Continuing with our series of debunking the myths of conventional economics, we examine the assumption that inflation and deflation only exist over periods of months and years.

Today was what some might call a bloodbath in the markets.  Virtually every asset class was down. Gold was down, copper was down, oil was down, bonds down, stocks down … it was as if they all got together in some spooky metaphysical conspiracy, joined hands, and said “All together now!”.

Conventional economists may believe in spooky metaphysical conspiracies, but I don’t.  Occam’s Razor says the most plausible explanation for a phenomenon is the simplest.

It may not be the most obvious, though.  Is there something we might have left out of our summary of market action?

Yes.  We stated a series of measurements, but failed to state the units with which we measured.  Put more fully, in fact all we really know is that all of those things were down as measured in US dollars.  By omitting mention of the unit, we imply that these things all lost value in absolute, real terms, effectively invoking our spooky metaphysical conspiracy.

There is another, simpler interpretation.  Dollars rose in value.

No spooky metaphysical conspiracy theory needed.  But if our alternative explanation is viable, why isn’t it obvious?

Simple.  We used dollars as our unit of measure. In dollar terms, a dollar is a constant, fixed quantity.

But is there any evidence that the value of the dollar is truly a fixed, unchanging unit?  Only if there were, could we truly settle the question in favor of our original, sloppy observation that everything else “went down”.

In fact there is no such evidence.  So statements like our original observation have no foundation whatsoever.  To the contrary, we have affirmative evidence that the dollar does in fact change in value.  Over long periods of time it has lost considerable value.  Decades ago a dollar could buy 1/35 ounce of gold, several loaves of bread, two or three gallons of gasoline, and certainly more shares of the S&P 500.  But instead of forthrightly recognizing this as dollar depreciation, we give it another name, inflation.

And then we talk about “inflation” as if it’s an economic phenomena of its own.  As we argued though in Inflation is Not an Economic Condition, inflation isn’t an economic phenomenon at all. It’s nothing more than depreciation of the currency.

Huh?  Doesn’t everybody think of inflation as an economic phenomenon?  Sure.  And everybody’s wrong.  As we reasoned in the above linked article, if it were truly an economic phenomenon, then you would see it no matter what units you used.  You could measure prices in another currency, in a commodity like gold, silver or oil, or in shares of the S&P 500, and see the same thing.  But you don’t.  Whether it’s “inflation” or “deflation” depends entirely on what you use as your pricing unit.

This gives new meaning to the Milton Friedman’s famous proclamation that “Inflation is always and everywhere a monetary phenomenon.”

There’s one more myth wrapped up in this same package:  Inflation only exists as a gradual unidirectional trend.  This is an artifact of our measurement habit.  Each month conventional economics takes an average of consumer prices and derives from it a “rate of inflation”.  But the dollar is a security like any other.  It doesn’t move in long smooth trends any more than the value of copper, or shares of the S&P 500.  It is volatile.

We merely remove most of that volatility in our measurement process, by taking a monthly average.  You could remove most of the volatility in stock prices if you only looked at monthly averages too.

Moreover, consumer prices themselves introduce smoothing by virtue of the way they incorporate inputs of various time delays.  A major component of consumer prices for example is wage costs.  But wages virtually never adjust on a real time, tick-by-tick basis like oil prices or stock prices.  So many of effects of changes in the value of the dollar only filter into consumer prices over time, obscuring the daily, tick-by-tick nature of fluctuations in the value of the dollar.

But that hardly means they’re not there.  Instead we see them reflected in the prices of things that are free to fluctuate on a daily tick-by-tick basis.

Like we just did today.

The Financology Dollar Index exposes changes in the value of the dollar down to a weekly resolution.