AI and Inflation — the two opposing forces

Men economise to increase the quantity and enhance the quality of scarce human time. For this reason, when faced with the same product at two different prices, we generally opt for the less expensive one. Since producers compete for market revenue share, over a long enough timeframe, businesses that can offer lower prices will oust those that fail to do so. All in all, this means that prices fall to the marginal cost of production. In other words, entrepreneurs who figure out ways to reduce the cost of producing goods can sell more of their produce than those who are not invested enough in figuring out cost-reduction methods. Therefore, producers are incentivised to discover ever more efficient ways to increase productivity. An increase in productivity translates to lower production costs, which leads to a competitive advantage for increased market share, achievable by offering products at lower prices, thereby lowering prices for consumers.

This brief economic analysis provides an important insight: deflation is the natural state of the economy. Under normal economic conditions, without monopolies or coercion, we all benefit from increases in productivity in the form of virtuous cycles of ever-lower prices and constantly decreasing costs of living, accompanied by an increase in the quality of life. From this perspective, it becomes clear why AI can be a force for good in the world. Fundamentally, AI is just a wave in technology, a process that began thousands of years ago when humans began hunting with spears and fishing with rods, significantly boosting productivity. Technology is a prime deflationary force, allowing us to produce more goods of better quality at a fraction of the cost relative to making the same goods “with our bare hands.”

So why are my eggs getting more expensive despite their increased availability, which should logically lead to them becoming less expensive? Why is almost everything getting more expensive? Why are wages not keeping up with higher prices, especially for relatively scarce but crucial utility goods, such as housing? The answer can be summarised in a few words: monopoly over money via central banking and government coercion.

The above analysis has an important assumption that currently does not hold true. It assumes that the common denominator with which we price goods, i.e., money, is constant. When the quantity of money is unchanging, indeed, everything we price it with becomes cheaper. Why? Because as productivity increases, so does the real abundance driven by ever-lower costs of production, as explained above. Logically, since money is constant, it becomes scarcer relative to the increasingly abundant goods themselves, meaning its price (i.e., the price of money) increases, making it more valuable over time. Another perspective is that a person has to bid up more of the abundant goods to get the same “share” of the “money pot” compared to less abundant goods and in competition with other people who are trying to secure scarce money. This means that the money people save buys them more as time and productivity increase, allowing them to give up less of it for the same amount of desired goods.

An illustrative thought experiment will help us understand the point I am making, as well as its reverse. Imagine an island with ten individuals, each owning one stone that they use as money, and assume that none has the ability to make any more of these stones. Suppose the island also has ten eggs. On average, this means there is one egg per stone. What would happen if productivity is increased, and we have twenty eggs? Then we have two eggs per stone, or half a stone per egg: the same amount of money will buy us more eggs due to the increase in productivity!

Contrast it with the opposite situation. Instead of having ten stones and ten eggs, we now have twenty stones and ten eggs. In this situation, there are, on average, two stones per single egg: a 100% egg inflation, as individuals must pay twice as much relative to the situation where the quantity of money is constant at ten stones.

Contrary to mainstream belief, Western civilisation does not enjoy a 100% free and capitalist market. Yes, we do not have a Soviet-style centrally planned economy with no possibility of private property (i.e., 0% capitalism), but I believe we are probably below 50% capitalism, somewhere near the 45% mark. This will be the case as long as central banks (and central bank-licensed commercial banks) and governments all over the world have the ability to expand the money supply, resulting in the extraction of productivity gains from technology to pass them to bankers (a.k.a. the UK chancellor being on the brink of the next bailout), government bureaucrats (a.k.a. people who are rent-seeking on the population and fail to provide value to society through their labour), and owners of scarce assets (a.k.a. the Donald Trumps of the world seeing the price of their properties increase despite being of the same size and quality), increasing the gap between haves and have-nots.

AI and inflation are on the battleground now. AI’s exponentially deflationary force should translate to greater affordability for us all, but it is “fought” by monetary expansionism, making many around the world increasingly desperate. In my first mini-essay, I argued that the notion that AI will make human labour redundant is nonsensical; however, as a word of caution, if the rate of monetary expansion is greater than the rate of AI-driven productivity gains, people will not have enough time to find jobs in new lines of production after their previous lines have become automated by AI. Normally, under a constant money standard, because people’s savings can go “a long way,” there should be plenty of time for the peaceful transition of human work into new avenues. Economic production and its enhancement do take some time, and if workers are being “priced out” due to AI and, at the same time, the fruits of their work are eroded by inflation, it leaves no time for appropriate work change.

Monetary expansion is creating animosity between man and machine.