June 5, 2003 (Ira Pilgrim)


Economists are people who work with numbers but who don't have the personality to be accountants.

Author unknown

Screw your thinking caps on tight because this is going to a wild ride. The wild part will be trying to understand what words like inflation, deflation, appreciation and depreciation mean. Those words are about the value of money.

Something has real value if you can eat it, use it, live in it, or trade it for something that you can eat or use. When I say that something costs $10, it means that I have to give a $10 bill for it. That is true today. Tomorrow I may have to pay $9 or $11 for the same item. A pound of beans, a shirt, a house, an automobile or land has real value, but the value of the dollar changes with time. A Coke that used to cost a nickel now costs from half a dollar to over a buck. In our economy, the value of the dollar has been continually decreasing. The same was true of the Japanese yen until Japan had deflation. Now the value of the yen is increasing. Or, you could also say that the price of products is dropping. There is a Chinese saying that "the man is behind the tree" is the same as saying that "the tree is in front of the man."

Long ago, money was made of gold or silver and its value was considered sacred. An ounce of gold or silver was worth so much, and the value of everything from land to diamonds to beans was measured by that "gold standard." As a consequence, a person could make money by coin clipping. He could acquire a bunch of gold coins and clip a very tiny bit off of each one, then spend his clipped coins on something else and make more coins out of the clippings or melt them down and sell the gold. Those days are long gone. Now money is a purely fictional concept represented by a piece of paper called a dollar, pound, franc, yen, euro etc. However, the ingenuity of people whose business is making money out of money alone is more devious than it was in the days of gold coins. Another problem with the gold standard was that when more gold was discovered, the value of gold decreased; that is, a gold coin would buy you less than it would have before the gold supply was increased.

We live in a world of inflation, where what a dollar will buy has been continually decreasing since the word dollar was (excuse the pun) coined. What has happened is that the value of the dollar has depreciated; become less. But depreciation means that the value of the dollar is going down, which sounds bad. If we say that we have inflation, that sounds better, since when you inflate a balloon it goes up, which is better than deflation, when the balloon goes down. Remember, however, that what makes a balloon go up or down is a function of how much hot air is in the balloon.

After World War I, Germany had a severe inflation. The value of the mark depreciated to the point where many people's life savings were wiped out overnight. Most economists consider "mild" inflation to be a good thing. In contrast, in the Japan of today, people who saved their money have found that their savings have increased in value. Their yens can now buy more of what they might want than it could have bought in the past. Now, what could be bad about that? I don't know, but all of the economists seem to think that it is a disaster. The conventional economic wisdom is that mild inflation is good and deflation is bad. Another bit of this wisdom is that growth is good and no-growth is bad. If a part of your body continued to grow, it would be called a cancer.

I got a bit of insight into economics, many years ago, when I attended a cocktail party hosted by a member of the board of directors of a private school that my wife was headmistress of. Many of the people there were very well heeled. I was making small talk with a successful developer. He mentioned that he was going to build a new home as soon as he could borrow the money. I said, "Surely you can afford to pay for a new house." He replied that he could, but that while he could borrow money to build a house at 7%, he could double his own cash in a few years in his business. He explained to me that being in debt was highly profitable to him because, due to inflation, he could pay off the money that he borrowed in dollars that were worth less than the dollars that he had borrowed. In other words, in an economy that is inflating, borrowing money can be much more profitable than saving money; provided the interest rates are not too high and you do pay it back.

Well, did you understand all that? Wonderful! I'm not sure that I understand it, and I wrote it.

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