Thursday, October 20, 2016

How inflation really comes about-the case of Argentina and Venezuela, explained in detail

I have lived in Argentina off and on for more than 10 years and also am very familiar with how things have been going on in Venezuela in the past 20 years. In this blog post I will explain how inflation is carried about in practice. Unlike what most people believe, the central banks have nothing to do with inflation. It is the hand of the Government which causes inflation.

Adam Smith said: The conduct of private individuals or companies can't ruin a large country of several million people, but the conduct of the Government can. The cases of Argentina and Venezuela are examples of this.

Inflation in Argentina

After the Argentine default of 2001, the country started to stabilize between 2001 and 2007 (dates are approximate). Around 2007, you could easily see that people were beginning to enjoy life normally and were able to count on the stability of next month's salary to indulge a bit with their salary of this month. However, in 2007-2010, the Government started to meddle quite heavily in the affairs of the country. There are several ways the Argentine Government did this, and the net result was all the same-they increase the taxes on the people. A larger share (as a percentage of the annual production) of the private people's produce was wanted by the Government. Here's what they did:

1. Increase of export and import taxes : Duties on export of soy, a major export of Argentina, were increased (measured in percentages, and valued in Argentine Pesos, the official currency of Argentina). Other agricultural commodities which are exported by Argentina were also slapped with bigger duties. The Government wanted a larger share of what was being exported out.

Duties on imports were also increased. Principle increases were in machinery and electronic goods, which form a major part of what Argentine's import.

2. The Argentine Government fixed the US Dollar (the international currency of choice in trade in South America at least) at a substantially lower rate than the market (20% in the beginning, and the gap between the market rate and what the Argentina's official rate for the USD kept increasing from this 20%). This in effect reduces the value of what exporters get for their exports (they get less dollars than the dollars they would get if they would sell at market price in international markets). In many ways, it acts like an additional tax on exports. The difference between the market USD rate and the fixed peg is the tax which the Government collects on each dollar exported (e.g. if Market rate of USD/ARP is 10/1 and the Government rate is 7/1, the government keeps $0.30 for every dollar worth of goods exported out of the country)

You would think that what is lost in exports would be gained in imports; but the Government does not really offer a two-sided fair market. It never lets you buy dollars at the official rate (if you are an importer, you need the dollars). It only lets you sell pesos at the official rate. The liquidity is one sided-there is a perpetual scarcity of dollars, and in effect, the benefit of the importer of getting a lower rate for the dollar is never honored in practice, because banks, under the instruction of the Government, give you only very small quantity of dollars, and make you fill out dozens of forms if you want to purchase dollars from them.

Since exports are taxed at a very high percentage now because of duties and these currency controls, as you might imagine, the volume of exports goes down considerably. As I have explained in another post, the value of exports is always equal to the value of imports-what being imported being necessarily because something was exported from the country (discounting the minor effects of carry trade which Argentine companies might be doing, or Argentine capitals outside of Argentina whose returns are being brought back to Argentina, etc.).  The volume of exports of Argentina started to go down considerably in around 2010. Correspondingly, imports also took a drastic drop.

3. In addition to trying to get a larger share of exports, Argentina also increased taxes on domestic companies. Worse than an increase in taxes was the arbitrary nature of Government Tax collectors-who would come regularly to remind you to pay taxes, and in many cases, would go away if you gave them a nice bribe. Your business would be fined with infractions of the safety code, health code, etc. etc. and you would have to pay them these fines. This had the effect of stunting down real production in Argentina-no capitalist likes being bothered by a rogue Government. Many small Argentine capitalists left the country-several arriving in Chile. In effect, the Government's meddling caused a real flight of capital from Argentina, which decreased production of goods and services of the subsequent years. Foreign companies were forbidden from taking out their own money from their subsidiaries in Argentina at market rates. Many such policies were put in place-effectively to fill up the coffers of the Argentine Government as much as they could. The local governments followed suit-and also started hassling businesses small and large for more taxes, and more fines if they didn't pay bribes. Corruption on Government acts as an additional tax on the country's citizens; and what went on in Argentina between 2010 and 2015 is an example of that.

