Why Everyone is Getting AI Economics Wrong

Artificial Intelligence, Deflation, and the Future of the Economy

Key Concepts:

• Deflation: A decrease in the general price level of goods and services, representing increased purchasing power (more output for less input).
• Inflation: An increase in the general price level of goods and services, representing decreased purchasing power.
• Creative Destruction: The process by which new innovations replace older technologies and industries, leading to economic progress but also job displacement (coined by Joseph Schumpeter).
• Fiat Currency: Currency declared by a government to be legal tender, not backed by a physical commodity like gold.
• Rehypothecation: The practice of using collateral (like deposited funds) multiple times to secure multiple loans.
• Monetary Phenomenon: The idea that inflation is fundamentally caused by an increase in the money supply.
• Universal Basic Income (UBI): A government program providing a regular, unconditional cash payment to all citizens.

I. The Core Disagreement: Utopia vs. Dystopia

The central debate surrounding Artificial Intelligence (AI) centers on its potential economic impact. One perspective envisions a utopian future of abundance, where AI-driven automation eliminates the need for work, providing universal high income and fulfilling all needs. The opposing view predicts a dystopian scenario of extreme wealth inequality, with a small elite controlling resources while the majority face joblessness and destitution. The root of this disagreement lies in a failure to recognize AI’s fundamentally deflationary nature within an inflationary economic system. The question becomes: what happens when an unstoppable deflationary force collides with an immovable inflationary wall?

II. The Historical Deflationary Force of Technology

The speaker argues that AI is not qualitatively different from any other technological innovation throughout history, all of which have been inherently deflationary. This deflation stems from the ability to achieve more output with less input.

• Fire: Allowed humans to extract more nutrients from food with the same effort, reduced illness, and lessened caloric needs for warmth – “allowed humans to get more with less.”
• Farming: Brought food sources closer to settlements, increasing abundance and freeing up labor for other pursuits. Reduced the labor cost of acquiring food.
• Industrial Revolution (Tractors, Steam Engines): Dramatically increased efficiency in food production and transportation, lowering costs and expanding access to goods. Machines replaced human labor, increasing output.
• Electricity: Made lighting and heating more accessible and abundant, reducing costs.
• Modern Electronics (Laptops, iPhones): Provide access to information and capabilities previously unavailable, even to the poorest segments of society.

Throughout history, each innovation has led to job displacement in older industries (e.g., candle makers losing jobs to electric light), a process termed “creative destruction” by Joseph Schumpeter. However, historically, these displaced workers have transitioned to new, more productive roles.

III. The Shift to Inflationary Economics (Post-1913)

Historically, prices decreased over time, particularly throughout the 1800s (excluding periods with fiat currency like the Civil War). Wages also decreased, but the cost of living fell more, increasing purchasing power and allowing savings to grow. This system incentivized skill development and saving.

This changed in 1913 with the establishment of the modern monetary system, where money is created through loans. This system operates as follows:

• Banks lend out a significant portion of deposits (e.g., 90% of a $1,000 deposit).
• This loaned money is redeposited, and the process repeats, creating a multiplier effect.
• The total amount of “money” in the system far exceeds the actual physical currency.
• This system is inherently unstable, as the total amount of money isn’t actually there if everyone demanded it simultaneously, leading to potential bank runs.

The Federal Reserve was created to prevent deflationary collapses like the Great Depression, which resulted from the unwinding of easy credit. The Fed now actively targets a 2-3% inflation rate to avoid deflation, as deflation requires constant repayment of loans with interest, necessitating continuous money creation.

IV. AI as a New Deflationary Force & Potential Outcomes

AI represents a powerful new deflationary force, mirroring the historical trend of technology reducing the cost of wealth creation. However, this force is colliding with an economy built on inflation. Historically, deflation always wins in the long run, though the process can take decades or centuries.

The speaker outlines several potential scenarios:

• AI-Driven Growth with Managed Inflation: The government might attempt to “thread the needle” by inflating the money supply just enough to offset the deflationary pressures of AI, similar to how the money supply was managed after the introduction of the internet. This could lead to continued, albeit moderate, wealth inequality.
• Accelerated Dollar Decline: If the government attempts to offset deflation with UBI or stimulus checks, it could accelerate the decline of the dollar’s value, as these measures don’t address the underlying deflationary forces.
• Preparing for Both Scenarios: The most prudent approach is to prepare for both inflation and deflation by:
  • Investing in assets that will increase in real purchasing power regardless of economic conditions.
  • Continuously developing skills to increase income faster than the rate of inflation.
  • Prioritizing income generation over consumption and investing the difference.

V. Notable Quotes

• “Growth and deflation in reality are two words describing the exact same thing: More output, less input.”
• “You cannot get more for less unless you do away with the thing that was causing you to get less for more.” (referencing creative destruction)
• “Every dollar in circulation…came into existence through a loan.”

Conclusion:

The speaker argues that understanding the interplay between AI’s deflationary nature and the current inflationary monetary system is crucial for navigating the future economy. While the exact outcome remains uncertain, preparing for both inflationary and deflationary scenarios through continuous skill development, responsible financial management, and strategic asset allocation is the most effective approach to thrive in a rapidly changing world. The key takeaway is that long-term economic progress is driven by getting more for less, and AI is poised to accelerate this trend, despite the challenges posed by the existing financial system.