Why is everything so expensive? Blame dynamic pricing. Oh, sure, you can blame other factors, like inflation and supply chain issues, but if high prices were a murder victim, dynamic pricing would be rounded up as one of the top suspects.
The preceding lines appeared at the beginning of a recent article in US News & World Report. Coincidentally, they are also confusing. This series will explain why, but will also flesh out how we should understand inflation and the issues that are related to it, including the cause(s).
So, why are those words confusing? Well, is the author really saying that inflation is not to blame for the high prices that we are currently experiencing? Is this thing called dynamic pricing the real culprit? Have you heard of anyone else in the media talking about dynamic pricing? Does this author know something that everyone else doesn’t?
But let me tell you why.
Let’s Start with How we Think About Money
We can thank money for much of what we enjoy in life today. I say this because I would argue that without money it would be extremely difficult, if not impossible, for the consumption of goods and services to reach the levels that we enjoy today. I would also contend that it is only because of current and historical levels of consumption that the development of goods and services has occurred as rapidly as it has, and with the quality that we have come to expect, at least in some cases.
The simple reason for this starts with the understanding that none of us, or at least very few, possess the knowledge, skill, and talent to be good at many different things. What this means is that most of us must, and most certainly do, specialize in one area, or just a few, for which we do possess knowledge, skill, and talent. Money serves to make that kind of specialization a more viable way of participating in the economy.
Without money, the only thing that each of us would have to offer a producer of a good or a provider of a service would be that which we could produce or provide ourselves. Further, with the production or provision of anything, there is an inherent choice: you can be a master or a jack—this comes from the expression jack-of-all-trades-and-master-of-none.
The reason why these are the two essential options is because of one of the fundamental questions we all have to answer, regardless of whether money exists: how we will afford the lifestyle that we want? In a world with money, that is an issue that can easily be quantified—e.g., your budget is ‘x’, because that’s how much money it costs to uphold your standard of living. In a world without money, lifestyle can also be quantified, but it might be defined by the number of chickens you have, or cows, or pants, or shoes, etc.
So, if we have to determine how we will afford the lifestyle we want, this means that we also have to determine if we want to produce or provide something that appeals broadly or something that is a bit of a niche or specialty—this, again, applies irrespective of whether money exists. To translate that a bit, appealing to as many people as possible means that you are seeking to effect as many transactions as possible. You do this by offering as many goods and services as possible, which means you’re a jack. Conversely, you could seek to capitalize on something that is rather unique or rare, due to quality or the difficulty of production, and this would mean you’re a master. Typically, specialty results in greater compensation, which means you don’t have to effect as many transactions.
The Value of Currency
By thinking through this a little more, we can see that money actually increases our ability to specialize. The way money performs this function is by reducing the risk of inadequate compensation that comes with specialization. After all, in a world with money, the master doesn’t have to settle for chickens when what he/she really wants is a pig. With money, the master can be compensated with something (money) that he/she can use to trade with anyone for anything. So, the master can take the money that he/she earned from the chicken farmer and go to the pig farmer to purchase as much pork as he/she cares to afford. The master’s customer base is expanded, thanks to money.
That’s great and all, but it should be pretty obvious that money hasn’t been around forever, and that means that barter preceded money as the means of facilitating commerce. The reason why this is noteworthy is that the transition from a barter-based system to a currency-based system must be a defined process. The transition must be defined simply because the value of a small piece of paper covered in colors, words, numbers, and designs (i.e., a dollar), or a small, round piece of metal covered in words, numbers, and designs (i.e., a coin), is not necessarily obvious. This creates a peculiar problem, though: how is this transition made—i.e., how do you get people to agree that a currency has value sufficient to replace barter?
(Side note: just how important are those colors, words, numbers, and designs? Well, try using a piece of notebook paper to buy your groceries. Kinda crazy to think that all that stands in the way of you being able to complete your transaction are colors, words, numbers, and designs.)
