicating this information is also declining, then we are in a positive environment.
We had better recognize something else. As the cost of any particular commodity or service declines, more of it will be demanded. This is a fundamental economic law. Because of Moore's law, which relates to the efficiency of computer chips, and because of Metcalfe's law, which relates to the value of communications under these conditions: an increasing number of communications, we are living in an environment in which information is becoming ever more important, precisely because it is becoming ever less expensive. In other words, the importance of information in the overall economy increases; so does the increased use of this information. More information is being used because its price continues to fall.
So, statisticians have to weight the consumer price index in terms of the increasing weight and increasing relevance of information. The cheaper that information is in relation to other commodities and services, the more important it becomes in our economy. This follows from the fundamental economic rule: as the price of anything declines, more of it is demanded. If we dismiss that rule, we abandon the logic of economics. Therefore, we had better pay close attention to it.
There is something else. Digital technologies, unlike all other technologies, affect every aspect of our lives. The cost of food continues to go down, but we do not consume an amount of food comparable to the decreased costs. We don't need that much food. What we need these days is an effective diet. The same thing is true of other commodities. As the price of the commodities fall, we start buying other commodities. But in the case of information, it is different. The cheaper it gets, the more that we buy, and the more areas of our life that benefit from this decrease in costs. This declining cost changes the way we spend our leisure time. It changes the way we make a living. It changes everything in our society, because information, like money, is central to the social order. In fact, information and money are linked, because prices convey information, and money is basic to a division of labor economy.
The decreasing cost of computing power, which includes the decreasing cost of data storage, is the most startling single economic fact of the modern world. It is producing an exponential curve. Nothing else in the history of man or nature has ever increased at as high a rate, for as long a period of time, as the supply of information per dollar. We can trace this back to the federal census of 1890. The cost of information from 1890 until about 1950 fell by half every three years. From 1950 until 1965, it fell by half about every two years. From 1965 until about the year 2000, it fell by half about every 18 months. There is some debate as to whether it has continued to fall, but it certainly has not risen appreciably. Nothing else in man's history approaches this rate of decline in cost. Therefore, nothing else in history has approached the importance of the decline in the cost of information to the overall society.
So, those people who dismiss the introduction of the information deflator into the CPI do not take economic theory seriously, and they do not take economic history seriously. There has to be a consideration of falling information costs in any price index. The accuracy of information keeps increasing, while the cost of obtaining it keeps decreasing.
Furthermore, because of Metcalfe's law, the value of this information keeps increasing as a result of an ever increasing number of participants in the market for information. Here is Wikipedia's summary:
Metcalfe's law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system (n2). First formulated in this form by George Gilder in 1993, and attributed to Robert Metcalfe in regard to Ethernet, Metcalfe's law was originally presented, circa 1980, not in terms of users, but rather of "compatible communicating devices" (for example, fax machines, telephones, etc.). Only more recently with the launch of the Internet did this law carry over to users and networks as its original intent was to describe Ethernet purchases and connections. The law is also very much related to economics and business management, especially with competitive companies looking to merge with one another.
We have recently learned that almost half of the world's population has access to the Internet: 3.2 billion people. In the year 2000, this figure was somewhere around 400 million. In other words, there has been an eightfold increase in people's access to the Internet. According to Metcalfe's law, this is an extraordinary increase in the value of communication.
We can barely comprehend what it would be like to go back to the year 2000. That would be a world without Google, without Facebook, and without YouTube. Then imagine what it was like before 1995 -- a world without a graphic user interface Web browser. Yet this social transformation has happened right under our noses. Eric Blair (a.k.a. George Orwell) was correct: "To see what is in front of one's nose needs a constant struggle."
FREE MARKET VS. RIGGED MARKET
The free market economy constantly decreases costs. The reason why this decrease is not visible is because of central bank inflation and fractional reserve banking. The money supply keeps rising, so the effects of the free market in decreasing costs are concealed from the general public.
There is no question that the spread of digital technologies has completely changed our lives over the last four decades. The cell phone is the obvious example, but widescreen televisions, Netflix, and the multiplication of websites all have contributed to the transformation of our lives, and this is accelerating. The introduction of the microcomputer in the late 1970's through 1995 did not have the same kind of cultural effects that the introduction of the graphics user interface Web browser for the Internet did after 1995.
The free market is going to defeat central banking. Central banking is on its last legs. It is holding together the fractional reserve banking system, and it is holding together the nation-states, which are all going belly-up in terms of fiscal policy. That process will ultimately lead to the de-funding of the nation-state in the 21st century, and a vast decentralization -- judicially, fiscally, monetarily, and especially digitally. The new world order of digits is undermining the old world order of central banking and the nation-state. This is a positive development, and one manifestation of it is the fact that consumer prices are rising slowly. The cost of information continues to decline exponentially.
We will probably get another round of mass inflation -- low double-digit price increases -- because central banks are continuing to counterfeit digital currencies. I doubt that we will experience hyperinflation in any Western industrial society. We have not seen this since Germany in 1923 and the State of Israel in 1985. But even if we do, hyperinflation never lasts more than about 36 months in industrial societies. After that, the central banks are forced issue a new currency unit. Then the digital economy will once again reassert itself.
It is going to get cheaper to live as this century goes on. Per capita output will increase. The free market, not central planning and central banking, is the dominant force today.
This is reflected in consumer price statistics.
Warning: do not become dependent on the nation-state for your income. The nation-state is suffering from red ink and digital money. The day of reckoning will arrive. There is going to be a Great Default.
CONCLUSION
Anyone who tells you that the consumer price index is not relevant is also telling you that the free market is not relevant. He is telling you the computer revolution is not relevant. If he cannot show how the computer revolution, the communications revolution, and the digital revolution are affecting prices, and are therefore affecting our allocation of scarce economic resources, then he has no theory of economics, and he surely has no understanding of economic history. You can safely ignore him.