[00:00:00] Intro: Forget the civilized path. It’s time to break the chains of debt and dependency, take control of our financial lives and live free. This is the Fiscally Savage podcast.

[00:00:15] Dylan Bain: Hello and welcome to Fiscally Savage. I’m your host, Dylan Bain. Happy Friday, everybody. If you’re new here on these Friday shows, we take something in the news and go one step deeper. And today I’m going to talk about everyone’s favorite topic, which is of course inflation. Fed data came out this week that indicates that inflation pressures in the United States are cooling and that we are actually seeing the lowest levels of inflation since March of 2021, which is a good thing.

[00:00:42] One of the things that has been coming out in the media, particularly if you’re one of the denizens of Reddit, that you start getting people saying, “Well, that’s great.” But inflation just slowing down is kind of like taking a beating in the street. You want the person to stop, not just slow down. And that’s how people are feeling because prices are still elevated.

[00:01:03] It’s not like the prices have reversed course and have started falling back to the earth. And there’s a lot of different reasons for that that we’re going to get into. But it’s an interesting place for us to be, because we have this cooling environment in the inflation numbers, the Fed wants to see an inflation target of about 2% in our modern economies.

[00:01:22] What that typically is meaning is that the economy is growing because inflation is a multifaceted thing. One of the things that causes inflation is a growing economy because the economy is generating more wealth. Other things are of course, government – money printing is certainly a factor in this, but as our supply chains and supply and demand shocks, it’s interesting to me because now the Fed is, is seeing them getting to accomplish their goals.

[00:01:48] They’ve already signaled that they’re planning to do at least one more rate hike. And the reason for that isn’t necessarily that the inflation numbers aren’t cooling as fast as they want to be, but because the jobs report that most recently came out on Friday – well, last Friday, at least – was surprisingly strong.

[00:02:06] Yes, hiring is down across the economy, but we’re still creating more jobs than are being lost. People are spending still a relatively low amount of time in unemployment, which indicates a strength in the labor market. And we’ve talked about this before on the show. The strength in the labor market has everything to do with COVID, which yes, people died, but it also knocked a lot of women out of the workforce.

[00:02:31] You have a lot of people who are suffering the effects of long COVID, which we know next to nothing about, and that’s taking them out of the workforce. And then, of course, there’s the accelerated retirement rate of baby boomers who took this opportunity to say, “Eh, to hell with it, I’m done.” And so, all told, we’re missing about four to five million working-age people who have left the labor force since COVID arrived on our shores in March of 2020. And so the Fed is now kind of like balancing this dual mandates that they have to keep inflation low, but also maintain high employment and they’ve well and truly signaled that they’re no longer interested in the employment numbers [and] are solely focused on inflation.

[00:03:13] So they’re willing to unemploy people by raising interest rates. But the Fed is concerned that they’re not doing enough because the employment numbers aren’t responding the way that they wanted to. One of the things that I’ve talked about on the show, and one of the reasons I went through all these different schools of economic thought was to really illustrate how little we know on a macro-economic scale, that is when we’re looking at big things, because we talked about the classical economists who were looking at it and saying, trying to describe what they were seeing. This is where the idea of market failures and invisible hands and all that other happy jazz comes from.

[00:03:48] And then we had Austrians who were just, “We’re going to sit in the room and think really hard about it and try to come up with some sort of logical model” in their ivory tower off somewhere about how humans make decisions. Then that brought in the Chicago School of Economics, where they were talking about monetary policy, Keynesian, which was talking about fiscal policy – and supply side, which just completely abandoned reason, and decided that if we just made one person really rich, they’d take care of all the rest of us.

[00:04:11] The point, of course, being is that – and I pointed this out throughout that entire series – these people try to make predictions. And of the five schools of thought that I actually covered, Keynes comes the closest, but he ain’t exactly on the money either. That is to say that when Milton Freeman was studying and working on his monetary ideas, when that formed the backbone of the Chicago school, he came up with a equation for inflation that in 2008 was definitively proven to be just an absolute work of fiction. And so we find ourselves in this environment where there’s a lot of these different factors that are driving this and Fed Chairman Powell is trying to balance this in addition to having to deal with the world’s most unruly and intractable people. And no, I’m not talking about terrorists.

