Wall St. And Business Wednesdays: E-Letter To Sue Kirchhoff and USA Today Re: "Delicate balance helps USA battle deflation, inflation"

I have to say that reading your article "Delicate balance helps USA battle deflation, inflation" today felt like riding a roller coaster. It was simultaneously entertaining, interesting and frightening and by the time I got to the end of it I was ready for it to be over.

I kept waiting for you to get to the bottom line, as you approached some very critical issues in your article only to, each time, snatch understanding out of the grasp of the reader.

The basic problem is that you really don't have the proper understanding of what inflation, deflation and "price" are - in their primary and secondary occurrences, and you equate - yet negate - all sorts of factors like monetary policy, oil prices and the value propositions that every business can make.

Inflation or deflation is ultimately a decline or increase in the monetary standard, or, a change in the standard of price - money itself. Karl Marx understood this best recognizing that, "Money fulfills two entirely different functions, as the measure of value, and as the standard of price. It is the measure of value, because it is the social incarnation of human labour; it is the standard of price, in so far as it exists in the form of a fixed weight of metal." I wrote about this at great length in a piece called "Cuba Searches For 'Price'".

The Federal Reserve controls the world's most important standard of price through its management of the value of the U.S. dollar relative to an ounce of gold, the most monetary of commodities. When the United States was officially on a gold standard de jure, the standard was fixed. Since the late 1960s (essentially) the United States has allowed that standard of prices to fluctuate in a world of floating exchange rates. But the world is always on a de facto gold standard because gold continues to be priced in dollars and anyone who borrows money can determine whether the dollars they are paying back are more or less valuable than the ones they borrowed - just by watching the price of gold.

A deflation is signaled when the price of gold drops below a certain level for a significant level of time. This happened from late 1996 through 2002 when the price of gold fell from a high of around $416 per ounce and went as low as around $255. This meant that every debtor that borrowed money in 1996 has had to pay loans back for the next 6 years with dollars that are more valuable, relative to gold, than the ones they borrowed. This simple formulation shows that creditors are the big winners. Imagine how excruciating this has been for Black debtors who are more prone to take out loans at sub-prime rates or under "predatory" terms.

But because the monetary deflation is due to the Federal Reserve not supplying adequate liquidity to the economy, creditors and everyone else have suffered for the last 6 years as an insufficient supply of dollars have been chasing goods, services and transaction demand, with the natural overall result being lower prices. Lower prices means less revenue and less revenue means less profits and less profits mean less incentives to conduct business or enter into it for the first time.

This form of monetary deflation is different than your confused focus on consumer price indices. Prices for goods and services can rise and fall for many reasons and usually have their most frequent fluctuations based upon not just the supply and demand for money, or the supply and demand factors impacting their respective industries, but specifically because of the sales and marketing efforts that influence the value proposition that every business can potentially offer. The equation for you to remember is :

Value = Benefits/Price

In the eyes of the customer, value only goes up in one of two ways - an increase in benefits or a decrease in price, in the offering of any good or service.

Your article completely misses this point. Your inquiry into price stability misses the larger point about price elasticity. When prices are elastic, raising them even slightly can significantly reduce sales. When prices are inelastic, raising them has little effect on sales, generally speaking.

Differentiated products and offerings have inelastic pricing and are able to raise prices - whether there is a monetary deflation or not. You can see this very clearly in the booming coffee retail business of the last decade. What made people pay $2 for a cup of coffee at Starbucks when coffee consumption was falling by nearly 3% for over 20 years, while the price of a cup of coffee was falling in a great many places, well below $1? It was the value proposition where Starbucks offered coffee drinkers an experience, increasing the benefits in the V=B/P equation and differentiating its product from Dunkin Donuts, in a big way. They were able to raise prices while others offering coffee thought that business could be increased only by lowering them. This value proposition also coincided with a general monetary inflation over the last 30 years. I know of one businessman in the restaurant/coffee sector who simply raised his prices in harmony with the price of gold and the rate of inflation, and was successful.

Another area where you can see price inelasticity is in the music business where even in the midst of a recession, relatively low-income consumers of Hip-Hop music will gladly pay a premium to obtain certain albums before they are available at the major retail chains. Black-owned record stores and Mom and Pop retailers can sell Hip-Hop albums days in advance of the official "street dates" at prices that are "inflated" by as much as 200% over the suggested retail price and even 300% over the prices charged for the very same albums at Best Buys or Circuit City. Why? Again, they are offering increased benefits in the all-important V=B/P equation.

Your lack of understanding of "price" is evident in the beginning of your article when you write:

During the past year, manufacturers and retailers have discounted electronics, cars, clothing and other items so ferociously that even the comic strip Doonesbury has worried the country was skidding toward deflation, a widespread fall in prices that is good news at the cash register, at least to start, but can choke economic growth.

While manufacturers have struggled, however, prices have risen a brisk 5% to 10% in parts of the far-larger services sector, including tuition, insurance and medical care.

Because you minimize how markets work, and leave marketing out of the equation you fail to note that service industries are much better suited to enjoy price inelasticity than are manufacturers or retailers whose revenue revolves around commodities that are more difficult to differentiate. It isn't a matter of inflation and deflation in various sectors of the economy as much as it is the ability of different markets to obtain product differentiation and increased benefits, and thus price inelasticity, through increasing the numerator in the V=B/P equation rather than by decreasing the denominator (price). A monetary deflation disproportionately affects commodities more than services because of the different dynamics of price elasticity and inelasticity as they affect manufacturing, retail and service sectors. Because commodity profit margins are relatively fixed due to the lack of differentiation capacity, monetary deflations caused by the Federal Reserve tend to put manufacturers and retailers in dire straits before service industries.

But you should never forget that price itself communicates. The price of a good or service says something about how valuable or "exclusive" it might be. Some people will actually not buy something if they believe its price communicates a lower value or less popular esteem.

I only raise that factor to show you how the issue of prices is simultaneously more simple and more compex than your article indicates.

We deal with these issues in a unique way at Black Electorate Economics University for 20 weeks - 2 semesters. I hope that you will consider enrolling. It will help you add more benefits to the service you offer your employer and even justify you getting a raise in salary! Yes, even in the midst of a slowing economy, and what you believe is a two-front economic war against inflation and deflation.


Cedric Muhammad

Wednesday, March 5, 2003