Inflation is measured by comparing the price of a basket goods (and services) and seeing how the price of this basket changes over time. If the amount of money in a country is constant (a majority is in the form of salaries to private and government employees), and there is a scarcity of goods, the prices of goods start to go up. The scarcity of goods is not perceived or imagine (as Keynes foolishly thought), it is very real and perceived quite easily by everyone in under-stocked shelves on the supermarkets, many stores closing down, a perpetual shortage of imported goods, etc. Most of the ruin is caused by Government employees, whose salaries in Argentine pesos were a constant, and essentially, because the Government was keeping a larger share of the net production of the private people, caused the value of the paper money to fall in real terms. It is goods which decide the value of money; not the other way around; money being just a tool to facilitate the exchange of goods (and services) of society. A reduction in the amount of goods in society, with the same amount of money in society (salaries of employees) makes the prices of goods go up. This is how inflation of 20% per year happened in Argentina in the years 2010 to 2015.

Since the Argentine Government accepts taxes in Pesos only; in effect it reduces the value of the Argentine peso in the real market (when measured in terms of goods, or by a basket of goods, as an inflation basket measurement does). People are less likely to save in Argentine pesos, and they are more likely to save in the form of foreign currencies like USD or buy a lot of land or real estate. Investments in production activities goes down when you know that an unfair Government wants more than it's fair share of money from you.

As you can imagine, the value of the currency, Argentine Peso, in US Dollars is a good proxy measure of inflation (but still an imperfect one). The USD vs. Argentine Peso doubled in 5 years between 2010 and 2015, which amounts to about a 15% gain in the USD per year. The USD vs. Argentine Peso has gone up almost 3.5 times from 2003 to 2015, with the bulk of the appreciation coming in later years.

Note that Argentina never had a shortage of basic necessities like food or clothing in all this time. Despite what all the news reports say-the nation didn't become a very poor nation between 2003 and 2015. Even the most crazy policies of the Government didn't prevent the production or import of basic stuff in Argentina.

This however, has not been the case in Venezuela, where there is a basic shortage of basic goods-even food and clothing. The Venezuelan Government has been far more tyrannical in it's actions that the Argentine Government.

Inflation in Venezuela

As I said above, the value of the USD is a proxy indicator of inflation. The Venezuelan Bolivar has gone from 10 to 1000 in a period of 20 years; with no end in sight. People have no intention of holding any of their savings in Bolivares; they would rather hold USD or even the Colombian Peso than hold a currency which next year will be even lower than this year (because Government employees are paid in Bolivares, without exception), unless there is a change in Government leadership at the top, which stops interfering with people's daily lives.

The Venezuelan Government implemented price controls in the local markets in 2012. This was even worse than currency controls; and the harmful effects of price controls, in not knowing where to put capital, are well documented by many economists. In daily live it is a big nuisance when Government official tell you what to price your goods at; and many capitalists simply run away to border countries rather than deal with this constant botheration. There has been an exodus of Venezuelans to all Latin American countries in the last 20 years. Many are capitalists who have shut down their small businesses in Venezuela, and escaped with 20K to 100K USD to other countries to start their businesses there.

Governments can cause inflation and kill economies

One reason why I posted the details of Argentina and how inflation is brought about here is to end the myth that central banks do anything by varying money supply, interest rates, etc. to control inflation.

But the main reason to post this is to show in detail how Governments ruin a country. Private people can ruin themselves; but a large scale collapse in Economy as in Argentina and Venezuela can be brought about only by the Government. The Government employees, and I suspect about 30% of the people work for the Government in these countries, can really retard the productive ability of the other 70% who are private individuals, who the Government lives off (in the classic sense, the Government lives of Taxes; not counting the small amounts of for-profit undertaking they may hold a share in, like PDVSA or YPF). Sudden increase in taxes, arbitrary tax collection, currency controls and price controls all effectively eat into the real capital of the productive citizens of society; and when this happens to an extent as in Argentina or in Venezuela, the country can stagnate or go backwards slightly for some time (the case of Argentina between 2007 and 2015) or it can really go backwards considerably (the case of Venezuela).

Something similar happened in Zimbabwe, where heavy handed Government intervention has caused a real drop in the production ability of that country (I am averse to use the term GDP because that number is full of errors, and doesn't capture the situation of in flux countries like Argentina, Venezuela, and Zimbabwe).

Zimbabwe's currency has also fallen in similar amounts, or even more than the Venezuelan Bolivar.

The situation of Greece has an important similarity to all these. Greece, because of massive loans from Germans, French etc (through banks in Germany and Greece) caused it to appear much richer than it really is. The Government salaries were inflated to ridiculous levels (more than even in Germany!) before the Greek Government default in 2011-2012. The country did not go bankrupt because of private Greeks; it went under because of a very fat and inefficient government paying exorbitant salaries to its employees. While there is no real currency measurement available because Greece still uses the Euro-the asset prices of Greece become inflated and now have come down to normal levels. However, the Government of Greece still is a major drain on the country; and the European Central banks and other banks who have loaned more money to Greece on the condition that they reduce the size of the Government are doing exactly the right thing. Where they err is in forcing the Government to collect more taxes from private persons; that will only delay the recovery of Greece. Even if the taxes don't go up, if the Greek government can reduce it's expenditure by a significant amount, e.g. more than 30%, they will be able to pay  off the loans which they have defaulted on.