[00:04:59] I’m talking about the United States Congress. I think this is a good point in time to talk about another economic phenomenon because it’s now starting to show up in the data and Reddit have started cheering and demanding this thing called deflation. And take this with a grain of salt – because numbers out of China are notoriously unreliable. Just look at what they’ve been doing with their population numbers. But the numbers out of China are that prices have remained flat, which means an inflation rate of zero. And this is probably not an indication that the Chinese are just going, “No, no, no, no. No inflation here.” It’s probably an indication that they’re in a deflationary environment.

[00:05:40] And I’ve said this on the show before, and I’ll say it here again. If you have to choose between – not hyperinflation, but high inflation, and there is a difference – or deflation, you want the high inflation. That is emphatically the better option: to have high inflation versus deflation. And if you have to choose between deflation and hyperinflation, choose the deflation.

[00:06:02] But at that point, you’re, you’re basically choosing between being stabbed or shot, like neither one of those is a great place to be and they’re next to impossible to manage. But let’s actually talk about what deflation is because some people have started to cheer this on because they think that it’s going to help them. And I’m here to tell you, ladies and gentlemen, I’m going to rain on your parade. It will not. Deflation is when prices start falling in the economy to a point where now the entire economy’s price structure starts to slump and decrease. Now, at first blush, this looks like a good thing, but you have to keep in mind how we actually all make money.

[00:06:40] No matter what we do in this world, we are selling something. And that something has an economic price. Typically, we are selling goods or services. And there’s a couple other ones in here, but we’re not going to talk about those right now, but when you’re selling a service, you’re still going to end up buying goods to consume to be able to sell that service on any company’s balance sheet, those goods.

[00:07:02] So even if you’re running a consulting business, and all you need is a laptop, a microphone, a pair of headphones, and a subscription to Libsyn so your podcast can go out, what you’ve done is you bought assets. My microphone costs me money. It’s an asset on my balance sheet. My laptop costs me money. If in a deflationary environment, the assets on my balance sheet start losing value, and if I’m somebody who’s selling a good instead of a service, I purchased that good say at $10 and I’m selling it at $12. So there’s a $2 profit, but as prices start to fall, once I hit $10, I’m only breaking even. That means that there’s no more profit to do things like pay my employees. Now, if the price has dropped to $8, that means that I am literally losing $2 on every sale under the best-case scenario.

[00:07:49] When this happens broadly across an economy, how long do you think companies can stay solvent? And this of course is the problem, because one of the things that drives deflation is when people stop spending money. It’s the supply and demand thing. And the same thing inflation is that if people expect inflation to go up, we run out and we buy a bunch of stuff because we’re expecting prices to rise and want to get the thing right now.

[00:08:16] But if we stop buying, what is of course the ideas of supply and demand going to do? It means that as the demand falls, we’re going to lower the price to incentivize you to buy. This is where you see car dealerships or shoe stores or whatever. They put things on sale, to try to incentivize you to go there. But as JCPenney, which was a department store that is not doing very well and Kohl’s – also in the same boat have discovered – is that when you do the sale, you’re lowering your price.

[00:08:47] If you do it enough, your customers become addicted to it, so then they never buy full price items. This is why Kohl’s and JCPenney’s are always running sales. Because they have to. Because if it doesn’t say on sale and the customer thinks they’re getting a 20% discount, they’re not going to buy. And it’s one of the things, one of the many things that’s actually killing those legacy stores.

[00:09:10] And so you think about that in terms of the economy, if you knew prices were dropping, you’re going to do the exact opposite of what you would do with inflation, where you go by, you’re going to wait because the prices will drop lower and lower, and then maybe that company will go bankrupt and they’re just going to take whatever they can get in the liquidation and pay.

