There is a curious collision of forces occurring today. The two most man made powerful forces are crushing against each other: the deflationary power of technology and the inflationary power of fiat money.
The abstract is this:
Elected government officials perform best when they do things that require borrowing money. The end of the gold standard and the proliferation of democracy globally means governments will indefinitely support inflationary policies as it makes paying off debt possible.
Technology is hyper-deflationary. Devices become more numerous, more powerful, cheaper, at an accelerating rate. The average smartphone would be worth millions of dollars (decades ago) and have access to information rivaling every living human. Consequently, old devices are now worthless. Because of this, the end-game for technology is free.
What this means, I suspect, is that the inflationary forces will drive some asset prices up while technology drives the value of human labor down. I believe technology will win.
How we got here
A tweet I saw a few days ago:
@codinghorror Can someone mansplain to me why the price of a Hershey bar was so weirdly stable until 1970?
And here is a little chart I whipped together in Tableau of the price per barrel of domestic crude oil:
Not being a commodities trader, this is hard to explain. A book I read last year shortly before the most-infamous man to ever be pardoned died: “The King of Oil: The Secret Lives of Marc Rich“, had a pretty good answer. Except from pages 57-58 of his biography:
In August 1971 President Richard Nixon abandoned the gold standard, whereupon the dollar immediately lost 20 to 40 percent of its value against most other currencies. As the global oil trade was based on dollars, this meant that the oil-producing nations were earning even less “real” income in terms of purchasing power. In effect, these countries had to spend more of the devalued dollars they had exchanged for oil to purchase goods on the international markets. Several important oil-producing countries now began nationalizing their domestic oil industries. The North African nation of Algeria was the first to do so, in 1971, and it was soon followed by neighboring Libya. The floodgates were opened when Iraq, one of the world’s largest producers, nationalized the concessions belonging to British Petroleum, Royal Dutch Shell, the French Compagnie Française des Pétroles, Mobil, and Standard Oil of New Jersey (now Exxon) on June 1, 1972. Six months later OPEC pushed through a plan of gradual nationalization of all Western concessions in Kuwait, Qatar, Abu Dhabi, and Saudi Arabia, and in spring 1973 the Persian shah nationalized all of Iran’s oil assets.
This post is not about gold. It isn’t about what should or shouldn’t be done. It is simply an explanation of the forces that exist whether you like them or not. No one follows the gold standard anymore and its quite unlikely they ever will again.
The Federal Reserve and other central banks around the globe practice inflation targeting. By controlling interest rates central banks choose whether borrowers or lenders (savers) are subsidized. Its a simplistic yes/no, up/down, 0/1 way of managing. Whether inflation rates are being targeting or employment, they lower or raise rates until the economy appears to be doing what they want it to do. Alternatively they just change how they measure inflation or employment.
Unfortunately even a modest 2% inflation rate looks something like this:
Deflationary, and Accelerating Technology
In case you haven’t been following the progress of technology, here are some excellent charts from one of my favorite books “The Singularity Is Near.” The Google guys liked it enough that they made the author Director of Engineering.
Moore’s law roughly applies to prices of other aspects of technology:
In some segments we see development pause or make little visible progress, and then suddenly jump forward by leaps and bounds. Virtual reality headset technology stood nearly at a standstill for two decades until the adventus of the Oculus Rift. By utilizing the massive advancements in display technology brought about by mobile phones, we went from clunky out of date headsets costing 5 figures to a super light weight nearly consumer headset costing about $300 overnight.
Why the economy isn’t working
The Western World has largely benefited from a vast middle class who had a living standard comparable to the most wealthy.
In the United States the difference between wealthy and the middle class is square footage and number of your homes. It is not dirt floor vs marble or glass windows vs no windows. While visiting NYC one of my offshore developers commented, your homeless don’t look homeless.
Government policy, both federal and local, appears oblivious to deflation. Outside of government, all of finance and all investing advice is based on price inflation. Investment bankers get rich off of borrowing your money at a subsidized rate (thanks federal reserve) and then buying assets before you have the money or need for them. Rather than seeing a solution as prices being too expensive, the solution is seen as prices are too cheap — even when you can’t afford them today!
There is an attempt to force inflation not just through low interest rates but also through laws. Rather than lowering the minimum wage, the federal government is trying to raise it. We will see a lot more of these attempts before we see fewer. While a profitable private technology company can ignore interest rates, government regulations can derail trains before they leave the station. Setting fixed prices forces economic activity outside of the law and cripples legitimate businesses.
Why tech gets so rich
Technology companies are worth an enormous amount of money right now. Without pointing fingers, some of these companies may be validly priced, with widening moats, double digit profit margins, and double digit growth. Others laughably lose money and are nothing more than turds painted in faux gold.
If you own a technology company you are simultaneously benefiting from asset price inflation and technology deflation. Each year you are better, faster, and stronger. Meanwhile interest rates are extremely low allowing you to finance growth almost for free.
A cheap, waste minimal, future
Some things are so cheap to provide at a mass scale that they can be nearly free. Education is interesting because right now prices are completely insane:
This is curious, since top tier colleges have endowments so large they just let students attend free. Meanwhile there are a massive number of high quality learning options online that cost nothing: Codecademy for programming, Duolingo for foreign languages, MIT OpenCourseWare, Coursera, Khan Academy, and many more. This is if you can’t teach yourself from the infinite books, message boards, and blogs online.
Free can come through benevolence and community support, such as Wikipedia, or it can come indirectly such as with Duolingo (crowd translating.) If technology followed old inflationary prices and companies paid more for less none of this would exist.
There is something else special that is occurring. Thanks to mobile, user bases are really fucking big now. You have a million users? No one has heard of you. Tens of millions or hundreds of millions of users are required now for relevance. That also means instead of charging customers $100 a month, you can charge them $9. In the case of WhatsApp it was actually 8.25 cents per month.
Information behaves differently than commodities. Commodity output will not double every two years. However, through the smart use of technology we can dramatically reduce waste both in production and consumption. Through better engineering we can construct buildings that we don’t simply knock back down.
There are a lot of really bad ideas out there. Focus on keeping your business running and eventually the power of those bad ideas will wane and then vanish.