Related post: The foolishness of inflation measurements.

Tuesday, August 30, 2016

On balance of trade- it's surplus and deficit still being a concern for most countries

Balance of trade is an often talked about subject by countries. US whines about a negative balance of trade with China, China whines about a negative balance of trade with South Korea, etc. etc. This was covered by Smith-but maybe needs a new look in the present context.

Rule: The net balance of trade of a country with all other countries is always zero.

Let us remember that money (dollars, yuans, Gold or Silver) is just a way to facilitate the exchange of goods (and services) between countries. It simplifies barter; but in the end, all trade is barter. What Chile imports annually from the world, is necessarily equal in value to what it exports annually (the major exports of Chile are Copper, wines, fruits, and salmon. The major imports are construction materials, cars, electronic goods, machinery). Everything which Chile sends out in the form of exports, comes back in the form of imports. There might be some delay obviously in the accounting and there may be a month to month variation where a surplus or deficit might run because of not receiving the money in the same month, but over a long period of time, say of 1 year (assuming payments in 30 to 90 days max.), the net exports should be equal to net imports. Chile is not sending it's good anywhere for free; and neither is any country giving away their stuff to it for free. Therefore, the equality of exports to imports is a necessary condition for trade.

It follows that if you export more, you import more. Similarly, if you export less, you have to import less.

Some allowance must be made for credit and foreign currency accumulation-for Chile might export stuff and instead of exchanging them for other goods right away, maybe hold US dollar reserves in the form of loans to the US Government, to buy something later on in the international markets. These are small corrections to the rule (dollar reserves are a small part of the net value of goods exported or imported), but the general rule of Exports=Imports holds for all countries at an individual country level. What goes out (as exports), must come back in (as imports).

Note that this is for a country with all the rest of the world. However, Chile may run surpluses or deficits with any one country for a long period of time, without this rule being violated. That's because countries are trading with each other, and surpluses with country A cancel out a deficit with country B. Let me explain this with an example.

Let us imagine a world with only three countries-Chile, USA and China. The numbers are just for example purposes, and are not real.

Chile exports 10 million dollars worth of wine to USA.
Chile exports 5 million dollars worth of Salmon to China.
Chile receives 15 million dollars worth of machinery and automobiles from China.
Therefore, against USA, Chile is always running a surplus in trade balance, because it is only exporting, but importing nothing from it.

But the surplus against USA must be exactly equal to the deficit against China, as you can see, to make sure that the net exports are the same in value as net imports.

There must be some form of trade between USA and China, where USA must be exporting something to China and running a surplus with China for exactly 10 million dollars.

So an example might be

USA exports 500 million dollars of airplanes to China
USA imports 490 million dollars worth of computers from China

and adding what we said before
Chile exports 10 million dollars worth of wine to USA.
Chile exports 5 million dollars worth of Salmon to China.
Chile receives 15 million dollars worth of machinery and automobiles from China.

Makes every country's exports exactly equal to it's imports.

Even if Chile is forever running a surplus against USA and a deficit against China, it all needs to balance in the end for it, where all exports come back as imports, directly or indirectly.

Note that in this example, the US must always run a surplus against China.

This example can be extended to 4, 5 and hundreds of countries, with similar results.

I have heard of people talking about the net exports of a country to the world being less than it's imports, and that the country is running a deficit. This can't be true. It may manifest that way because of measuring the value of exports and imports incorrectly, delay in payments, etc. but in the end, if you are a country X, your total deficit or surplus with the rest of the world is exactly zero, in real terms.

Hopefully you can see with this explanation that there's no fuss to be made about a country running a deficit with a particular country. It is just the nature of trade. For every surplus, there must be a deficit with a different country somewhere.

Note that you can extend this example to smaller divisions within a country (to States), to counties and ultimately to even to the individual level.

Therefore, Texas has a net trade balance of zero with the rest of the USA+other countries. What goes out of Texas, must come back into it, either from other States in the US or from other countries directly to Texas.

For an individual-what you produce, you must eventually exchange for what others produce. You eventually exchange all what you produce with the productions of others.  You must discount for savings and the part of the savings you invest for further returns-but it still means that overall, what you produce will always be exchanged for the same real value of what others produce.

