Tuesday, May 2, 2023

I found the dumb: how you get deflation

So I figured out that deflation doesn't happen when you get more goods, which is wrong, which mean I was dumb. I must have dropped a factor somewhere. Figured out where.

I saw that there were more transactions and figured more transactions = more velocity. Bzzt. Not if the transactions are smaller. "Plus means plus," I thought, neglecting that these are scalars, not booleans.

Imagine a very simple economy. There two guys and ten bucks. One guy makes one thing, and sells it for ten bucks to the other guy. The other guy makes one thing, and sell it to get his ten bucks back. Total demand = 20, total supply = 20. Velocity = 1/1. 

Now imagine ONE HUNDRED PERCENT GPD GROWTH. My god, they're making two things each!

Right, but the guy still has only ten bucks. He can't bid ten. He can only bid five. He makes two transaction, of five dollars each. And vice versa. Total demand = 20, total supply = 20. Velocity =1/1. Having twice as much stuff means per-stuff prices are half as high. 

Although you can also use velocity to mitigate deflation. My previous logic isn't completely invalid, merely incomplete. Increasing supply can show up in lower prices or increasing velocity. On average, it will be both. 

Velocity itself is an expense. Transactions have transaction costs. Better one big transaction made of many small prices than several transactions made of big prices. To get total demand/supply up to 40, we have to implicitly assume our two guys have a second free day to make into market day. And after we've increased velocity, they don't have that day anymore. It would be more efficient to bundle the transactions and go back to one market day a year. Which means prices go down. 


P.S. The market itself isn't free. The market commands a rent, out of friction if no other reason. Communication isn't magic. Talking takes time. 

You don't want unrestricted transaction options either. You want a transaction securer, or rather a whole industry of such, which secures individual transactions. You're allowed to make unsecured transactions, but you'll find they're insecure.

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