March 20, 2017

Deflation Declination and Dungeon Crawling

The other night, my friend BOB!1! and I were discussing current events, in particular, we engaged in a back and forth over the theory that the reason we've seen limited inflation from the various rounds of quantitative easing over the years is that a majority of the inflation they created has been masking a destructive deflationary cycle. This is a disturbing notion as it puts the world economy on a bit of a tightrope. 

Those of us of a certain age remember inflation and the memory is not a pleasant one. The inflation of the 1970s was an anomalous event, coinciding as it did with a general contraction of the economy (stagflation). 

Inflation is normally an inevitable byproduct and indicator of a growing economy. More economic activity and more money in circulation means that the real value of any unit of money goes down. After a certain point, this actually encourages investment, since inflation reduces the value of money that is just sitting, eventually overtaking any reasonable interest rate. This means that in order to grow or even maintain one's savings one must invest them in moneymaking enterprises. This is hard on everyone, but especially the poor with no savings, those on fixed incomes and the inert, but having that money reinvested in business ventures expands the economy overall, and that increases job opportunities which mitigates some of the problems. 

The '70s were unusual due to a series of problems including the fact that the Johnson administration had printed scads of money specifically to devalue the currency just as the first round of World War Two bonds was about to come due, thus effectively cheating the bond holders out of their investments, but freeing up cash for the great society programs. This was followed by Nixon taking the U.S. off the gold standard and printing yet MORE money while the oil crisis damaged the economy by raising the cost of energy and therefore, industry. This was a dreadful situation, but paled in comparison to events like Weimar Germany and Zimbawe.   

Inflation is intuitively bad and we have examples of why this is so. 

However, except perhaps in cases of runaway inflation like Weimar or Zimbabwe, Deflation can be much worse than inflation. 

Deflation is insidious. The value of whatever is currency increases because the amount of money in circulation decreases (is deflated). This is great in the very short term, especially for the poor, those on fixed incomes and the inert. The problem is that over the long haul money actually gains value when hoarded EVEN IN THE ABSENCE OF ANY INTEREST RATE and thus the risk associated with investing with a business becomes exceedingly unpalatable. 

People with money cash out, their businesses close which results in fewer paychecks, which further reduces the money supply causing businesses to go bankrupt or their owners to liquidate them before that happens. People hoard, rather than invest money and the economy slowly, over time, comes to a crawl. The tax base evaporates because there is no money and things like roads, bridges, canals, ports and other infrastructure stop getting fixed, further putting a pressure on businesses and the economy. Gradually, over time everything grinds to a halt, and only those with money in personal hoards are in any way well off, their hoards appreciating in relative value as the rest of the world slips into darkness...but such people would be increasingly isolated by the inevitable uptick in lawlessness and ultimately only those who could defend themselves and have access to food would manage to eek through. Of course, with unemployment rampant labor would be cheap, perhaps as cheap as room and board, and such people could probably be put to work growing food in exchange for  protection from the rising tide of lawlessness.

Our back and forth at this point took an unexpected turn. What the end state of our worst case scenario ended up in was...


... which, as my friend BOB!1! pointed out, brings us to Dungeons and Dragons.

"Because...of course it does."

This scenario explains the D&D world.

There are ruins EVERYWHERE. There was obviously a great and prosperous civilization (or group of civilizations that shared a transnational economy) and then deflation hit. Most of those dungeons are the hoards of increasingly paranoid rich people who hid their money vaults behind traps and guard animals, eventually, either through the 4 or 5 generation process in which marrying to obtain a dowry self selects for infertility, straight-up inbreeding, or stepping on one of their own damned rot worms, the affluent who did not offer protections to their neighbors or were too autistic to socialize died out and left these "dungeons", ruins of their former mansions and money vaults which have, in addition to their traps, developed their own deadly ecosystems evolved from the guard animals and invasive species. 

Feudal lords and the occasional collection of such fiefdoms in a kingdom or duchy, are stable but inherently resistant to change, innovation, and any disruptive developments in thought or technology.

