Van Hoisington's Low Inflation Outlook Isn't

In a recent speech before the clients of research firm Applied Finance Group, Entropy Economics president Bret Swanson showed an ad from 1989 which featured "the most powerful computer ever!" The Tandy 5000 MC Professional System retailed for $8,499, mouse and monitor not included.

Further on in the presentation, Swanson noted that while Dell Computer customers can today purchase a 1 terabyte storage drive for $150, back in 1992 that same computer capability would have set the average consumer back $5,000,000. Translated, for a small fraction of what they would have paid roughly 17 years ago, consumers today can buy faster and more sophisticated computer technology without remotely breaking the bank.

Many would call this deflation, but in truth this shows how non-monetary factors of the innovative and productivity variety regularly reduce the prices of all manner of consumer goods. Indeed, to reference the above examples as instances of deflation or lack of inflation would be to pervert the meaning of both.

All of this brings to mind recent commentary by Austin, Texas based money manager Van Hoisington, president of Hoisington Money Management. Sensing an economic outlook that will remain weak for the foreseeable future, Hoisington argues that low levels of demand will keep inflation down.

But the first problem with Hoisington's reasoning is revealed by the examples offered by Swanson. Falling prices aren't by themselves evidence of deflation anymore than rising prices necessarily signal inflation. Both are always and everywhere monetary concepts that result from a rise or decline in the value of the unit of a account, meaning the dollar. No one would credibly say that the stupendous decline in computer prices since 1989 resulted from a strong dollar. Productivity and innovation, as mentioned earlier, were the deciding factors.

Furthermore, the sharp drop in computer prices could in no way change the general price level. That's the case because when the price of one or many items declines thanks to innovative production techniques, rather than driving down prices broadly, what more realistically happens is that the range of goods we have access to expands.

Thanks to cheaper computers, more and more Americans can buy goods previously out-of-reach, including cellphones with computer technology exponentially more powerful than the aforementioned Tandy, along with for instance flat-screen televisions. Both the Apple iPhone and flat-screen televisions made by Sony started out very expensive, thus mitigating price declines elsewhere, but their rising accessibility in terms of price will expand consumer reach again for the introduction of other expensive goods that will in time become cheap. In short, falling prices thanks to productivity cannot change the price level.

Looking at the above in reverse, if the next generation of cellphones and televisions prove both expensive and popular, there similarly won't be any change in the broad price level. That is so because if demand for certain goods drives their cost up, that must mean that demand for other goods is flagging such that their prices would moderate. Rising and falling prices free of monetary disturbance have nothing to do with inflation or deflation.

Hoisington makes the point that thanks to economic weakness that he presumes will be with us for some time, companies won't be raising wages, thus no inflation. The problem there is that the labor force's quantity is hardly static. When demand for workers is low, many go to the sidelines or, as has been the case recently in Las Vegas, many will leave geographical locales where labor demand is low altogether. High unemployment can't change the level of wages in any sustained way given the basic truth that workers are mobile.

In much the same way, low levels of unemployment similarly can't change wage levels either; this despite protests from the Federal Reserve which suggest they can. The problem with the Fed's thinking is that it doesn't account for rising wages luring sidelined workers back into the workforce, nor does it account for the migration of workers from weak economic regions (think Detroit) to growth regions such as Silicon Valley. The logic here also doesn't account for the basic truth that U.S. firms regularly access the world's labor pool in producing the goods we buy, not to mention innovations such as the ATM and computer that make low supplies of labor less pressing.

Hoisington goes on to argue that high levels of unemployment mean that consumers won't be increasing their spending. At first blush he might have a point, but what can't be forgotten is that no act of saving or lack of spending can in any way detract from demand. That's the case because unless our savings are put under the proverbial mattress, they're either being lent to entrepreneurs with immediate demands or consumers eager to purchase what they presently can't.

In that sense Hoisington's argument that debt repayments will put a damper on prices doesn't stand up to the greater reality that one man's debt burden is another man's income stream. Many Americans will spend the next few years paying off debt, but those dollars must by definition go to someone else who previously delayed consumption. Dollars are dollars are dollars, and all debt repayments tell us is that the profligate will transfer their earnings to the prudent. Spending power won't change thanks to debt.

More broadly, Hoisington argues that future economic weakness will mean that demand for commodities and other goods will be muted. At first glance this too makes sense, but the greater reality is that supply and demand are but two sides of the same coin, or identical. In that sense, if there's lower demand in the future, it will surely be the result of lower supply with no price level change. Indeed, we can only demand insofar as we supply first; that, or we can borrow against the productivity of others willing to lend to us based on their optimism about our future productivity.

So while basic supply and demand when it comes to goods prices can't be inflationary or deflationary, changes in the value of the currency - in our case, the dollar - can. And when we look at the dollar, be it against foreign currencies or a more objective commodity such as gold, the dollar has been impressively weak dating back to 2001.

Not only are we inflating, but we have been for quite some time. And inflation regularly correlates with economic weakness given the basic truth that when money loses value, capital flows into hard, unproductive assets, and away from the entrepreneurial, wage or growth economy.

In short, the economic malaise and tough employment climate that we're in the midst of is a symptom of, rather than a cure for inflation. Van Hoisington says the weak economy will temper inflationary pressures, but it is in fact inflation that presently has the economy weak.