Sunday, August 28, 2016

How technological development helps economies and society

We have come a long way from inventing stone tools to axes to hacksaws, but there are still people who believe that technological developments lead to loss of jobs, and are somehow bad for society. I just came across this article by Economist Robert Schiller where he starts out with "Innovations in robotics and artificial intelligence, which are already making many jobs un-competitive, could lead us into a world in which basic work with decent pay becomes impossible to find." For all his accolades, Mr. Schiller doesn't seem to have much clue about how Economics really works.

When we make a tool to simplify our job, whether it is a sharp stone to cut wood fast or an axe to remove trees faster, as our ancestors did, or an electric hacksaw which we use today to make chopping of trees even faster than an axe, we make our jobs simpler. The same holds for all inventions-software, robotics, computers, etc. We invent tools to make our jobs simpler, to produce more for the same hours worked. Both capital owners and workers benefit by these improvements in the productive powers of labor, by the employment of new tools, technologies, etc.

Let me give you an example to clarify this: assume you have several wood cutting factories which were employing workers uses axes. Then the owners of these factories buy electric hacksaws. Assume electric hacksaws are 10 times more efficient and you need only 20 minutes to cut a tree, instead of 200 minutes using an axe.

Once an electric hacksaw is employed, the same work can be done in 1/10 of the time, so you need to pay the worker only 1/10 of what they earned before. The output is the same, but the worker now has 9/10 of his time free-he or she can find other jobs. Even if he doesn't find another job, you can employ him to do 10 times the work, because now he can chop 10x the number of trees for the same hours worked.  Since the output of each factory can go up by 10x by this operation of replacing axes with hacksaws, it increases the competition for labor-and the net result is that the worker can demand more wages per hour, because he can find jobs with other wood cutting facilities. Maybe the factory owners and the workers will settle for something in the middle- in the extra 9x chopped trees by this operation, maybe 6x will be kept by the factory owners, and the 3x chopped trees (or their wages in dollars) will be kept by the workers, whose real value of labor is increased by this operation.

All parties-capital owners and the workers, benefit by the introduction of hacksaws instead of axes for chopping wood. The same holds for all improvements in technology and tools which simplify our jobs-they benefit the workers as much as they benefit the capital owners.

What happens to all the jobs which are eliminated by computerizing the paper ledgers, by employing all these machines in the fabrication of things? They are lost, but those workers find other jobs! Our predecessors were doing entirely different jobs than us-there was no NASA or Boeing or Mitsubishi in 1500 AD- clearly jobs shift, and that's the nature of things. But it is nothing to worry about. If a machine or robot takes away a job, the best job for the person who lost their job is making more machines of this kind. This is how Japan does it-that country loves automation, machines, and instead of manual labor, the Japanese want to invent machines and robots for everything, which is the right approach to development. Women are even marrying robots now in Japan, and it is a perfectly legal union! The best job for humanity is to make tools and machines (robots included) which do your work faster, and this is exactly what technological development has been for thousands of years. However, to employ someone to make machine X, you need capital-materials for making the machine X, fixed capital employed in erecting the factory and the machines and tools employed to make the new machine X, and the wages which employees must be paid before machine X comes out of the factory. Economics is about increasing this capital.

Whenever someone talks about loss of jobs because of new software, robots,  tools and machines etc. you should tell them that the best jobs are to develop more software, robots, tools and machines. Repetitive and mundane tasks can be done by machines; and humans can dedicate themselves to producing more and more machines, which is the hard part. When you see a bullet train or a plane you cannot not be marveled at the genius of humanity. If McDonald's can serve burgers using robots, it would be awesome-the people who work in McDonald's right now can find jobs building or fixing or maintaining these robots, instead of flipping hamburgers all day. McDonald's does use a lot of tools and machines already-and every industry benefits from better tools and machines, including robots.

Semiconductors, software, robots internet, telephone, etc. are just an extension (over centuries) of stone age tools, chisels, axes, matchsticks, paper, watches, washing machines, etc...technological advancement is continuous, and we are constantly improving our productive powers by inventing new tools. We produce more for the same work with these tools, which is what human progress is all about.

Sunday, August 7, 2016

Bad Science behind introduction of genetically modified Zika mosquitos to control their population

Zika is spreading a little bit outside Brazil and Colombia, and a company called Oxitec is proposing a solution. In all likelihood they are twisting their data to fit their needs-to make it look like the mosquitoes they introduce really cause a decrease in the overall mosquito population.

