On money and wealth, pt. 3

What are inflation and deflation?

If real wealth and virtual wealth are traded for each other then it follows that each are subject to the effects of supply and demand. For example, if the amount of all real wealth remains unchanged and the amount of virtual wealth increases then we expect one unit of virtual wealth to trade for a lesser amount of real wealth than it did previously. This is one form of inflation, and it fits with its classic definition of too much money chasing too few goods and services.

But in the previous post I wrote that it's curious how during inflation goods' and services' prices increase but become cheaper and how during deflation goods' and services' prices decrease but become more expensive. The classic definition of inflation suggests that prices increase, goods and services become more expensive, and that is all there is to it. What do I mean when I say that prices increase and goods and services become cheaper?

Though all we need to satisfy our immediate needs and wants is real wealth, virtual wealth is no mere medium of exchange nor is it only a product of greed and excess. Virtual wealth is conducive for creating real wealth. Anyone who has been on the borrowing end of a student loan knows this. Instead of borrowing to go to school, one could save all the necessary money first and then go to school using the savings. However, such a strategy, though fiscally safer, is less feasible. How long would it take a doctor-to-be to save enough money for medical school? Much too long. He would be saving money through a less-skilled and lower-paying career, and so by the time he graduated from medical school there's a chance he might be on his way to reentering medical school--this time as a cadaver. Instead, the more feasible strategy is to borrow the necessary money for medical school--i.e., to create a promise--and pay back the money using the smaller proportionate savings from a better-paying medical career. The doctor benefits because it's easier for him to borrow and pay back than it is for him to save, and society benefits because we all enjoy having younger doctors with longer careers. This is an example of virtual wealth creating real wealth.

Because of the power of virtual wealth, in a capitalist economy there exists a motive towards over-promising, a motive towards the excessive creation of virtual wealth. It is observed by many that it is generally easier to pay for things in the future than it is to pay for them in the present, and we come to finance an ever greater amount of things in the present based on a promise to pay for them in the future. When the strategy works all is well; the amount of real wealth increases and things are easier to pay for in the future, though optimism and the ratio of virtual-to-real wealth increase too. The result is a benign form of inflation whereby prices have increased due to the increase in the ratio of virtual-to-real wealth while simultaneously people are able to afford more due to the increase in real wealth.

The downside is, as we are now seeing, that these same economic forces also work in reverse. If things generally become more difficult to pay for in the future than in the present, such as due to a future limitation of resources, then promises become worth less. It becomes more difficult to finance things in the present, and so the amount of both real and virtual wealth decrease, and the unwinding of virtual wealth happens faster than the unwinding of real wealth. The result is a malign form of deflation whereby prices have decreased due to the decrease in the ratio of virtual-to-real wealth while simultaneously people are less able to afford as much due to the decrease in real wealth.

Final thoughts

This is an awful series of blog posts, is it not? If you've made it this far then you did a better job than me. I think I started doubting what I was writing around halfway through. Again, thinking about economics leads me to the conclusion that the subject is far too complex for my comprehension. It was fun to try, though.

I'm inclined to state my contrarian prediction that deflation, via pessimism and loan defaults and a generally recessing real economy, is more likely in our nearish future than inflation, via optimism and good credit and a generally growing real economy. But after thinking about the matter these last two weeks, I think my prediction may be the product of an overly limited imagination.

I do believe that the virtual economy is forever tethered to the health of the real economy, and, like how a spring resists movement in either direction away from its resting state, that markets swing up and down only as far as the varying manias and depressions with which men move them. And I am worried that environmental destruction, either through climate change or resource depletion, poses a very serious risk for our real economy and way of life. But when has it not posed such a risk?

I will quit the maze for now with the hope of someday returning with better insight.