All goods and services (henceforth the term output will be used) are produced from “pure” resources, such as land and labor. The output derived from pure resources can be augmented through man-made resources, sometimes referred to as “produced means of production”, more commonly known as capital, but more accurately termed non-permanent resources.
It is through the growth in capital that the output produced from the pure resources has increased throughout human history and all capital growth (or more correctly per capita growth) is the result of advancing knowledge. Knowledge enables an increase in the yield produced from a given set of currently utilized pure resources, but it also allows previously valueless pure resources to yield valued output (e.g. uranium and oil). If we assume that we live in a closed system, then the amount of pure resources is fixed and thus the main constraint on output growth is the knowledge required to transform the pure resources into valued output.
Given that knowledge constraints (i.e. total knowledge increases) are relaxed over time, per capita output consistently increases. What does that imply for relatively prices? Relative prices should change with every new product that comes to market. In other words, in a non-stationary economy, prices should be in constant flux – only products where changes in the marginal rate of substitution vis-à-vis all other goods (including newly emerged products) matches the changes in the opportunity costs of producing that good will remain unchanged.
BTW, from time to time this thread will link to posts that exhibit common errors. The intent is not to embarrass anyone, but rather to use the post to illustrate constructs that are bound to lead to errors in portfolio allocation. Consider this post:
Message 21544957
The substitution method of computing inflation is one of the dumbest ideas that government bureaucrats could come up with.
To assert that the CPI should use fixed weight quantities, guarantees that price shifts due to changing opportunity costs, and relaxing knowledge constraints, will be recorded as inflation – and thus, the CPI will overstate inflation to a higher degree than it does already. Let’s assume for a moment that the CPI is understating inflation – perhaps due to government conspiracy, i.e. to mask monetary inflation. I can see two likely portfolio allocation errors that might result: an allocation towards precious metals and other hard assets (if one believes the financial structure might collapse), and taking on more debt than is prudent, i.e. thinking interest rates are artificially low.
The bulk of the evidence suggest the CPI overstates inflation. Some studies suggest an overstatement of about 1% a year, while the most conservative estimate I've seen asserts a 0.34% overstatement. As previously posted this thread will use the trend in unit labor costs as an inflation measure. |
