My Last Post on Monetary Policy...For Now...I Hope

In all media outlets, the same topic is being discussed as nauseam: inflation. Inflation? Yes. Interest rate cuts/hikes, the depreciating dollar and relatedly oil price appreciation all speak to monetary policy, which is but one small step removed from inflation. Remember, the Fed's mandate is to strike a balance between economic output/growth and a stable price level.

What I keep coming back to is Milton Friedman's famous assertion that "inflation is always and everywhere a monetary phenomenon." For there to be a general rise in the price level, there must be either growth in the aggregate money supply (M2, M3, whatever), a spike in the velocity of money (think turnover), or both.

With me so far? Good.

Now let's suppose there's a fundamental shift in a key commodity market. Say, oil. All of the sudden, the world realizes China is on an oil bender (the data actually do not say this...yet) or some other plausible story catches the attention of market participants. As a result, the equilibrium price of oil goes up (in the spot market, let's ignore futures). Oil and its derivative products are a key input to our economy (blatantly obvious). Surely an increase in gas prices will boost inflation, right?

Well, let's go back to Milton. Inflaiton is a monetary phenomenon, the overall price level will climb only if more money is pumped into the system. This relationship is separate and distinct from relative price movements among goods/services. In other words, if oil prices go up, consumers will curtail gas purchases. If real estate prices drop, renters might decide to purchase housing assets. What I've described is a reallocation of dollars, a new way to slice the pie. But I haven't said anything about growing (or shrinking) that pie.

Inflation scares me as much as the next guy, don't get me wrong. But I belive discussions regarding the CPI (or any of the other myriad measures of inflation) would sound a lot less dire if we put the matter in its proper (ie, monetary) context. Remember, the CPI was created as a proxy to read changes in the aggregate money stock.

"Influence" Chapter 1

I've decided it'd be a worthwhile endeavor to summarize the key ideas from Robert Cialdini's Influence, a book I recently read. My motivation is twofold: (1) to improve my retention of the content and (2) to spare you, my loyal reader, the trouble of separating the wheat from Cialdini's abundant chaff.

Where possible, I'll also try to infuse the book's tenets with my own personal anecdotes, ideally in a comical fashion. Hopefully this added incentive will keep you sufficiently enticed.

We begin with chapter one, entitled "Weapons of Influence." The core idea:

[Ethologists]...have begun to identify regular, blindly mechanical patterns of action in a wide variety of species. Called fixed-action patterns, they can involve intricate sequences of behavior, such as entire courtship or mating rituals. A fundamental characteristic of these patterns is that the behaviors that compose them occur in virtually the same fashion and in the saem order every time. It is almost as if the patterns were recorded on tapes within the animals...Click and the appropriate tape is activated; whirr and out rolls the standard sequence of bahaviors. The most interesting thing about all this is the way the tapes are activated.

An animal will react to certain trigger features representing one tiny aspect of the totality for which its "tape" was originally recorded. As an example, a mother turkey can be tricked to nurture a paper predator when the doll makes the distinctive chirp of baby turkeys. Without the sound effects, the mother becomes hostile and pecks at the puppet.

Humans too are guilty of relying upon automatic, programmed responses.

In fact, automatic, stereotyped behavior is prevalent in much of human action, because in many cases it is the most efficient form of behaving, and in other cases it is simply necessary...To deal with [our complicated stimulus environmnet], we need shortcuts. We must very often use our stereotypes, our rules of thumb to classify things according to a few key features and then to respond mindlessly when one or another of these trigger features is present.

This is a recurring theme in Cialdini's book: in our brave new world, we're ever more dependent upon the heuristics and shortcuts our low level animal ancestors and cousins never outgrew. Let's call this irony.

Cialdini's beef isn't with our use of time-saving rules of thumb. Rather, he fears "they make us terribly vulnerable to anyone who [knows] how they work."

The three components shared by most of the weapons of automatic influence described in the book:

The nearly mechanical process by which the power within these weapons is activated

The consequent exploitability of this power by anyone who knows how to trigger them

The jujitsu deployment of the power -- exploiters need exert minimal effort by using leverage and have the ability to subtly manipulate without the slightest appearance of manipulation


An example: the contrast principle.

