Why We Need to Embrace Deflation

Tech has made everything cheaper. It’s time our economy caught up.

local maximum: the value of a function at a certain point in its domain, which is greater than or equal to the values at all other points in the immediate vicinity of the point

Human beings are often fooled into thinking the local maximum accurately represents the world they live in. When Roger Bannister ran the four-minute mile, he broke through a psychological ceiling as much as a biological one. People thought for years that the human body was incapable of running that fast. Once eclipsed, however, the four-minute mile came to seem eminently doable for elite runners. The impossible became commonplace.

There are other kinds of fallacies around local maximums that inform our assumptions in business. Entrepreneurs who find and exploit these create immense value from what was once thought of as impossible. A current example is Elon Musk and the question of whether we could develop a great electric car. Before he came along, “everyone” understood that there was an upper limit in fuel efficiency and performance that we’d never break through. Now we have electric cars capable of travelling 270 miles per charge and going from 0–60 mph in less than 3 seconds.

What if local maximums have likewise corrupted our way of thinking about growth, debt and inflation for the last couple hundred years? What if the time-honored systems that we have used to drive wealth and better living conditions were in fact built around a misleading local maximum.

Part I: The traditional thinking on GDP growth and inflation as drivers of wealth

Gross Domestic Product (GDP) is a measure of a nation’s total economic activity. Specifically, GDP is the monetary value of all goods and services produced within a nation’s geographic borders over a given period. The basic equation for calculating GDP is as follows:

GDP = Consumption + Government Expenditures + Investment + Exports — Imports.

This equation is important because we live in an interconnected world today. Some countries choose to drive their growth by exporting more, some by consuming more. Think China and the U.S. — just two sides of the same coin. One does not work without the other. As a result of these forces, jobs and businesses are created in different areas of the economy and those businesses and jobs in turn create wealth.

Once all the pieces of this equation are in place, a government can add more growth by leveraging debt. Enabling borrowing leads to more growth, which increases the wealth of the population, who in turn spend more, which creates still more growth. This wealth effect has driven prosperity and lifted billions out of poverty. But — similar to borrowing for a business to drive extra growth — this approach works only to a point. Once debt becomes too great a burden, the whole process is compromised.

Traditionally, inflation and deflation have been two of the key economic levers for managing debt. The difference between these two terms is largely about who wins — and who loses.

• With inflation, debt is borrowed today and paid back with currency tomorrow that is worth less, which in turn makes the cost of the debt less. As long as the debt is driving good growth, it’s easy to see why economists, governments and the business community are generally comfortable with this arrangement.
• But what if the economy still isn’t growing? Central banks can change the rules to drive interest rates on debt and savings down to zero or even into negative territory. The problem is that this amounts to picking the pockets of the savers to bail out the spenders. As governments play this pyramid scheme, the byproduct is serious misallocations of capital and inevitable economic bubbles.
• As currency is devalued, and interest rates are near zero or negative, purchasing power declines. People on a fixed income or whose salaries are slow to respond to economic shifts are hurt most.
• Deflation works in the opposite way to inflation. With deflation, prices get cheaper.
• Most consumers would greatly appreciate that idea, even if there are well understood hazards associated with long-term deflation. Indeed, economists worry about a deflationary spiral: deflation can ultimately lead to a feedback loop, where people believe products will get cheaper if they just wait long enough, so they stop buying and wait for the cheaper product. That decreases all consumption and, in turn, hinders the growth and wealth of the economy.

Our assumptions about inflation and deflation have held up for enough years that many people — even those who are in a position to know better — believe that we have the macroeconomic mechanisms now to control these complementary forces and push the economy forward. When inflation threatens to hurt our purchasing power, we raise interest rates (reducing borrowing, employment and production nationwide). When deflation looms, we do the opposite.

And it has always worked. So why doesn’t it seem to be working now. What has changed?

Part II: A new economic (and technological) reality

The truth is that our perception about how much we are really in control is warped to a dangerous degree. In our efforts to spur growth through inflationary measures like low-interest borrowing, we’re now trapped in a debt supercycle, where higher-than-ever debts have no realistic prospect of ever being repaid because growth has slowed. Both creditors and debtors here ultimately get hurt, as evidenced by the 2007–2008 subprime mortgage crisis in the U.S.

But there’s a more important factor here that I believe is overlooked. Fast-paced technological change has made the conventional thinking on how to drive growth dated and of limited relevance. Rapid innovation, founded on technologies like AI, machine learning and 3D printing, is ushering in a period of massive deflation. Stuff is easier to produce and cheaper than ever. And this phenomenon is just getting started. We’re entering a “technology supercycle” that’s bigger and more powerful than anything we’ve seen before.

As futurist Ray Kurzweil has pointed out, computational power is doubling roughly every two years at the same time that the cost of it keeps going down. I think it’s fairly self-evident to anyone who remembers shelling out exorbitant sums for brick-sized cell phones that technology is getting better and cheaper all the time.