News stories Here and Here for a sum-up of what they are proposing.

"Trials of the modified mosquitoes in Brazil, Panama and the Cayman Islands suggest they reduced local populations of Aedes aegypti mosquitoes by more than 90 per cent," Oxitec says.

Here's the problem from an evolutionary point of view-just because you have created this male Aedes aegypti mosquito which transmits the gene so that  the offspring are killed before they reach adulthood doesn't mean that the females will mate with them. Even if the sexual selection be random, you will just eliminate the offspring of these males; but the other males, who are a large part of the population, will continue producing offspring. This is the best case scenario.

Sexual selection is not random-it is not like that females will mate with any mosquito-and if the mosquito population realize that the offspring of these genetically modified males are not reaching adulthood, they will probably weed them out by sexual selection even faster. Sexual selection by females will accelerate de demise of these traits.

From what Darwin explained in his Domestication of plants and animals and a little bit in the Origin of Species, it is clear that introducing new strains in a plant or animal is the easy part, the hard part is to make sure that their offspring survive the selection pressures of the others who are the more "stable" varieties. In his words, hybrids are easy to create-but will tend to revert to the stable varieties after a few generation, even if they can reproduce. Hybrids most likely will not even reproduce-and the reason was unclear to him-but the evidence is very strong that hybrids are difficult to breed, and even if they do breed, even more difficult is to ensure that their offspring survive and don't revert back to the parent varieties used to create the hybrid.

This thing about Zika males is very similar-and my bet is that introduction of these males has no effect whatsoever on the mosquito population of Zika.

Regarding the data from Brazil, Panama and Cayman Island-I  think the data has been fudged to give them what they want to prove. And doing it in a lab setting may have nothing to do with how this turns out in real life-with loads of other selection pressures on the mosquitoes, both from within and outside their species. This is similar to the myth of antibiotic resistance in many ways.


Thursday, March 10, 2016

The foolishness of inflation measurements

A lot of garbage statistics is used to collect inflation data and to calculate stuff like CPI (Consumer price index). Your mortgage and other interest rates and sometimes your rent are adjusted to this number; and this statistical trickery of taking data to find out the value of money and how it varies over time has a bearing on your everyday life.

Problems with how inflation is measured

Can you give a precise value for money (dollars) by measuring the value of all other things the way the Index with the inflation basket does? I don't think so.

1. It does not consider the statistical deviation in prices. Whenever an inflation data is published, I would like to know the standard deviation of the data. No mention is made; to hide the fact that the prices vary all the time! For the basket used to measure this data, what is the standard deviation of the prices?   The Index covers prices consumers pay for services from medical visits to airline fares, movie tickets and rents-all kinds of variable things, and you just can't add the means and come up with a value without talking about the variability or standard deviation of these things!

2. The choice of basket is arbitrary, and even if the data for the basket was statistically reliable, one can't say that the basket can be used to measure the general value of money over all things for all human beings (thousands of things and millions of human beings consuming them in different ways). It is a measure of money for that basket only, and any conclusions about the general spending habits of people in so many other ways they spend money from that basket is outright silly. The inflation data, strictly speaking, is valid just for that basket.

Any changes in the basket composition will give you altogether different values of inflation (which shows there's nothing real behind the data-what you are measuring is all noise, or in Nassim Taleb's terms-randomness).

3. Measuring the value of a basket in money terms, or a bunch of items in money terms, does not give you the value of money. The demand of money varies just like of other things (potatoes, electricity, whatever) and you cannot just average it out over a bunch of things and come up with "one value" of money, as a CPI calcuation does. The natural variation of prices of everything, and of money (cash) in itself, is not considered at all.  It also assumes that the reason the value of money is what it is is because of increase or decrease in supply of money; and does not consider that the demand of money, just like of any other commodity, is itself variable.

To explain this further-let's say we started measuring things in potatoes, and we could control the production of potatoes so that every year we would increase the potato supply by 2%. Can this be captured by measuring everything else in potatoes and coming up with something like "the supply of potatoes increased 2% in 1 year"? I believe it is impossible. With all things valued in potatoes, and because their value is itself very variable depending on the supply and demand, you will end up with a very noisy idea of the value of things in terms of potatoes. It is very unlikely that you will hit the mark of 2%. So even in a controlled enviroment, when you simply increase the supply of potatoes by 2% in a year, you will not be able to come up with the exact value by your statistical data taking of market prices. The same holds if you measure it in dollars or pesos.