Before we delve into that question, however, let’s consider another question: why does it matter how the transition is made? Well, if you were king (or queen, I suppose), and you decided to transition your kingdom’s (or queendom, I suppose) economy from barter to currency, it would seem that the very first problem you would have to solve is how much currency would be issued.
The reason for this is that if you issue too little currency, then there’s not enough to go around, which would make the currency rare, relatively speaking, and would most likely give it a high value. Potentially, the value of the currency could be seen as too high, if it resulted in people not wanting to part with the currency they have, expressly because of its value. This would compromise the potential for economic activity to take place.
If you issue too much currency, then that would give it a low value. Potentially, the value of the currency could be seen as too low. If a currency has a value that is too low, it can make financial transactions overly burdensome, which would also compromise the potential for economic activity. This is especially true in a world where you don’t have small pieces of plastic that you carry in your pocket to relieve you of the burden of carrying buckets of cash to buy groceries.
Given those considerations, it becomes pretty obvious that the amount of currency issued can’t be arbitrary. If it’s not arbitrary, that means that the amount has been determined through a defined—there’s that word again—process. A defined process is simply one that is rooted in sound reasoning. Ultimately, this means that the value of the currency must be based on something else. The best basis for value would be something that is uniformly regarded as valuable and stable.
Further, if you hoped for your subjects to be able to trade with the subjects of other kingdoms (or queendoms, I suppose), and if the currency was to be used to facilitate that trade, you would need a way to compare the value of your own currency to others. Now, the simple way to ensure fair valuations would be to base all currencies on the same thing, but you only control your kingdom (or queendom, I suppose). If another currency was based on a different standard, that would mean that you would need to establish a way to understand the value of your currency, relative to others—i.e., you would need to know how to convert the value of your own currency into another, without compromising the value of either. Otherwise, how could anyone ensure that trade was conducted fairly?
Welcome to Avariciousland
Let’s talk about why all of this matters. Let’s say that in a world ruled by monarchs, there’s a land known as Avariciousland (just rolls off the tongue, doesn’t it?). Now, the people of Avariciousland (a.k.a. Avaricians) are known for their, well, avarice. As such, they are loath to part with their wealth and all too eager to add to their possessions. Inevitably, this has led to a bad reputation and the people of other kingdoms (or queendoms, I suppose) regard Avariciousland as a bad trade partner.
If Avariciousland were to base the value of their currency on the same thing as yours, this might not be such a big deal to you. After all, the value would essentially be locked and would not be something that could be easily manipulated, if not outright impossible to do so. If, however, the two currencies were based on two different things, thus necessitating conversion, the added complication would make the manipulation of value easier. The only things that might serve to offset that risk would be faith and trust—things that are not likely to be extended eagerly to the Avaricians.
If it is exceedingly difficult to manipulate the value of a currency in a world with a uniform valuation standard, then it is only through the Avarice—the only appropriate name for Avarician dollar—being based on a different standard that the ability to take a manipulative approach to trade is created. Specifically, it is through the selection of a different standard, and the conversion process that is necessitated in doing so, that allows for manipulation to occur.
If Avaricians are, in fact, as avaricious as their reputation defines, then it is unlikely for people outside of Avariciousland to want to possess an Avarice. The simple reason for this is the hassle involved in obtaining it and disposing of it. In other words, possessing an Avarice would mean that you would have engaged in trade with Avariciousland, which is a wholly unpleasant experience. Further, the only way to realize the “full value” of the Avarice would be to engage in even more trade with the Avaricians. As a result, you are likely to minimize the chances that you will end up possessing an Avarice, if you don’t avoid it altogether. The fact that most, if not all, potential trade partners, are likely to take the same approach, then that would automatically devalue the Avarice outside the borders of Avariciousland.
Up to this point, we have discussed factors that impact the value of currency. You might be wondering, what does this have to do with inflation? I’m so glad you asked.
In part two of this series, we’ll discuss how the value of currency plays a huge role in the inflation situation we now find ourselves in.