For example, many experts believe that inflation, which reached a peak of nearly 10% on an annual basis in the United States in 2022, is on a downward slope, and that the ebbing we should continue to observe in 2024 is excellent news for the economy. Yes, excessive inflation can be a disaster for some savers. But a total absence of inflation, or even deflation (a decrease in prices), reflects slowed consumption that can lead to an economic recession, layoffs, and ultimately have just as catastrophic consequences (skeptical readers can refer to the post<\/a> I wrote a few months ago).<\/strong><\/p>\n\n\n\n Similarly, stock markets have been flirting for a few months with their historical highs <\/strong>in a large number of developed countries, benefiting, among other factors, from the \u201crobust economy\u201d and \u201cexpected decrease in interest rates\u201d cocktail. However, central bankers tend to lower interest rates<\/a> to stimulate economic activity when inflation is low and their concerns about the health of the economy are strong, the very opposite of a \u201crobust economy\u201d! The ideal situation in which we seem to find ourselves hides, after brief analysis, a paradox.<\/strong><\/p>\n\n\n It\u2019s a bit like trying to play a game of chess without considering the next moves, both ours and the opponent\u2019s. A brilliant short-term move can turn out to be a mistake in the longer term.<\/strong> This is how, until recently, human players could beat the best chess programs: by building a diffuse threat over the long term that the computer, accustomed to anticipating only a few moves ahead, saw coming too late…<\/p>\n\n\n\n We cannot blame the authors of these shortcuts. In a few paragraphs, they must manage to convey complex ideas and make them attractive enough for the reader. Untangling the entire skein would prevent them from achieving these two goals.<\/p>\n\n\n\n In general, the capitalist system is built in such a way that so-called \u201csecond-order\u201d effects<\/a> compensate for initial effects<\/strong>. Let’s return to inflation. The excessive price increase of a good or service tends to decrease demand for that good or service, thus curbing, or even partially reversing, the initial price increase.<\/p>\n\n\n\n While many capitalist mechanisms tend to counterbalance any deviation, others, on the contrary, tend to create self-perpetuating dynamics. Often, an element of human psychology is at work in these situations. <\/strong>I am thinking in particular of speculative bubbles<\/a> that can be found in real estate, in the stock market, or, more recently, in cryptocurrencies: the price of an asset increases, generating juicy returns for existing investors, consequently attracting others, and driving the price even higher, without any link to the quality or attributes of the underlying asset… This dynamic is unfortunately not infinite (\u201ctrees don\u2019t grow to the sky,\u201d as the saying goes). When there are no longer enough new buyers or the subjective appreciation of the asset worsens, the opposite dynamic sets in: investors seek to get rid of their assets, sometimes \u201cat any cost\u201d. This is the principle of stock market crashes. Similarly, human psychology tends to reinforce movements of inflation or deflation for durable goods: if I know that the price of the computer I want, for example, will decrease by 10% next year (because newer models will be introduced), I will tend to delay its purchase as much as possible, thus decreasing demand, reinforcing the price reduction mechanism, and therefore reinforcing the appeal of waiting.<\/p>\n\n\n\n Outside the purely financial world, the business world at large tends to limit its analysis to the first order<\/strong>, without taking into account the consequences on the external environment, and the responses that this external environment would provide. From experience, I have regularly observed this when a company establishes its strategic plan, especially in niche markets characterized by a small number of players. Each company then observes its competitors with great acuity, seeks to anticipate their movements and to counter them \u2013 the chess game metaphor is particularly apt here. Imagining that one can launch a new product, make a major marketing investment, or profoundly change pricing policy (among other examples) without generating any reaction from the rest of the market is an illusory and even dangerous intellectual limitation.<\/p>\n\n\n\n![\"\"](\"https:\/\/www.theFTexplained.com\/wp-content\/uploads\/2024\/01\/Capture-decran-2024-01-08-143417.jpg\")