E-piphany

Every few years or so, this story goes around to great acclaim: inflation is dead, killed by the internet. Recently, we have been hearing this story again, quite loudly. The purchase of Whole Foods by Amazon helped bring commentaries like these to the fore:

“Credit Suisse’s Varnholt Says Internet Killed Inflation” (Bloomberg)

“Low U.S. Inflation? It’s Your Phone: BlackRock Bond Manager” (New York Times)

“Amazon Deal for Whole Foods Casts Doubt on Fed’s 2% Inflation Goal” (Barron’s)

And the list goes on and on. These are some of the more-reputable outlets, and they simply misunderstand the whole phenomenon. This isn’t unusual; almost no one really understands inflation, partly because almost no one these days actually studies something that most people presume isn’t worth understanding. (But pardon my ranting digression.)

The internet has not killed, and will not kill, inflation.

In the late 1990s, the internet was having a much greater relative impact. We went from having essentially zero internet in 1995, to a vast array of businesses in 1999 – most of whom were busy transferring money from capital markets to consumers, by raising equity investments which were then use to subsidize money-losing businesses (see especially: Amazon). And inflation? Core CPI in 1999 was 1.9% (Median CPI was 2.03%).

“But there’s more internet now than there was then!” runs the natural objection. Yes, and the internet was dramatically more impactful in 2001 than it was in 1999. Indeed, as the penetration of the internet economy exploded further despite the recession of 2000-2001, core inflation rose to 2.8% (Median CPI topped out at 3.33%) by late 2001.

There is always more innovation happening, whether it’s the 1940s or the 2010s. Innovation is a relatively steady process on the economy as a whole, but very dramatic on parts of the economy – and we tend to fixate on these parts. But there is no evidence that Uber is any more transformative now than Amazon was in the late 1990s. No evidence that Amazon now is any more transformative than just-in-time manufacturing was in the 1980s (in the US). And so on.

“But the internet and mobile technology pervades more of society!” Really? More of society than the J-I-T manufacturing innovation? More of society than airlines and telephones, both of which were de-regulated/de-monopolized in the 1980s? More of society than personal computers did in the 1990s? We all like to think we are living in unique times full of wonder and groundbreaking innovation. But here’s the thing: we always are.

“But Amazon bought Whole Foods and disrupted the whole food industry! How can you be more pervasive than food?” It remains to be seen whether Amazon is able to do what Webvan and FreshDirect and other food delivery services have been unable to do, and that is to remake the entire delivery chain for food at home. But let’s suppose this is true. Food at home is only 7.9% of the consumption basket, which is arguably less than the part of society that Amazon has already reorganized. Moreover, it’s a highly competitive part of society, with margins that are already pretty thin. How much fat is there to be cut out by Amazon’s efficiency? Some, presumably. But after Amazon makes some kind of profit on this improvement, how much of a decline in food prices could we see? Five percent, over five years? 10%? If Amazon’s “internetification” of the food-at-home industry resulted in a 10% decline in prices of everything we buy at the grocery store, over five years, that 2% per year would knock a whopping 0.16% off of headline inflation. Be still, my heart.

“In any event, this signals that competition is getting ever-more-aggressive.” No doubt, though it is ever so. But here is the big confusion that goes beyond all of the objections I’ve previously enumerated: microeconomic effects cause changes in relative prices; macroeconomics is responsible for changes in the overall price level. Competitive pressures in grocery may keep food prices down 10% relative to price increases in the rest of the economy. But suppose the money supply doubles, and all prices rise 100%, but food prices only rise 90%. Then you have your 10% relative deflation but prices overall still rose by a lot. If the governments of the world flood economies with money, no amount of competition will keep prices from rising. This is why there wasn’t deflation in 2010, despite a massive economic contraction in the global financial crisis and concomitant cutthroat competition for scarce customers in many industries.

So inflation isn’t dead, and neither is this myth. It will come back again in a few years – I am sure of it.