The basic idea of measuring things to get the value of money is not bad-you can get an idea, a very rough idea about inflation, if EVERYTHING in your basket goes up in price by a significant amount (at least 10%). This happens in Argentina and Venezuela, for example. Then you are able to see inflation-but even then to give an exact number to it like 20% per year or 50% per year is foolish. For small variation in prices, less than 5%, you cannot conclude that the price of things increased because you printed more money, or because of simply that the demand of money went down in relation to other things, etc.

If there was something real in measuring the value of money using things in the inflation basket-ALL items would go up with a very similar amount e.g. 5%. Then you can say with confidence that it is the price of money which is changing and it is not the statistical variation in it which you are capturing.

4. Inflation results (that it is generally a positive number, and that prices are going up with time) are contrary to what every human being tries to do in life-save money, get a better deal and a constant push towards finding the same product at a cheaper price.

If everyone is given 10% more money: the salaries of wage-earners go up by 10%, the capital returns of all capital owners go up by 10%, and the rents which landlords collect also go up by 10%), it cannot be said that the prices of all goods will go up. We hate to pay higher prices for the same product-and many times will simply not buy the product at all if prices are raised. The inflation proponents in this case will say that part of the raise in salaries (or capital gains and rents) will go up to raise prices (e.g. 3% of the gains will go towards raising prices, while the rest of 7% will go towards finding better deals, etc. or just saving the money, lending it out at interest).

A raise in a salary will not cause you to run out and pay a higher price for the exact same product (only a fool would do that!)-and the natural desire of human beings to find better deals from several producers is always pushing prices lower for the exact same product. A corollary: buyers will pay higher prices for higher quality products in the same category.

One must note that it is buyers who decide the final price in any transaction; sellers only make offers. Buyers enter into the transaction voluntarily (no one forces them to buy something, they can just sit with the money, or buy something else with the money) and are the final deciders of what all goods are priced at. Since buyers are always trying to lower prices, it follows that there is a constant pressure on goods to go lower in money price, or a constant tendency of deflation. Every man wants to buy the cheapest, and deflation is the norm in that sense. If sellers were setting prices it would not be the case; but it is the buyers who set prices. Buying is a voluntary act, and they can choose not to buy, with nooone forcing them to go ahead with the transaction. Since most goods except  basic foods are in reality luxuries, it follows that buyers are always lowering prices of goods, shopping between different producers to find a better deal on the same or similar products.
However, buyers will pay higher prices if the product improves; which is really the best use of their increased wages (or capital gains or rents). This explains why over long periods of time (several decades), when you can see that wages do go up, why goods seem to go up in price. Many goods are now better quality than before, and comparing even simple products at two different points in time, the points separated by several decades-will make you realize how much their quality has improved. The quality, includes durability and packaging of vegetables in much better today than 50 years ago. The price of carrots seems to go up in 50 years; but if you consider how much the quality of carrots has gone up, you will realize that the gain has been nothing more than an adequate compensation for better quality, better packaged, cleaned, ready to eat and nice looking carrots rather than the same carrots being sold at higher price. In real life at a certain point in time, when we go to a supermarket, we do pay slightly more for a better product (you will pay more for cleaned, ready-to-eat carrots than unwashed carrots with their leaves attached to them). Accumulate this preference over several decades and you will see why carrots today are much better than carrots 50 years ago. I chose carrots as an example of a simple good; the real quality improvement in complicated machinery, electronics goods, etc. is much larger over a period of decades; $1000 would buy you a 2MHz Processor, 200KB RAM computer 20 years ago, today it gets you a 2GHz processor, 5GB RAM. Or in other words, the computer of 20 years ago will cost you pennies-because of the improvement in the production technology of computers. I remember paying $500 for a 1.2M pixel camera 15 years ago, today a 10M pixel camera is a standard, free feature in all smartphones which cost $200. Improvement in digital camera technology has been very rapid, and the costs of the same product have dropped down exponentially. It is the slow accumulation of higher prices for better products by consumers which caused the elimination of the 1.2M pixel camera. Let me explain this further.

Fifteen years ago, when the 1.2M pixel camera was launched, it cost $500. In one year after that, the price of 1.2M pixel camera was $400, but a 1.5M pixel camera was $500. I chose to pay $500 for the 1.5M pixel camera. Do this successively for a few years and you will realize how it was consumer preferences together with better (cheaper) technology which caused the elimination of the 1.2M pixel camera from the market.

