More and more people looking for more and more headlines or more and more air time are warning me, more and more, about inflation. They either lack basic knowledge of what kicks off or sustains inflation or don’t care, like a bad preacher trying to give his or her flock lessons based on the Bible without a fundamental grasp of the Bible.
There are several things that have to happen to kick off and sustain inflation, the primary equation being too much money chasing too few goods. There are derivatives of this simple equation: cost-push inflation where there is a monopoly over a vital good or service, such as oil - and the cost to everyone rises and becomes embedded in other goods and services, pushing up their cost and igniting generalized inflation. But at the end of the day, it was too much money willing to buy oil given the limited supply of oil in the world, so you end up at the beginning -- too much money chasing too few goods.
In modern parlance, and to make a point, let’s split inflation into two categories – asset inflation and goods inflation. Asset inflation is when too much money is invested in assets – equities, bonds, real estate, commodities – pushing the price up. Goods inflation is when consumers and businesses have too much money to spend on a basket of goods and services typically available in the economy.
You still with me? I can already see some blow dried pundits leaving for more make up or coffee.
Today, the doomsayers are screaming the Fed and Uncle Sam, together, are creating way too much money through expansion of the Fed balance sheet and the running of large deficits. This excess supply of money, they argue, must eventually find a home in the economy and drive up assets and goods prices. Why? Well, classical economic theory as refined by Milton Friedman and partners Rose Friedman and Anna Jacobson Schwartz says so, and they won the Nobel Prize, so they must be right. That is true, but the pundits really have not read Friedman, let alone Adam Smith, the intellectual father of modern capitalism. And they should for they are missing some basics.
• The supply of money is a combination of the amount of money available to circulate and how fast it circulates. Despite all the Fed has done, and printed, so to speak, it can easily be argued the money supply has been stagnant or contracted as the banks have taken a trillion dollars or so printed by the Fed and parked it back in the Fed. Recent Fed plans to slowly ease off liquidity measures and restrain this trillion from hitting the economy too fast indicate they read Friedman.
• Friedman did not completely take into account credit as a component of the money supply – actually no one does – as it relates to inflation. Logically, available credit is part of the mix chasing goods and services. And consumer and small business credit is shrinking at the fastest rate since data has been collected.
• Bottom line – the more logical argument to be made using real world data, and not read or unread economic theory – is the Fed needs to increase, not decrease, liquidity measures. Simply put, available monies continue to shrink in the real world.
• On the goods and services side, there is no inflation outside of that stemming from commodity and oil prices, and these are minimal. And there is none as far as the eye can see. There is excess capacity to make virtually everything – probably half of the world’s car making capacity and one third of its other manufacturing capacity lies idle. Due to near unspeakable foolishness by western powers, China was admitted to the WTO without provision for their creation of enormous capacity to make many things, an excess that is growing and destabilizing the manufacturing component of many national economies.
• On the asset side, inflation occurs when available monies are leveraged with excess credit – and there isn’t any of that going on in the developed world, although asset inflation is a gigantic problem in China and some emerging nations. The bigger problem is asset deflation, which impacts the perception, and the reality, of wealth, restricting spending and growth. Again, the logical argument is on the side of more inflation to counter the staggering loss of wealth due to the collapse in real estate and equity prices in developed nations in the past three years.
The bottom line, logically, is that the Fed should be increasing liquidity measures, not reducing them.
What about the dollar? The doomsayers have a tough time when I meet up with them at trade shows and seminars. They then run to that part of the discussion most current, the US dollar. They yell and scream that our borrowing and printing of money debases the currency and that leads to inflation also. Not true – only if we debase our currency faster than other nations, and we are not. The Europeans and Japanese – the euro, the pound and the yen – are far wobblier and subject to the behavior of governments far more in debt and with structural economic issues leading to permanent deficits than the US. So, if we debase our currency, but the euro, the pound and the yen are debased faster, our currency will rise.
Why? Currencies in and of themselves – like gold – have no inherent value. Their value is relative; what is the value of the greenback relative to the other currencies of the world. I have written about this earlier and the answer is the same – for economic, financial, political, military and cultural reasons, the dollar is the place to be. Our pension obligations are silly, those of other nations’ are ridiculous bordering on dangerous; our debt is high and less than half that per capita of Japan; and so on.
Does this mean the US can print money and borrow heavily in the coming years without paying a penalty? Yes and no. The “yes” depends on the fiscal rectitude of other nations, and it will not be there. Not even the Germans will risk social unrest to protect the euro. The thought of the French or Italians or Spanish seriously reducing runaway special spending is amusing at best. They will borrow and borrow some more in the coming years to promote peace and quiet among voters. The “no” is much more important and is about debt service. Debt service is going to hit the US and other national budgets hard, especially once rates rise, and this will be the brake – not fear of inflation or currency devaluation – on spending and borrowing.
Again, the logical argument is to print money to pay these fiscal obligations – debts – and if high but manageable inflation occurs (5%-7% or so), so be it. Inflation shrinks debt obligations and pushes asset values, two things we want to see.
Funny, I began to write this to argue there is no real inflation in the real world – and now I think we need more.
