“Supply-side inflation” is a term of deep ignorance

I was asked about the nature of inflation at the present time which apparently is being described as “supply-side driven”. Somehow it is the supply-side of the economy that is driving inflation. I suppose this is some kind of deep-state effort to subvert supply-side economics. This is what I replied.

  1. Inflation is a product of an excess in the rate of growth in the medium of exchange (all forms of domestic purchasing power) relative to the rate of growth in the goods and services available for purchase. This is neither supply side nor demand side since, as in most things in an economy, it is both sides. Or more precisely, it is everything all at once.
  2. I might add here that as a classical economist myself, inflation does not refer to movements in the price level but to government spending over and above the level of production. Since that was exactly the recipe for a Keynesian stimulus, they changed the definition of inflation in the 1930s merely to refer to an increase in the price level, and so that is what I will use as my definition here.
  3. They are trying to argue that the price level is rising because of supply constraints due to the inability of ships to land or for the goods and services to show up in retail outlets because of supply-chain deficiencies, and that it is therefore nothing to do with government policy in any narrow sense. They are therefore asking everyone to believe that when the various supply-side constraints end, that everything will go back to normal so that the price level will fall back to where it had previously been.
  4. The CPI everywhere has been distorted to suppress the evidence of price movements. The housing component in every index underestimates the contribution of  the rising cost of accommodation, which has been part of the reason that consumer prices have stayed relatively calm while housing prices have gone berserk. The reality is that there has been a fall in the ability of individuals on average incomes to buy as much as they used to, also in part because they are not permitted to because of covid. The level of demand across most economies has been flattened if not actually fallen.
  5. The question probably of most interest is what will the Federal Reserve do about interest rates? The whole thing is a mess and they have made it clear that rates will have to rise. Will they? Will they be allowed to? Will there be an almost instantaneous collapse in confidence and expenditure if they do?
  6. The Fed has allowed so much rate complacency to enter the market that my guess [a complete guess] is that the moment rates go up, business plans will go on hold all across the world. Because once rates start going up, it is impossible to know when they will have reached their highest level. The Democrats are in The White House and there is a Congressional election in November in the US. Will the Fed be willing to see the Dems routed even more than they are about to be at the coming election? They may have no choice, but in my view, if they can they will put it off as long as possible and then let the coming Republican Congress take the blame.
  7. It is all a mess. As for the term “supply-led-inflation”, it is economically meaningless. We are living in Zombie economies where it is hard to see things working out without quite a reversal before they can go forward again. The US is cushioned by hosting the world’s reserve currency, but it is only partially protected.
  8. Meanwhile, as my one further conjecture is this, that the one place purchasing power can be removed from the community with the least political pain [not no pain, but the least] is from those of us on retirement incomes. If I have to guess, and it is a guess, that it is from those of us on fixed incomes whose incomes they will try to steal from to cover the insane deficits found everywhere. But the deficits cannot disappear without a large rise in the price level.

“The best way to destroy the capitalist system is to debauch the currency”

Can you guess who said that?

Something that I have focused on in my Classical Economic Theory and the Modern Economy, but which is an otherwise unknown consequence of the Keynesian Revolution, was the shift in emphasis from the real side of the economy to the monetary side. If one is to understand the operation of an economy it is essential firstly to look at the actual real level of activity and only then look at the monetary side that lies above it and largely outside of it. Every classical economist understood the point. Virtually no modern economist does, and certainly no one without a serious study of economics ever does, which really does mean that near enough no one at all any longer understands this even slightly. Which leads me to this: Pandemic moves Modern Monetary Theory from the fringes to actual US policy.

[Modern Monetary Theory (MMT)] has received increased publicity over the past three years as politicians realized there was not a plausible plan to raise the funds necessary to fund “Healthcare for All,” the “Green New Deal,” free college and other initiatives through taxes alone.

The core principle of MMT is that sovereign governments with sovereign currencies can “print” or “coin” money to support full employment or essentially any government program that would benefit society in the here and now. Critics have labeled it the “Magic Money Tree Theory.” Those detractors include Keynesian and Monetarist economists, who cite Hungary in the 1840′s, Brazil in the 80′s, Mexico in the 90′s as examples of where easy money policies led to hyperinflation.

Warren Mosler was one of the founders of MMT, and what is known as `Mosler’s law’ states: “No financial crisis is so deep that a sufficiently large increase in public spending cannot deal with it.” These words fundamentally represent the actions our policy makers have taken in response to the virus. This pandemic has moved MMT from the fringes to the dead center as the actual monetary policy of the United States.

These are people with PhDs in economics who will comprehensively ruin us, and on this let me quote Keynes with absolute approval:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth….

As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

It was Lenin who said it, but quoted by Keynes as a warning to us all. Are you that one in a million who sees the point? Well if you are, there are then the other 999,999 who do not, which includes every single political leader heading every single government across the Western world today, each one of whom is engaging “all the hidden forces of economic law on the side of destruction”.

The trick to picking winners is not to pick losers – how easy is that!

It is a big part of what I try to teach – that the future is unknown and all decisions are made before the consequences of those decisions can be known. So people take inferences wherever they can, and in this case the inference is that McDonald’s tells us why the market will collapse. It seems to tell us more than just what is happening to the market:

We had, essentially, very poor sales from McDonald’s. Now, McDonald’s is a very good indicator of the global economy. If McDonald’s doesn’t increase its sales, it tells you that the monetary policies have largely failed in the sense that prices are going up more than disposable income, and so people have less purchasing power.”