Inflation baskets and measuring inflation using them do not consider well the improving quality of products, i.e. they do not control for product quality. While some exact products might really increase in price with time, for most products, there is constant improvement going on in quality. Most price increases you see in life on products is because of a real improvement in the quality of these products, which is not captured by inflation measurements. In the United States, the cheapest car might have cost US $5000 in 1965 and today in 2016 it costs US $15000, but the increase in price is not because of inflation or more money in the system; it is a real improvement in the quality of the car in this period. Wage increases are also completely real-and inflation doesn't "eat away" into wage increases as often quoted.

What happened to the $5000 car of 1965, why is it not available in 2016? That's because there has been a real improvement in the US (and other countries) in these years, and people earn enough money to not have to buy the $5000 1965 type car anymore. In poorer countries, you will find a car for $5000; because society there has not improved to an extent that everyone can afford a $15000 car. A $5000 car today in a poor country is much inferior in quality than a $15000 car in the US, as anyone can plainly see. It is normally much smaller in size, power, sturdiness, etc.

An improvement in the quality of products is the reason their price (as a category) may up in time, and inflation measurements by baskets do not consider these improvement in quality, attributing all the increase to an increasing supply of money.

Now let me give you an example of how inflation actually comes about.

My experience in Argentina and Venezuela, where there is inflation

Having lived in Argentina myself, and being quite familiar with how things are going on in Venezuela and having been there as well, I can testify that yes, there is a  problem of inflation in these two countries. But it is not because the money is being increased-it is a real decrease in the quantity of goods in the country, which is pushing down the amount of money people, especially businesses, hold in local currency. Note that if the goods were a constant and we pump more money, inflation would increase; but the same happens if money is a constant and the number of goods decreases. The real annual produce of goods in Venezuela has gone down in the last 15 years-as anyone can see when they go to a supermarket (well stocked vs. less number of goods), the types of cars people drive (old cars, vs. news cars), etc. The inflation you are seeing is not because of more money in the Venezuelan society; it is because there are less goods being produced in the society, and a future uncertainly of even more troubled times-which causes people and businesses to hold less cash. You can't eat cash; you can eat wheat and oil, etc.-which causing a sort of hoarding behavior which leads to a lesser value of cash.

If it were the real increase in money supply of bolivares or pesos, you would see a lot of new currency notes in these countries. I can assure you that you do not see freshly minted currency notes there. You would also see new coins-and that also is not observed. The bills and currency notes circulating are not increasing in quantity. The real production of society is falling apart because of bad government-who interfere in production by increasing taxes, random factory closings, bribes, etc. Capital owners withdraw their capitals when there's no certainty that they will reap the rewards of their labor-when you have a tyrannical government like in Venezuela restricting everything and wanting a share of everything. The net output of society goes down considerably due to this, and that is the real cause of inflation in Venezuela and Argentina.

The Venezuelan central bank doesn't do anything to change inflation (a point explained in this post) , except for the currency it prints and gives away to the Government on easy loans, etc. or even  just gifts it to them (The Government and not the central bank sometimes controls the printing press of money; and can print a lot of bills if they want-but that would show in an increasing larger number of freshly minted bills in the country, which is not the case in Venezuela and Argentina). The goods are becoming scarce in these countries, and that's what is pushing the money price of these goods in Pesos and Bolivares higher. The salaries of the employees are not increasing, they are staying the same in Pesos and Bolivares. And printing 40% more bills per year and distributing them for free is a difficult task in itself, which you can be sure that a Government can't do easily. Printing currency is not an easy thing to do.

Except in Argentina and Venezuela, for all other countries in South America, North America, Europe and many in Asia, I don't believe there is an inflation problem. They are measuring whatever to come up with numbers; but it is just noise.  I have heard of inflation problems in some countries in Africa, and my bet is that they are in the same situation as Argentina and Venezuela-the real quantity of goods in these countries is going down because of bad Government policies, etc. but no country is creating inflation by printing more currency and maintaining the amount of goods they produce annually a constant.

A detailed examination of what happened or is happening in Argentina and Venezuela, and how inflation is really created.

The case of Panama and Ecuador

The futility of inflation measurements is best illustrated by countries like Panama and Ecuador, which use the US dollar as their currency. Since they have no influence or control over how US dollars, a foreign currency there, is valued, or is brought into their country, their inflation measurements are nothing but noise-in the sense that there can't be regular pattern to it. Amazingly, they do have inflation measurement departments...where dozens of statisticians and bureaucrats are employed to come up with this data. Link for Panama here   and Here for Ecuador. Since they can't do anything if the inflation is high or low, why measure it at all!