[00:09:27] [For] me as a consumer, I’m great. Oh, but my job is dependent on somebody else selling another thing. When deflation hits this, what you start to see is very quickly people start going bankrupt. You end up having first, you have a bankruptcy crisis. Then you have a financial crisis because people went bankrupt on the loans. Then you have an employment crisis because shops close up, which then of course panics people who then hold on to more money. And this creates a deflationary spiral and deflationary spirals are extremely dangerous because your only real option there is to try to put price floors on things which only incentivize black markets.

[00:10:05] So while there’s a lot of data and research on how do we deal with inflation, mostly because A: There’s a lot of natural experiments, it happens more frequently, so we can study it more frequently, and B: because we can actually do things with it. Deflation doesn’t happen that often, and when it does, it just basically kills the patient and we all move on.

[00:10:25] This is where you’re going to have to re-jumpstart an economy. And so there’s a question right now, ladies and gentlemen, is that if China’s in a deflationary spiral, where they’re saying, “No, our inflation numbers are actually completely flat”, but if they actually go into a deflationary spiral, which is probable – because if you remember, if you’ve been following the news at all, and you understand anything about how demographics work, you know that China is actually in a severe demographic crunch.

[00:10:52] That is, that they have this double whammy going on with, they have a lot of retirees are the fastest aging population in the planet. They don’t have enough young people coming through to take care of that aging population. But more to the point, the Chinese … they’ve industrialized so fast that most of the opportunities that the previous generation had are not there.

[00:11:12] So what the Chinese are dealing with is the same thing that a lot of people in the United States are dealing with it – although the Chinese government is not dealing with it nearly as well – is that people are going to college and doing the “right thing” to do, and the job and opportunities aren’t there. Younger people do not believe that they’re going to be able to have the careers that their parents more-or-less promised them. This leads to two things. Number one, they stop having kids because, why would you do that? Right? Years of saying, “Well, if you can’t feed them, don’t breed them.” It takes its toll.

[00:11:42] So people start taking that seriously, making what their parents told them to be good financial decisions. But then of course, what does that end up meaning? No grandkids. And then if you have no grandkids, well, you can see where that goes. But the other thing that happens is that they stop spending money.

[00:11:57] Oh yeah. And if you stop spending money, what happens to prices? Prices start to come down, and then you can trigger a deflationary spiral. So there’s an open question as to whether or not China is going to be going through that. There’s also the danger that the Fed could overcorrect by raising interest rates too much and cutting our economic growth – which our economic growth here in the United States has actually been pretty good – you run the risk of tripping off a deflationary spiral. And if the Fed were to manage that, well. You thought inflation was bad. We’re going to be in for a real bad ride here real quick. But all this is to say is that it’s one of these things that I think illustrates very well inside of the economy that at first blush, it may look like it’s going to be the best thing in the world to have a deflation. But it’s not.

[00:12:44] Now, I know what you’re saying. There’s some people who will come in – and Bitcoin apologists love to do this, where they come in and say, “No, deflation happens all the time. It’s a good thing. Look at the iPhone. We started off with astronomical prices and now they’ve dropped. That’s deflation.” Okay Dylan, is that actually deflation? And the answer is no, what you’re seeing there is economies of scale. So let me give you an example. In the early days of computing, computers were relatively new and we needed this new material that we had had before, but we had never really needed it in the massive quantities that we would need for the computing age.

[00:13:16] And that of course is silicon. Silicon is what you etch your transistors in that give you the ability to be, to have semiconducting chips and therefore voila, computers. I’m obviously skipping a few steps here. But when that first happens, because the supply of silicon is very low because it wasn’t exactly profitable to be producing it, therefore your price would be very high. Not to mention the fact that this is new technology. We haven’t refined processes where a lot of this stuff was manual and you kind of see where this is going. So we’re paying out the nose for labor. We’re paying out the nose for materials. And then of course, the demand side isn’t necessarily there because computers are a brand-new thing.

