Over a year ago I posted on Flyertalk.com a fairly lengthy explanation of why I thought that the mileage required for most airline awards — especially premium class international awards — would go up over time.

In light of Northwest’s recent announcement that its best awards would cost 25-40% more next year, I thought it prudent to recreate the argument here … So that folks can attenuate their strategies accordingly, before more airlines follow suit (which they will).

The August 2003 issue of Inside Flyer had a cover story (subscription required) on making your miles last into retirement, essentially creating a mileage 401(k) plan. With all due respect to the folks at the magazine, this strikes me as the worst possible mileage strategy.

1. Miles are worth more now than they will be tomorrow and the day after and years from now. The value of your retirement pool can only go down and not up.
   
2. Even if mileage values held constant, I’d rather spend miles now instead of money and save the money. Money earns a rate of return when properly invested. Airlines don’t pay a return on miles held in your mileage bank.

The reason why award prices will go up, almost inevitably, is obvious with a bit of basic economics.

Nobel laureate Milton Friedman is the father of an economic school of thought known as Monetarism. Uncle Milton, as he is affectionately known, showed the world that inflation is a monetary phenomenon — increase the supply of money in the economy, and the general price level will rise.

The famous and deceptively simple formulation of this is: mv = pq

m = quantity of money

v = the speed at which money circulates in the economy

p = general price level

q = quantity of goods

Friedman argued that the speed at which money circulates is, generally speaking, constant. Folks plan over time for their spending needs. On the whole, if people get paid on Friday they don’t spend all their money on Saturday but spread the spending out until their next payday. (Obviously this isn’t universally true, but on a macro level it winds up being true.)

The upshot of this famous formulation is that when m goes up, p or q needs to go up. If the quantity of goods remains constant (q), that means that p (price) must rise and you have inflation.

I think that this simple formulation is helpful in thinking about loyalty programs.

If m = miles, v = the speed at which folks redeem awards, p = the price of awards, and q = the supply of available award seats, then…

Sometimes the speed at which awards are redeemed goes up. For instance, when loyalty program members are uncertain about the future of their points. There is a common belief that when United declared bankruptcy, there was a ‘run on awards’ — people believing that they needed to cash in now while the airline and the loyalty program was still around.

But on the whole, the fact that 8% or so of seats go to award redemption (over time and across programs) suggests that v is usually stable or that award redemption is at its production possibilities frontier (such that q will not rise).

If m — the quantity of miles or points — goes up, then one of two things has to happen:

Either the quantity of award seats have to become more available, or the price of awards has to go up. Otherwise there will be a shortage.

As unhappy as members get about award price increases, member unrest over award shortages is even less manageable — hence the David Spade commercials for Capital One (by the way, the Capital One ‘mileage cards’ are about the worst credit card decision you could make outside of earning no reward at all).

And since it’s so much easier to accumulate miles than at any time in the past — as programs sell miles to all comers, and miles have become such a popular phenomenon and useful marketing tool — the quantity of miles is ever increasing. It’s profitable to the airlines to sell miles.

As I explained, one of two things has to happen when the quantity of miles rises:

• The quantity of award seats goes up
  
• The price of awards goes up

It is true that award redemption is slightly on the rise. But the quantity of seats available for redemption hasn’t been growing, in large part because of the economic problems of the airlines which are forcing them to restrain capacity growth. Plenty of planes that were flying before 9/11 are still parked in the desert. There’s less slack in the award system. Even though the number of redemptions goes up, it’s increasingly hard to redeem. Besides, no one would claim that the pace in growth in award seats is keeping up with the pace in growth in available mileage.

Since the quantity of available seats can’t keep pace with the rate at which airlines ‘print’ mileage, award proces will go up. Mileage balances will become worth less. It’s the same thing that happens to money savings under inflation. It’s also why I don’t like the idea of stashing away miles for retirement. I’d rather use my miles now and save money, putting the money away for retirement — because I have greater faith in the Federal Reserve to control inflation than I have in the airlines to control point inflation.

I haven’t been shouting from the hilltops that you should redeem your miles due to airline bankruptcies (although full disclosure I’m down to 20,000 USAirways miles). But I do think you should redeem your miles for awards now, because awards will only become more expensive later. Miles will never be worth as much as they are now.

You should still accumulate miles. They’re an excellent value proposition. But the key to a successful return on your miles is to burn as you earn rather than build up large balances for use later.

I do have a seven figure mileage balance, but I’m also enjoying my miles. I’m spending at a rate of over half a million a year — spending miles just as fast as I bring them in the door. My net increase isn’t more than a hundred thousand a year or so these days.

This advice won’t change until we get an independent mileage currency board or appoint Alan Greenspan as head of Mileage Plus and Paul Volcker of Aadvantage.