Furthermore, many consumer goods aren’t just getting less expensive — they’re practically free. Just think of the number of things on your smartphone that you no longer buy, from your camera to maps, newspapers and even guitar tuners. In this sense, deflation is already very much part of our reality, in a beneficial way.

However, technology’s role in changing society has not been entirely positive — or to be more accurate, human beings haven’t discovered a way to mitigate some of the consequences of introducing that technology. Many of the jobs it took to make and distribute all of those products now packed into your phone are gone forever. And as jobs are eliminated, wealth is concentrating into fewer hands.

While today’s tech innovators may be creating billions in value for their shareholders, they create relatively few jobs and may be displacing far more roles than they generate. Indeed, as futurist Martin Ford has postulated in Rise of the Robots, this situation has the potential to get a lot worse, very quickly: “It’s not just about lower-skilled jobs either. People with college degrees, even professional degrees, people like lawyers are doing things that ultimately are predictable. A lot of those jobs are going to be susceptible over time.”

It’s easy to see this happening right now. Today, Amazon can have a book value north of $200 billion (beating out Walmart in 2015) with a workforce of around 200,000. Meanwhile, Walmart employed 2.1 million people in a recent year, or 1 percent of America’s total working population, to be operational. We’re seeing fewer Walmart-style companies relying on massive workforces and pricy infrastructure with each passing year. Meanwhile, the number of companies built around online platforms is growing rapidly, but employing smaller ratios of people.

In short, while computing technologies may have been a net-positive driver of employment thus far, new advances in robotics and AI threaten to change that dynamic. A smaller workforce will be required to labor in companies that earn record profits for a shrinking elite.

So where does this leave us? As I see it, this situation has the potential to lead to two, very different end games.

• The worst-case scenario: Governments continue to fight the forces of technology-induced deflation with enormous monetary easing and negative interest rates, which pushes wealth faster to the top technology companies, worsens income inequality and keeps prices from dropping. (In some respects, rising food prices and even home prices already reflect this.) A permanent underclass of alienated, unemployed (and unemployable) people emerges and grows progressively larger. Societal unrest, large-scale protests and any number of unpleasant outcomes ensue.
• The best-case scenario: Aided by technology, we approach a world without scarcity (or at least certain types of scarcity) for the first time in human history. Deflation makes our consumer goods free (or close to it). We find a way to share wealth — not easy, but doable. People may not have jobs (in the traditional sense), but they find far more meaningful pursuits.

The worst-case scenario represents the culmination of the the old way of thinking: creating abundance through increasing prices. The best-case scenario requires embracing a new way of thinking: creating abundance through decreasing prices.

Part III: The future is coming faster than you think

We don’t have much longer to wait to see which end game awaits us. It’s not centuries or decades away. Thanks to smart technology, prices are plummeting, and the whole sharing economy phenomenon (enabled by technology, of course) promises to reduce costs even further. (Who needs to spend on owning a car when a ride can be hailed for pennies on the dollar.) At the same time, however, whole sectors of the job market are being dismantled and replaced by that same smart technology (a fate to be inevitably suffered by Uber’s own drivers).

I feel passionate about this issue because our company shares similarities with the tech giants behind these changes. In the home-improvement supply sector, our business strategy competes against a legacy supply chain that is less efficient. At the same time, it provides near-infinite selection and value by harnessing real-time big data, cloud computing, mobile technology and intelligent algorithms — the same technological levers driving so much change today. This approach has worked and we’ve seen the results. Products are being delivered cheaper, consumers are getting what they want on demand and manufacturers are selling more than ever. But, while job growth is happening, it’s at a far lower rate than the overall growth of the company. We’re part of this new economy — and we want to be part of the solution that helps us steer away from the dystopian vision I’ve laid out and embrace the utopian one.

So how do we take concrete steps now to ensure that these forces culminate in the right outcome and we can all share in the prosperity promised by technology? For me it comes down to the concept I opened this piece with — the local maximum. It’s time we looked beyond the here and now and the familiar reference points and acknowledged that unprecedented change may be on the horizon. With unprecedented change comes the need for new thinking and strategy.

This time around, for instance, deflation — fueled by new technologies — may not be the villain that it has historically been seen as. A shift in thinking to embrace deflation, rather than fight it with inflationary countermeasures like low interest rates and monetary easing, may in this case represent a step forward. At the same time, it’s key to start thinking now about a future where jobs are an endangered resource. How do we set up systems to equitably distribute the winnings of this tech boom to those who are being displaced by it?

The so-called “Fourth Industrial Revolution” that we’re now experiencing has brought enormous prosperity and new opportunities across huge sections of the planet, but it has also destabilized many of the foundations we’ve built our economies and societies on.

Above all, this much is clear: if we want a say in what our future looks like, we need to start that conversation today.

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I dive deeper into this situation: how we got here, where we’re set to go from here, and what we can do about it my new book entitled The Price of Tomorrow, Why Deflation is Key to an Abundant Future. Prepare to be challenged.

Available now on Amazon.com and Amazon.ca