[00:13:55] So it is absolutely true that a computer that was only about as capable as my old trusty TI -3 would take up an entire apartment complex and would cost literally millions of dollars. And now I’m running around with a cell phone that is more powerful than the entire computing power of the world in 1969, when we landed a man on the moon and it cost me $300. So, is that deflation? No, it’s not. It’s economies of scale. Why? Because once people realized that computers were going to be a thing – all the inputs for computers, there was a rush to try to get in on this market. Which means that silicon manufacturing started to increase, new shops opened up, we were starting to discover new processes to both produce silicon and to turn into wafers and etch those wafers, and we ended up with this arms race.

[00:14:45] So as supply grew, the price started to start to go down. Now you say, well, but Dylan, that’s deflation. No, it’s not, because the reason the price is going down is because this is how economies of scales work. When you start manufacturing, you spend a million dollars for a machine, and then you put in $12 worth of materials to produce a widget.

[00:15:06] That widget needs to sell for $1,000,012 in order for you to break even. But if I produce a billion widgets with my million-dollar machine, that million dollars gets spread over those billion units. And so I only need to cover my inputs, which would be $12. So it might be $12.01. That is an economy of scale. The actual price of the machine didn’t drop. It was the volume I put through [that] allowed me to take the fixed costs of manufacturing and spread it over more units. This is exactly what’s happened with the iPhone and personal computers. The fact that we are able to produce chips en-masse, the fact that we’re able to produce computers en-masse, we’re able to drive [down] the fixed costs of the inputs of production across all those units.

[00:15:54] And of course, there’s limits to this because for my million-dollar machine, eventually the machine becomes free in terms of my volume and my sales, but the inputs are always going to be there. Those are my variable costs because I have to spend $12 every single unit. So my total cost is number of units times $12 gives me variable costs, but you get the idea here.

[00:16:16] And so when you see prices on things like TVs or cars or computers dropping, it’s not because there’s deflation. It’s because we’ve made the process more efficient and we’re taking advantage of economies of scales or geo-arbitrage or comparative advantage. Or any of these other things that are going on, but it’s not deflation.

[00:16:37] And so yes, it is absolutely true that as we’ve scaled up, particularly on a global scale for production, we, the consumer have been better off because prices are cheaper, because we’re able to take all of our costs and spread them over far more units. But that’s not deflation. That’s just economies of scale. And it’s important not to confuse the two.

[00:16:57] Oh, side note, if you’ve ever wondered, have you ever seen these charts where they have, “These things have completely gone off the rails with inflation, while these things have gotten cheaper.” It’s typically a graph that shows college and healthcare and other educational costs and childcare, skyrocketing over 10 years and saying we’ve had a 200% increase in price[s], whereas computers, chips, cars, TVs have all declined. And if you notice right off the bat, the difference between those two is we can outsource the manufacture of TV[s], but I can’t outsource nursing at the nursing home. And that’s the difference. So it’s not that somehow there was magic in one place and not in the other.

[00:17:39] It’s that we weren’t able to take advantage of geo-arbitrage when it comes to labor costs. But ladies and gentlemen, all this is to say is that I hope I’ve given you a better explanation of what’s kind of going on the news and that can have markets that will have a direct impact on you. And maybe over the weekend, if you’re having a barbecue and somebody starts spouting their mouth off about how deflation would be a good thing, because it’s only going to hurt the rich, you can start pointing out to them that they’re entirely wrong. And you can do that by sharing the podcast.

[00:18:06] Before I close out today, ladies and gentlemen, I’ll remind everybody I’m going to be rebranding the podcast into Intuitive Finance with Dylan Bain. If you’re already subscribed to the podcast, you don’t need to do anything. You’re already covered. If you’re not subscribed, stop what you’re doing right now.

[00:18:20] Hit the subscribe button, share the podcast. And please, I’m asking you to stop and leave a rate & review. It means a ton to me to get the word out. We’ve got so much good stuff coming. As soon as we get through the rebrand, I am so excited to be sharing all the value that I’m planning to put out through the podcast, through my email letters and on my website. So ladies and gentlemen, have yourself in fantastic weekend. I’ll see you on Tuesday. I love each and every one of you. Have a great weekend.

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