Tag Archives: Peace

War, Peace, Inflation, and Software

Is inflation dead?

Source: Morguefile

Growing up in the ‘70s, inflation was a fact of life. Sometimes we would see prices rise four or five percent in a single month. Persistent, high inflation was a problem, economically. The purchasing power of our savings was depleting at a rapid rate. Federal regulations kept interest rates low; banks couldn’t pay more than 4.25%, even while inflation was running at 10% per year. Gerald Ford declared a war on inflation.

Annual change in CPI. Source: St. Louis Federal Reserve

But those days seem as remote to us today as buggy whips and livery stables did to folks back then. What happened? The most important change happened in the early ‘80s, with monetary policy. The Fed reduced the growth of the aggregate money supply, and since the velocity of money in the economy was fairly steady, slowing money’s growth also slowed the rate of price increases.

But since 1990 – well after Paul Volker’s monetarism was implemented – inflation has fallen even more: from about 5% then to only 2% now. The most current measures indicate that it might run at only 1.5% going forward. And low inflation is a fact of life everywhere, not just in the United States. To answer this, we need to go a little further back.

Source: Ed Yardeni

The answer may have to do with war and peace. Dr. Ed Yardeni has written that during times of war, labor is in short supply, markets don’t work, commodities get requisitioned, and the Government prints money to finance the war effort. It’s inevitable that for prices to rise, often dramatically. During peace-time, the opposite happens: markets expand and trade flourishes, competition comes back, and prices fall. War is inflationary, peace is deflationary. Note that in the past this happened whether or not we had a gold standard. Congress determines the basis of all weights, measures, and standards, including our monetary base.

In 1989 the Cold War ended with the fall of the Berlin wall. The last 28 years has seen the greatest expansion of markets, trade, and capitalism that the world has ever known. The influx of supply has been met with an influx of demand as well, as billions of producers and consumers have entered the global marketplace. In addition, the nature of demand is changing: In the past, we needed raw commodities; as economies developed we needed finished goods. Increasingly, we need knowledge: knowledge about our work, our environment, our finances, even our own bodies. Increasingly, this knowledge is provided by software, readily available via computers we carry in our pockets. That’s why software is eating the world. And the marginal cost of software is virtually zero.

Software costs money to develop, but once it’s in place, it costs almost nothing to replicate. That’s one reason software companies that provide free products have done so well: Google provides free search, Facebook provides free networking, Amazon provides free streaming, storage, and shipping, if you’re a Prime member. Of course, nothing is truly free. These companies make money on your browsing and buying behavior. But the marginal cost of providing software is practically nothing, and they’re passing those savings on to consumers.

This is why inflation is dead. Peace killed it. And software.

Douglas R. Tengdin, CFA