Simply put, if the second item is fairly different from the first, we will tend to see it as more different than it actually is. So if we lift a light object first and then lift a heavy object, we will estimate the second object to be heavier than if we had lifted it without first trying the light one.

From clothiers to used car salesmen, retailers wield this weapon of influence. How? By showing customers high priced items before moving onto the more likely purchase. In negotiation terms, they set a high anchor.

Anyway, I think this principle has even greater implications. If humans are so sensitive (and susceptible) to contrast, it's like our world is two dimensional; binary. Can anyone claim objectivity? A Cialdini points out, myriad studies would lead you to conclude "no." Scary stuff, this.

Stay tuned for chapter two. It'll be less dire, I promise.

Currency, Commodities Revisited

James Hamilton raises and answers an interesting question: what if we'd been on the gold standard?

If the U.S. had decided to go back on the gold standard in 2006, where would we be today?

Parts of the passage read more like speculation than thought experiment, but I was pleased to unearth this nugget:

Now, if the number of dollars you have to surrender to obtain an ounce of gold is fixed by the government's commitment to a gold standard, and the number of umbrellas, or cars, or chairs you'd be willing to surrender for an ounce of gold has gone up, the only way that can be is if the dollar price of umbrellas, cars, and chairs have all fallen. Maintaining a gold standard while the relative price of gold increases requires deflation in the dollar prices of all other goods.

Loyal readers will immediately notice the striking parallel.

Different strokes...

Graphic inflation.

Studies show men think about sex every seven seconds. My mental vice? Monetary policy.

Good Thing I'm Not Vain

While there's no way to win the non-competitive Tour de Cure diabetes fundraiser, I think most would agree being whisked away in an ambulance on mile 16 of 50 constitutes defeat.

On Sunday, after a PowerBar and banana, I ate pavement. An ambulance was coming at my cycling group, causing the rider in front me to brake unexpectedly. Drafting directly behind him, I was unable to avoid a collision. Our wheels locked and I was thrown off my bike into traffic on Highway 29. Luckily, my pops had my back and stopped the approaching big rig from finishing me off. In a bizarre twist, the ambulance, which caused the problem also availed itself as the solution. The EMTs saw the whole thing and were promptly on the scene, instructing me to hold the detached skin to my face while they drove me to the hospital.

I ended up with 19 stitches and a few fractured teeth. My bike took no real damage, though it remains covered in blood. I figure it'll go away on its own with time.

Now, you might expect me to walk away from this near-death experience with a renewed sense of "carpe diem" or perhaps awe at the fragility of life and randomness of death. Poppycock. It'd be analogous to all the recent grads who told me to "enjoy my last semester" and offered no practical advice for doing so. "Enjoy your youth" is sage wisdom I often get from folks in their fifties. Great. Fantastic. Thanks for reminding me of how quickly these years of virility pass and for subtly pointing out there's no way to slow Mother Time's advance.

I'd be a hypocrite if I implored you to "live each moment to its fullest" (or offered some other platitude). I leave you instead with a bit of levity.

Oil and the Dollar

From today's WSJ: Strong Dollar Pushes Oil Lower.

As per convention, oil is a commodity priced in dollars.

Let's suppose for a moment that the fundamental market forces, which determine oil's price (ie, supply and demand) are held constant. If the USD, oil's currency denominator, appreciates (depreciates) then by definition the dollar price of oil will decrease (increase). In effect, the relationship between oil and the dollar (again, ignoring oil's fundamentals) is an accounting identity.

This begs the question, why would the WSJ Commodities desk lead with such an asinine headline? Granted, the article does mention something about XOM reaching an agreement with striking Nigerian workers, which could be a production boon. But this subsidiary story clearly plays second fiddle to the strengthening dollar's overture.

To make an informed judgment about the price of oil, we need to quiet the "noise" introduced by the dollar donimation convention. How? One simple solution would be to offer oil's price in Euro terms alongside its price in dollars and the EUR/USD exchange rate. Suppose: (a) the dollar appreciates against the Euro; (b) the dollar also appreciates against oil; and (c) the Euro price of oil is unchanged. In this scenario, what have we learned about oil in observing its dollar price decline? The answer: nothing we couldn't have gleaned from the WSJ's Currencies column.

I'm not the first person to criticize the media's coverage of oil price movements. If you're interested, Felix Salmon has been tracking other instances of "the oil price denomination fallacy."