Deflation in the Technology Industry

In today's NY Times Paul Krugman says that the core rate of inflation is 0.6% -- the lowest number ever recorded.  Those of us in technology realize that current inflation measures are inadequate because they do not measure Moore's law.  We all know that the technology of tomorrow will be better and cost less -- and that is definitely deflation.

Economists fear inflation, but they fear deflation more.  Inflation can be addressed by raising interest rates.  There is no known cure for deflation because by the time we get there, we will have flooded the market with cash and it clearly will not have worked.  In addition, deflation incents people to do things that cause more deflation -- where inflation is self correcting.  After all, if a buyer cannot afford the inflated price, less will be purchased, and if less is purchased, the price should come down.  Falling prices is the same as falling inflation -- and there is the self correction.  

The two devastating effects of deflation are the increased relative cost of debt, and the underlying incentive to put off purchases until the prices go down more.  Both of which reduce demand for products or services.  Less demand is addressed with lower prices, and lower prices only make the trend accelerate in the wrong direction.  Deflation breeds more deflation.

Some years ago we had all of the computing power we needed.  We used to buy upgraded machines because we needed more computing power.  Features and functionality, often formed into the "killer app", drove sales.  It has been a long time since a new version of office brought us productivity enhancing new features.  

Realizing that their customers had no compelling reason to buy, the makers of the technology started eating other industries.  First was advertising.  Google is a technology company, but all of its revenues come at the expense of the advertising industry.  Google offers better advertising for 1/10th the cost.  Replacing analog dollars with digital dimes is clearly deflationary.

Next the technology industry is going to eat the labor market.  With all of the computing capacity moving to centralized data centers, also known as "the cloud", companies are going to need much fewer technology people.  It is already possible to run a 50 person business without any technology people on staff.  Lowering the demand for workers is absolutely deflationary.

After that the technology industry is going to eat the energy market.  A very large percentage of the power used to run today's computers is wasted.  Not only are the power supplies to PCs over sized by design -- and therefore consuming much more power than necessary, but many PCs just sit there using the electricity for no other reason that to create heat all night long.  The centralization of computing will address this too.  The result will be less need for electricity.  Less need for electricity is deflationary.

So I don't know if all of the QE going on will lead to out of control inflation anytime soon.  I do know that the technology industry is going to be contributing to deflation for as far as I can see into the future.

My Current Thinking About Wall Street

After thinking and reading about this issue for some months now I have settled on the following set of conclusions:

•  The stakes are very high so we can expect the financial sector to continue to attract the smartest, most self assured, and most self centered people.
• Knowing that the participants are motivated almost entirely by personal gain, it is probably not fair to call them corrupt -- until they take positions in government.  Yesterday's action by the SEC vs Goldman Sachs puts an interesting twist on this one.
• The relative size of the finance and insurance industries to the rest of our economy is an important macro measure of economic health.  Finance and insurance certainly must be in the single digits, and 5% would be a good goal.

 Other Reading

Krugman in March 2009

NY Times this week about potential reforms

NY Times today about SEC vs Goldman Sachs