Simple way to sane prices

Dec 18 2014 07:40
*Edward Ingram

OUR best economists seem to be lost. Why so?

Occam's razor

Wikipedia says: “Occam's razor (also written as Ockham's razor and in Latin lex parsimoniae) is a problem-solving principle devised by William of Ockham (c 1287–1347), who was an English Franciscan friar and scholastic philosopher and theologian. The principle states that among competing hypotheses, the one with the fewest assumptions should be selected. Other, more complicated solutions may ultimately prove correct, but - in the absence of certainty - the fewer assumptions that are made, the better.”

Again from Wikipedia: “…Simpler theories are preferable to more complex ones because they are better testable and falsifiable.”

The most popular link which readers of my column clicked on last time concerned the main problem today: the LOW INFLATION TRAP.

The number of viewers prompted me to have another look at it. I have improved it significantly as a result. It was published long ago, years before 2008, that is before the problem surfaced.

The simplest explanation for this ongoing problem is that our economic structures are distorting interest rates, costs, and prices, all of which are just different forms of prices.

According to my team of researchers and myself, price distortions originating in our economic structures can explain why all of the world’s economies are always in need of attention. Hello Occam’s razor.

Why low inflation trap?

Because the developing nations were not caught in the same trap. Rather than try to explain all that here, I have, as I said, taken time out to upgrade that LOW INFLATION TRAP page.

Several illustrations and tabulations have been added. These make it very clear how sensitive economies are to interest rate changes. It is just the way that the current borrowing architecture/structure misbehaves. The lower the interest rate, the greater the mayhem created.

When times were simpler

In the days of Adam Smith, the ‘founder of economics’, people may have had a better understanding. There was not as much debt around. Things were simpler. But without big debt, big business, government projects and house buying are not possible.

What we have to do is to restructure debt so that it no longer runs counter to what Adam Smith taught. Let me explain that.

When the demand in an economy rises by 10% over a period of days, months, or a small number of years, unless there is a corresponding 10% rise in the supply of everything then the cost of everything and the price of everything and indeed the value of everything - including our homes - should also rise by 10%.

If the supply side has increased, then prices should be 10% higher than they otherwise would be.

This is probably as simple a statement as can be made to describe the implications of Adam Smith’s pricing law. But this seems to have been forgotten. Instead, when incomes and prices start to rise by 1% p.a. faster taking interest rates and demand levels up by 1% p.a. we get the tabulation shown below for mortgage finance. Check the middle figures for 4% and 5% interest. Costs increase by ten times too much and instead of increasing 1% p.a. faster, property values fall as mortgage sizes fall by 10%. Crazy.

Source: My spreadsheets

Occam's razor

Ask any economist to explain what is going wrong to make things difficult for everyone. You will get a complicated explanation. If you keep on asking questions, you will get even longer explanations. If you really press the issue, you will be told: “There is something we do not know. We are feeling our way in the dark.”

And that brings me to Occam’s razor. If readers would like to have a look at that page on the LOW INFLATION TRAP they will not be mystified about the cause of the main problem. It is down to ignoring Adam Smith. The fallout may be complicated but the cause is very simple.

And unlike our policy-makers, I hope that readers will be able to see a relatively simple way to get us all back to some kind of normality.

* Edward Ingram is a past investigative quality control engineer of complex systems, who turned to managing investments and learning all about economics and finance from the experts. Combining these disciplines has enabled him to understand what others see, but have not understood.

edward ingram  |  economy



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