Fractured Myths

Readers often ask if I really believe there’s no threshold for so-called “money printing” in advanced economies.

As a quick aside, this is one case when you can take “readers often ask” literally. Sometimes when I say “often” as it relates to reader inquiries I just mean a handful of people over the course of, say, a few months. When it comes to the current policy conjuncture (i.e., the overt, barely-veiled enabling of fiscal outlays by monetary policy) and the read-through for inflation, I get an email once every couple of days. On this point, at least, a fairly large number of people seem to genuinely care what I have to say.

The answer to the question (Is there a threshold beyond which an advanced economy, with a high level of monetary sovereignty, will create inflation by printing money?) is obviously “yes.” I just don’t generally agree with how most people conceptualize of that threshold.

I think I captured my view best on Monday, in “Suffering Fools: The Blank Check Rant Continued,” when I spoke about “real world inflation directly associated with identifiable shortages created by straightforward mismatches between supply and demand.” Crucially, I wrote that “we can create that kind of mismatch across the entire economy overnight if we inexplicably decided, for example, to send everyone $15 million in the mail.”

People often use that as a straw man argument when railing against Progressive fiscal policies. Obviously, we could engineer hyperinflation if we went totally crazy one day and decided to make everybody a multi-millionaire. If everyone is rich, then nobody is rich. And, very quickly, everyone is poor.

But that’s something different than creating money to finance, say, infrastructure spending. Or green initiatives. Or to pay for two years of community college for anyone who wants to learn a skill.

It’s certainly true that green-lighting (I don’t know) $50 trillion to rebuild every road and bridge in the country from scratch, would invariably lead to shortages for certain materials, but that’s not the same as what would happen if you armed a couple of hundred million spendthrift Americans with $15 million each. If we did the latter, the result would be an economy-wide melee, culminating in a total disaster, likely by lunchtime. That’s “too much money chasing too few goods.” You hear that phrase a lot these days. But if you conducted an online poll of Americans and asked them to identify the biggest problem they currently face, how many of them do you reckon would check the box next to “Other” and write in: “I have too much money”?

You laugh. Because it’s funny. I’m not sure if this has occurred to all of the people who insist on pushing a traditional narrative about inflation while lambasting the Progressive policy agenda, but Americans are broke. It’s not just that they don’t have “too much” money. They don’t have any money at all. There’s too much money chasing financial assets, that’s for sure. And yes, stimulus checks can create fleeting conjunctures where people who couldn’t otherwise afford a new living room set go out and buy one. But America is quite possibly the poorest “rich” nation in the world. To let some commentators tell it, you can’t even turn around in Joe Biden’s America without running into somebody who’s just now rich. As if, thanks to Democrats, the entire country is living in a rap video — just driving down the street in a Rolls Wraith throwing hundred dollar bills out the open suicide doors.

Now that I’ve constructed my own set of straw men, let me drop the jokes and get to the point. All money is inherently worthless. It’s a confidence game. I’ve said it over and over again: I believe in the dollar because I know you believe in it, and you believe in it because you know I believe in it, and we both believe in it because we know our neighbors believe in it. Once that confidence network is sufficiently large, it becomes pointless to disagree. You don’t have to believe in the dollar, but participating in the economy sure is easier if you pretend.

Things go awry when the number of doubters reaches some critical mass that renders the myth useless as an ordering concept. This is a continuum, not some line in the sand. On one end is the US dollar and on the other the Venezuelan bolívar. In the middle are any number of currencies whose fortunes wax and wane with locals’ confidence in the coin of the land. In Turkey, for example, there are periods of acute dollarization and then there are periods where demand for hard currencies abates. And so on.

This is why inflation expectations are so important. Up to some ridiculous threshold (like the $15 million example described above), the psychological element is far more important than any ratios comparing a monetary aggregate to some measure of economic output (e.g., the figure below).

With apologies to all the analysts out there, no regular people care what the ratio of M2 growth to GDP growth is. We’re talking about a nation which, not five years ago, elected a president who once suggested that GDP (the aggregate, not the growth rate) could be negative. Those are the voters we suppose are sitting around, clicking the refresh button on FRED? Give me a break.

What matters is the possibility that inflation expectations among everyday people become unmoored, because that could be indicative of hairline fractures in the myth. For example, the latest vintage of The New York Fed’s consumer expectations survey (released this week) showed median one-year-ahead inflation expectations unchanged at 4.8% in July, while expectations at the three-year horizon rose to 3.7% (figure below). Both figures are extremely elevated.

That’s not a disaster in the emerging market sense, but it’s not exactly “good” either. Assuming you believe a (very) moderate level of inflation is healthy in advanced economies, medium-term expectations near 4% isn’t generally consistent with the word “healthy.” Too much higher than that and we’d be in “unhealthy” territory.

More disconcerting (and this is a recurring theme in these pages) is the demographic breakdown or, “K-shaped inflation” (figure below).

With the exception of the least educated (whose near-term inflation outlook hit a high of 5.7% in June, but fell sharply in July), year-ahead expectations for those without a four-year degree and those making under $100,000 per year are now 5% or higher.

By contrast, near-term expectations for those with at least a bachelor’s degree and/or with six-figure incomes, are both around 4%. Three-year expectations for college graduates and for those making $101,000 or more are around 3%.

You can slice the data anyway you like. And that’s not just a figure of speech. The New York Fed survey is great. The data is easy to parse and you can drop it straight into Excel.

I mention that in passing as a kind of disclaimer: I’m sure you can paint pretty much any picture you want to paint if you set about cherry-picking the numbers. My cursory analysis of this particular dataset typically just involves refreshing the charts shown above.

So, my point isn’t to say this is definitive evidence of “cracks” in the foundation. Rather, it’s just to highlight the importance of paying close attention to what lower-income and middle-class Americans expect as far as price outcomes. Because that’s the majority of consumers. And it’s their faith in the myth that, in the final analysis, determines whether an inflationary mindset does, in fact, set in. Not some ratio that “real” people don’t care about.

Coming full circle, I doubt I’ve answered readers’ questions about what I believe and what I don’t believe. About inflation or anything else.