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We must unlearn what we have learned

Permanent Linkby wisconsin_cur on Sun Nov 22, 2009 1:59 pm

If you are under fifty you have benefited from a long period of “price stability.” Since the stagflation of the 1970's we have experienced low single digit inflation as normal. For large parts of our population this is the way things have always been and, by extension, the way it always will be. Experience governs our view of the world, from our sense of morality to our sense of cultural propriety. Along with the stories we have heard from our parents and grandparents; it also is the toolbox for the management of our personal finances and home. As a culture, however, we have discounted the value of the stories of our elders and, as a result, our toolbox is limited. It is not too late, however, to listen to those stories and learn from them.

The experience of relative price stability has led to an assumption of further stability. Money may still “burn a hole in our pocket” but this springs from a desire to consume; not an evaluation of the possibility that the dollar will be worth more (or less) in the future. Erupting from a desire to consume the money burning a hole in our pockets is not generally expended on an investment or to purchase necessities but rather to splurge on a new toy. That toy might be a snowmobile, an ipod, or a fashion accessories but the purchase is discretionary. We make the discretionary purchase because we assume the stability of prices of necessities and hence we do not need to stock up beyond our immediate needs just in case prices shift in the future. Likewise, we do not feel the need to transfer our dollars into another store of value; believing the dollar will be worth more or less next month or next year as it is today.

This is not the case in much of the world. In my confessionally limited trips overseas, the shops were full of merchants buying and selling gold in small amounts (or dollars) in exchange for the local currency. Most of those people had in their toolbox of experience a currency devaluation. One morning they awoke to find out that their currency was worth far less than when they had gone to sleep. Sometimes this was the work of their government in response to a crisis. Sometimes it was the work of the market re-evaluation their nation's accounting. Either way the effect was the same: anyone who had their savings or investments denominated in the local currency woke up a lot poorer. While it unfolded much more slowly, this was also the effect on many savers during the inflation of the 1970's. Especially those who were on a fixed benefit pension found at the end of that inflation that they were much poorer, that benefit buying much less at the decade's conclusion than its beginning.

Deflationary spirals are just the opposite and more rare. With notable exceptions the last widespread deflationary spiral took place in the 1930's (there were two others in the history of the United States in 1830's and the 1860's) but both Japan and Ireland have suffered deflation within the last 20 years. In a period of deflation currency actually increases in value over time and has more purchasing power in another month or year than it does today. This often leads to the delaying of purchases until the moment of need. Consumption and production decrease which is followed by job losses. People begin to fear that they will loose their own job in the future so they save even more followed by more decreases in consumption and production. In this situation it makes sense to hoard a currency in the face of personal and market uncertainty.

Personally, I am an inflationist but for both monetary and economic reasons but there are strong arguments to be made for a deflationary future. It may even be possible that what we might see is actually a mutation of the two. We may see the price rise of some products (necessities) and a deflationary spiral in the case of other more discretionary goods. My purpose, however, is not encourage one or the other but rather increased mental flexibility when we think about the future. The moment we come to terms with the possibility that the relative stability of the last thirty years could come to an end, it changes how we view our own homes and lives. The effects of instability are threatening enough that it makes sense to prepare for them mentally and physically while they remain only a threat.

Under the assumption of price stability there is little reason to have a large pantry or a first (or second) freezer. If prices will remain the same, why bother to store food? In an age of instability, however, a well stock pantry or freezer is more than just good for peace of mind, it is good for the pocketbook. It allows the putting away of food when it is cheap so that it can be consumed when it is more expensive. Likewise, in rural areas, the purchase and filling of a large LP tank allows the homeowner to purchase their winter's heat when prices are at their annual low or, if their storage is ample enough at multi-year lows. Both of these are not “bets” because they rest in purchasing something which the family will consume in the future regardless of when it is purchased. If prices continue to go lower, than one just rotates their stock: continuing to regularly fill the pantry, freezer or LP tank until prices begin to increase and increase to a point where one decides to live off the reserves.

A perspective that embraces the possibility of price instability also takes another view of maintenance of the family car. Many of the parts that go into any vehicle, foreign or domestic, are built overseas and, as such, are subject to the relative value of currencies as well as many other economic factors. One response may be to purchase a car which is largely made from parts produced in the United States but another response is to choose when repairs will be done rather than have them forced upon the owner at the time of a breakdown. By becoming active in our own preventative maintenance, be developing a relationship with your own mechanic, we can not only get more miles out of every vehicle but also manage the risk of ownership. One can sleep a little easier if parts become more expensive for a time if that rattle was already taken care of before.

The number of possible personal adaptations are nearly limitless. Farmers will react differently than the cubicle worker and the rural small employer will find alternative adaptations to the urban townhouse owner. Once the adaptation of thinking takes place and we begin to reflect on a greater range of risks, it will be the task of those who know their own situation most intimately to choose the proper manner to manage that risk into the future. Farmers will cross pollinate ideas over their morning coffee and so will urban hipsters; but each demographic is going to find their own way forward. We all, however, will benefit by having the correct set of tools for the job and the first tools we need is to see the multiple risks before us and not take stability for granted.
Last edited by wisconsin_cur on Tue Nov 24, 2009 7:53 am, edited 1 time in total.

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Re: Searching for a few good tools

Permanent Linkby FoolYap on Sun Nov 22, 2009 6:21 pm

In a deflationary environment, I would expect that many things will stop being made -- especially things that everyday average people don't have a need for. Therefore, while your dollar's purchasing power may rise, it's only theoretical goodness if you can't easily find what you want to buy. For example, I can buy bucketloads of high-quality new hand tools now, assuming I have the cash for them. But I'd since most of these things get sold to a few dedicated craftsmen (who may go out of business in deflationary times), or many more well-heeled hobbyists (who will likely be keeping what cash they have to buy necessities), then in a deflationary depression, will I be able to find any? Maybe my local craigslist will become a hunter's paradise, but maybe not.

So, perhaps it makes sense to buy what you view as essential goods now, whether we have inflation or deflation? The difference may be in what kind of cash savings it makes sense to have. In a very inflationary environment, I guess it makes sense to spend most of it now.

--Steve
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Re: Searching for a few good tools

Permanent Linkby wisconsin_cur on Sun Nov 22, 2009 6:36 pm

I agree. Moving dollars into something useful is a good idea in the face of price instability regardless of the way(s) the trend runs.
http://www.senecasdog.blogspot.com

“It does not do to leave a live dragon out of your calculations, if you live near him.” J.R.R. Tolkien

Sevareid's Law: "The leading cause of problems is solutions."
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