Tuesday, March 1, 2011

The Flight into Real Values

I cannot stress how important it is that you understand this concept. It is something that is bound to happen in an increasingly inflationary environment.

According to the Mises Made Easier Glossary, The Flight into Real Values, or the Crack-Up Boom, is:
The frantic rush to spend all monetary savings and other available cash, buying goods, whether needed or not, in order to avoid holding, even for a short time, any rapidly depreciating monetary units. This occurs at that point in the development of inflation when the public is convinced that prices will continue to rise endlessly and at an accelerated pace. The flight into goods or real values is also known as a "Crack-up boom" (q.v.) and marks the complete breakdown of a monetary system.
It goes like this:

(1) People will begin to realize that the prices of all goods and services in the economy are rising.***

(2) People will realize that prices are continually going up.

(3) They will therefore buy now while prices are “low” rather than wait until prices go up again.

***Usually, economists mention that the reason the prices are going up and people are “unloading the currency” so quickly is because the purchasing power of the currency is weakening at a speedy rate.

Simple right? Let’s add some numbers to the mix.

Let’s say the price of peanut butter is $5 for a 1 lb on Monday. But on Tuesday the price increased to $7.50 which is a 50% increase from Monday. If this is the case, and if the consumer that wants peanut butter knows this will happen, what then is the rational thing to do? Buy Monday while the prices are low.

Without going into much detail, think about the micro-situation we as Americans are going through with gas.

Last Monday, prices were on average around $3.07 (roughly – I could be wrong. I am going by memory). This Monday, prices are on average $3.37 (again, roughly – I could be wrong. I am going by memory.) What is a person who wants gas to do?

Buy before the price goes up. (And for anyone who is wondering, the price of gas is expected to go up again)

To look at the problem in a slightly different way, let’s say the same thing happens in the automobile industry.

What if a new sports car is $50,000 one month, and then twelve months later it is $1,000,000? What then does it mean to be a millionaire? To extend the question, what then does it mean to be a millionaire if you can only buy one sports car with all of your money?

Not much.

So when will we see this kind of behavior?

The answer: during a hyperinflation.

During hyperinflation – defined as an increase in CPI at 50 percent per month – a scenario like the one above is the norm. Since I am more learned in economics than when I first started blogging in winter 2009, I no longer believe hyperinflation is a certainty, although I do still believe that high inflation is a mathematical certainty. (For those who wonder why, read Michael Pollaro’s recent article called America, Poised for a Hyperinflation?")

So we have seen that the phenomena leading to the flight of real values not only hurts the poor, it also hurts the “rich” as well. The only way to avoid this flight—as much as you can—is to buy what you need early. And as I’ve mentioned before in other blog posts, some things you just can’t buy in advance. (Like a doctor’s visit or gas [at least in a state-approved storage unit])

For inflation to be reversed, the supply of money must be contracted (the Federal Reserve must raise the Federal Funds Rate). Unfortunately, this correction will cause a further depression which is why it is better the government doesn’t get in the business of inflating the money supply in the first place.

Also check out the videos I’ve posted on the site during the last two weeks. I’m sure there is something to pique your interest. (At least I hope so)

Timely reading
“The Mirage Of Inflation” Chapter 22, Economics in One Lesson by Henry Hazlitt

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