In Ecuador, the reported annual cumulative inflation was 3.38% in 2015, and 3.67% in 2014. The geniuses in Ecuador and Panama who are reporting these numbers, massage the data to make it look like a nice number, instead of saying it is statistical noise. They publish this number to keep the banking community and financial guys happy. As long as it is between 0 and 5%, everyone is happy. Data which will make it go beyond these is readily discarded.

Digression 1-As a general comment, I think most people, including Scientists, will make up or polish data to prove what they want to prove-because their jobs, their funding, etc. depends on it. In the end, for most people, it is just a job; and a bit of data jugglery is a part of their job, just as it is for people who work in Sales and Marketing-who will make up data to sell their products. Not more than 5% will publish the data as it is, and agree that it might just be noise (and this is in all walks of life, not just Economics, Medicine and Global Warming; subjects I have covered in this blog to show you how a lot of what you see is noise disguised or polished as data).

Digression 2-As I grow older, I realize that a lot of data we have around is is just noise, and a large amount of foolishness of humanity is to confuse this random data as relevant. This is how stuff like the existence of God and astrology was born. Even though Science has advanced greatly in the times since we invented the idea of God and planetary movement affecting our daily lives, I still find that a lot of humanity still confuses noise with data. Wherever people see patterns, I generally see noise. And as Nassim Taleb said so well in one of his books-good data shouts at you, you don't need to look for it or justify it by long arguments.

There are a lot of holes in the basket measurement of inflation. Any number which is less than 5% and is quoted as inflation is but noise-and they are careful to hide the noise by not publishing the standard deviation of data.

Other holes in the measurement of inflation: a) they invented something called "core inflation" to remove the volatile parts of the inflation basket, food and energy. A real statistician never discards any data, here it is being discarded on purpose to remove the deviations and noise in the data, to make the inflation numbers "smooth" and b) a small change in the composition of the inflation basket will lead to an entirely different number for inflation. If the real value of money was being measured, a change in just the composition of the inflation basket should make no difference.

Inflation measurements which are increasing steadily at say 2 or 4% per year are in reality a clever way of defrauding the persons who borrow-who almost always see their interest payment go up with time, because they measure the index in a peculiar way to make it increase slightly almost every year. The noise of the measurements is removed carefully to always come up with a slightly positive number  between 0% and 5%, to give the banks a license to increase interest payments on the borrowers. Or rent payments, which are also adjusted to inflation in most big cities. The inflation data publishers meet the needs of the market well-the massage the data to come up with a number of between 0 and 5%, and get to keep their jobs. But the real value of all this data is zero, for the reasons mentioned above.

Inflation feedback loops

The most ridiculous use of inflation data is by utilities  (electricity, telecom companies, etc.) and essential services companies. Utilities use this data to justify increasing rates. They say that because of inflation, they be allowed to raise rates. Since their own products form a part of the basket of things used to measure inflation, they basically go into a feedback loop-the basic necessities companies raise rates because of inflation data, and since they raise rates, next year inflation data shows even more inflation, and they raise rates even more. Imagine if every product or service in the inflation basket started raising rates, the next year's inflation would go through the roof! Here in Chile where I live, this is why gas and electricity prices are the highest in the Americas (North and South)..and the Government lets these utility companies increase rates , who use the excuse of higher inflation.

Here's what Smith said about increase of paper money possibly causing inflation (which seemed to be a theory in 1760 as much as it now!) in Book 2 of the Wealth of Nations, chapter on "Money Considered as a particular Branch of the General Stock of the Society"

"The increase of paper money, it has been said, by augmenting the quantity, and consequently diminishing the value of the whole currency, necessarily augments the money price of commodities. But as the quantity of gold and silver, which is taken from the currency, is always equal to the quantity of paper which is added to it, paper money does not necessarily increase the quantity of the whole currency. From the beginning of the last century to the present time, provisions never were cheaper in Scotland than in 1759, though, from the circulation of ten and five shilling bank notes, there was then more paper money in the country than at present. The proportion between the price of provisions in Scotland and that in England is the same now as before the great multiplication of banking companies in Scotland. Corn is, upon most occasions, fully as cheap in England as in France; though there is a great deal of paper money in England, and scarce any in France. In 1751 and in 1752, when Mr. Hume published his Political Discourses,*36 and soon after the great multiplication of paper money in Scotland, there was a very sensible rise in the price of provisions, owing, probably, to the badness of the seasons, and not to the multiplication of paper money."

Related post: Central banks have no influence in jobs creation, unemployment or real interest rates. Here's the post explaining this.