There is only one bright spot economically.
The aforementioned rising transportation costs might serve to juice the economy a tad, but only if the infrastructure was privately owned and only if the return on investment was perceived as good, which might well not be the case with businesses going under left and right. However, an association of businesses in need of transportation services might well band together as a co-op to maintain a transportation infrastructure for their interests and provide mutual protection much like the old Hanseatic League did. These became the guilds. Which are the only (sort of) free market that is not completely the plaything of nobles. 
It occurs to me, that there are darker aspects to this too. 

As people grow more desperate and fearful, they tend to stay with their own kind, so in many locales, the races self segregated. Those that did not eventually became the "mutts" that are described as human in the game. The differences might be accentuated by starvation selection putting pressure on some groups for small bodies, (Halflings, Dwarves) and in more affluent groups sexual selection favoring beauty (Elves). Such racial balkanization would, in general, be non-conducive to most trade.


What all this means is that adventurers in D&D, whatever level, or even alignment  that they are, actually happen to be, by their very nature, saving the world! Everytime they loot a dungeon, they are placing into the economy currency that has not been in circulation in millennia. When adventures begin D&D at level one, the coin of the realm is copper. Then as a party prospers, things get better in whatever locale they frequent and more and better goods become available.

All this money is stimulating trade and competition between the guilds and encouraging wiser feudal lords to invest in and support their resident merchants. 

The fact that the most effective parties contain a wide variety of races, classes and skillsets that normally do not interact in any meaningful way only serves to further breakdown barriers put up by an eons long deflationary cycle.

Adventurers ROCK!

So what have we learned today?

Deflation is, in the long run, far worse than all but the worst inflationary events due to its insidious nature and the extreme difficulty in reversing it due to its self reinforcing system on perverse and societally destructive incentives. 

Against this, when conducting a risk assessment and cost benefit analysis must be considered the potential for providing future generations with elves.

Art by Houtengeki (also here)

May our economists choose wisely.

Posted by: The Brickmuppet at 08:22 PM | Comments (3) | Add Comment
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1 That's probably the first cogent explanation of why deflation is bad I've read.

Although it leads me to wonder if managed deflation can be useful in a society that already has a declining working population (like say, Japan) to help keep the economy and the population in scale with each other.

Posted by: Mauser at Mon Mar 20 21:18:00 2017 (5Ktpu)

2 Your arguments have some real heft.

I used to get really annoyed by the first-generation MMOs like Ultima Online for their claims of a "realistic economy", in which players could vendor unlimited amounts of gold and gems for high prices, while cheap staples remained available in every town. "Realism", in their mind, meant that massive quantities of spell reagents would go on sale every N hours and be bought up by players who camped the vendor so they could grind their magic skills.


Posted by: J Greely at Mon Mar 20 23:41:33 2017 (tgyIO)

3 Excuse me, but what nonsense is this: "Inflation is normally an inevitable byproduct and indicator of a growing economy. More economic activity and more money in circulation means that the real value of any unit of money goes down." The second sentence fully debunks the bogus first sentence!

What does it mean, "more money in circulation"? Suppose it means the M2 or other measure of total money supply. Isn't it obvious, then, that it's not created by "growing economy"?

Remember it: inflation is only a measurement of government activity of emission, and that's it. You can have growing economy with inflation or without.

What your long explanations completely miss is the concept of velocity, or productivity of the banking sector. Imagine that you have a responsible government that is not inflating (of course it is impossible, unless you're in Switzerland, but let's run it as a thought experiment). Imagine also that the manufacturing and services are growing, but banking's productivity remains stagnant. You still have clerks with abacuses writing transactions down into gross-boochs. In this case, as you can easily guess, you get deflation, because growing economy needs money. There is no magic inflation that your first sentence presupposed! None! (This situation, BTW, will put a brake on the economic growth, but not because of deflation itself, but because the interest is going to grow.)

But, if we run the same experiment, but have our bankers start using Merchant calculators, and, later, computers, so their productivity keeps up with the rest of the economy, there may not be a deflation. This increase in the banking productivity is known as "increase in velocity".

Posted by: Pete Zaitcev at Wed Mar 22 23:56:19 2017 (XOPVE)

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