Faber has long argued that the policies of the Federal Reserve and other central banks simply increase asset prices and create inflation rather than actually stimulating the economy. But while the long-predicted inflation has not come to pass, Faber says that the McDonald’s results reflect the fact that inflation is rising faster than income, reducing the amount that individuals can spend.

Who can be in any doubt that the cost of living is rising around us? But whatever else, very few of us are able to maintain our living standards, with plenty of shifts in expenditure patterns to accommodate the harder going. I was reading The Senior the other day and its front page was on “Living in ‘energy poverty'” with the subhead, “Disconnections up: more seeking hardship plans”. The example given was of a 77-year old woman who received a $1500 gas bill. Not that long ago such a notion would have been impossible. Now we are all being careful of this and so many other things.

Our living standards are being chiselled at in countless ways, only some of which show up as a rise in the price level. It’s not just monetary policies that are failing but the entire range of policies which divert resources away from value adding production and into the usual low-productivity nonsense aimed at by governments. The wonderfully whimsical headline in this morning’s AFR captured it all:

Abbott to pick winners not losers

No doubt this will appeal to everyone, a political winner. One can only hope that those who are promoting the policy understand it can never do anything but waste money so will be very restrained in following up on this:

Federal cabinet has approved a “competitiveness agenda” that will lead to government support for parts of the economy where Australia is strongest and require greater collaboration between businesses, schools, universities and training colleges.

Mercantilists all.

Modern economics is such junk

I was once again reminded about the multitudinous things that are wrong with economics today by two stories this morning. The first: Fed: US consumers have decided to ‘hoard money’. And then there was this: Cramped seats and angry passengers lead to diverted flights. Let me start with the first.

“Hoarding money” amongst all of the Keynesian idiocies is the most idiotic. Q: Why are people not spending? A: Because they are hoarding money. Q: What does it mean to “hoard money”? A: People are literally hanging onto cash rather than spend. And literally means literally. It means keeping money on hand and not even putting it into a bank.

It was idiocy in the 1930s when Keynes said it even though bank failures were not uncommon in the US. It has been a stupidity ever since as a cause of anything, and so far as I know, most textbooks tend to overlook this notion because it is so stupid. But not the Federal Reserve of St Louis:

One of the great mysteries of the post-financial crisis world is why the U.S. has lacked inflation despite all the money being pumped into the economy.

The St. Louis Federal Reserve thinks it has the answer: A paper the central bank branch published this week blames the low level of money movement in large part on consumers and their “willingness to hoard money.” The paper also cites the Fed’s own policies as a reason for consumers’ unwillingness to spend. . . .

“Why did the monetary base increase not cause a proportionate increase in either the general price level or (gross domestic product)?” economist Yi Wen and associate Maria A. Arias asked in the St. Louis Fed paper. “The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money.”

These people are clueless about what’s going on, absolutely clueless. The lack of real income is crushing the American economy as the ersatz version driven by government spending has replaced the real kinds of income that are based on value adding production.

So what’s this got to do with the cramped seating on planes? Inflation means that what a unit of currency will buy diminishes. The same things cost more money, or the same amount of money will buy you fewer things. If you think of an airplane seat as a specific amount of room on an aircraft as you go from place to place, the inflation is coming in the form of less legroom and reduced space. On a cost per inch basis, prices have rocketed, but the CPI will never pick such things up.

The other way that the suppressed inflation is affecting things is in the way out capital structure is being run down. Again invisible using the national accounts or the CPI, but if you have travelled on an airplane in the US, just to give you one example, you can see just how decrepit the stock of capital in the US is becoming. The US, along with the rest of us, are finding our living standards declining because we are drawing down rather than building up.

Economic theory is such junk! But on a brighter note, the 2nd ed of my Free Market Economics will be released at the end of the month.

Depression economics

If you want further reason to be depressed about our economic future, this article Janet Yellen and the Phillips Curve will supply it. If you believe this thing called the Phillips Curve relationship works, then you believe that higher inflation can bring faster growth and lower unemployment along with it. It is exactly this that Janet Yellen apparently believes. This is a direct quote:

“Each percentage point reduction in inflation costs on the order of 4.4 percent of gross domestic product, which is about $300 billion, and entails about 2.2 percentage-point-years of unemployment in excess of the natural rate.”

That is, reducing inflation slows growth and raises unemployment. If you want growth, inflation is therefore the way to go.

Yellen believes that the central bank should maintain enough inflation to prop up business activity, because ‘uncertainty about sales impedes business planning and could harm capital formation just as much as uncertainty about inflation can create uncertainty about relative prices and harm business planning.’ This approach extends the Fed’s mission beyond even the dual mandate of Humphrey-Hawkins and into the sphere of American corporate activity, a place that the business economist Greenspan was reluctant to go. Yellen, a disciple of predictive modeling, dismisses the notion that the Fed could go too far. To her the record shows that ‘tuning works even if it is not “fine.”‘

Here’s the article’s conclusion:

It isn’t just the 1970s, but the last few years, that show how money creation does not produce permanent employment gains. This was raised time and time again at Yellen’s recent Senate Banking Committee hearing, when several Democrats bemoaned the absence of any ‘trickle down’ effect from quantitative easing. Do we want the Fed to double-down on that folly with Janet Yellen at the helm?

This is not going to end well.