Cost is NOT Price, and Neither Cost, nor Price, are Value

Prices Provide a Misleading Measure of Dollar Devaluation
Forbes Magazine Online – Keith Weiner

There’s not a human being alive who doesn’t know the dollar is falling. Everyone over 25 has stories of what prices were like, way back when (and younger people have heard them). I remember when gasoline was 60 cents a gallon, and my mom remembers when it was 20 cents.

Federal Reserve Chair Janet Yellen acknowledges the official objective to push the dollar down by 2 percent per year. This intention is behind the Fed’s ill-conceived loose money policy.

It’s important to measure each drop. This is not just to keep a scorecard on the Fed, but because a change in the dollar skews historical comparisons and distorts business decisions, like giving increases to workers and pensioners….

Read the whole piece, and then come back…

The thesis statement of the piece is correct, in that prices provide a misleading indicator of currency valuation (and that our weak dollar policy, as pursued by every administration since Bush 1 to some degree or another, is fundamentally wrong and destructive for that matter).

Unfortunately the author suggests that simply using a different price denomination and comparison (to gold) is a less misleading indicator… In this, he’s absolutely incorrect.

What you really want to compare is purchasing power parity (PPP) as measured by equivalent standard of living, expressed as a dollar cost in constant dollars normalized to average labor hour wage or compensation.

i.e. this item costs 5 minutes of average labor, this costs 8 hours, this costs 20 years; the cost to maintain this equivalent normalized standard of living across an aggregate population is 1940 hours of median labor wage etc… etc…

Note, this is NOT an expression of the fallacious labor theory of value, it is an explicit measure of purchasing power parity as actual cost, INCLUDING opportunity cost (in terms of time), not currency denomination.

The critical function isn’t price, and it isn’t wage… it’s cost, in this case expressed as a cost to value ratio as a normalized dollar (to make it easy to relate to wages and prices).

Cost is not price; it’s a totalized measure of inputs including resources, time, and opportunity.

I am a cynically romantic optimistic pessimist. I am neither liberal, nor conservative. I am a (somewhat disgruntled) muscular minarchist… something like a constructive anarchist.

Basically what that means, is that I believe, all things being equal, responsible adults should be able to do whatever the hell they want to do, so long as nobody’s getting hurt, who isn’t paying extra

  • Sarah Baker

    I really like this. The only real way to measure cost is not via price in a fluctuating currency–and all currencies, including gold, fluctuate–but by asking how hard we have to work to get it. And in that respect, there are competing forces at work: innovation works to drive down that cost while debasement of the currency works to drive it up (because wages are sticky). Did I say that right??

  • Brad Warbiany

    Well said. Donald Boudreaux over at Cafe Hayek has been a strong proponent of the idea of measuring purchasing power in terms of “necessary hours worked”.

    That said, he looks at it more as justification to talk about how wonderful the increase in standard of living over the “old days” has been. I.e (for the sake of argument) a vacuum cleaner cost 20 hours of labor in 1965 but only 2.4 hours of labor in 2014. That said, this metric masks the actual effect on the money supply by including other technological change. As the Forbes writer points out, an “iPhone today is more powerful than supercomputers that used to cost millions”.

    The problem with these metrics is that only in certain cases (i.e. a gallon of milk) can you really state that the product today is functionally identical to the product 40 years ago. And even if you do, it masks certain shifts such as, for example, the prevalence of other non-dairy drinks in consumer demand and the relative supply/demand changes that occur as a result. Even things such as houses are difficult to measure because average square footage has grown significantly over time, so a house today may be considerably different value compared to a house bought 40 years ago (i.e http://www.aei-ideas.org/2014/02/todays-new-homes-are-1000-square-feet-larger-than-in-1973-and-the-living-space-per-person-has-doubled-over-last-40-years/)

    And thus, trying to normalize a standard of living is nearly impossible. We work different jobs than we did 40 years ago, we buy different (more) goods, the quality and capabilities of those goods is different, and we pay different prices for those goods than 40 years ago. It’s very hard to measure this without finding yourself down the road of “lies, damn lies and statistics.”

    In short, it’s REALLY, REALLY complicated to try to measure these things and draw direct lessons from any single metric, whether it’s “value in ounces of gold” or “value in median labor hours consumed”. I agree that the first is a terrible metric, and the second is a much better metric, but both have significant limits in their application.

  • Sarah Baker

    I would add to what you have said that: even where the analysis presents a pretty picture on its face–i.e., you can buy the vacuum cleaner for 2.4 hours of labor now when you had to spend 20 hours 50 years ago–you have to ask how low the cost would be in a free market or with access to a currency that was not constantly being debased. One hour? Ten minutes?

  • cbyrneiv

    Yes, because it accounts for true value adds, changes in quality of life standards,and increases in productivity.