The Real Cause Of Inflation

On the eve of the January FOMC meeting, at which Jerome Powell will likely reiterate the Fed’s determination to fight inflation in the course of preparing investors and traders for a rate hike in March, let’s extricate ourselves from the (highly specious) world of economic theory and spend a few minutes in reality.

With inflation running the highest in four decades, economists, traders and many politicians are keen to suggest the “laws” of economics finally caught up to the Fed, and also to the US government.

“Money printing” and fiscal profligacy triggered inflation, they’ll say. And inflation is poised to spiral out of control unless the Fed hikes rates and shrinks its balance sheet while the government pivots away from debt-financed “handouts” and transfer payments. Even those still clinging to some version of the “transitory” narrative are on board with the idea that tighter monetary policy is, at the least, a palliative.

It’s obvious that demand-side stimulus and easy monetary policy contributed to the current state of affairs. On the other hand, it’s equally obvious that supply chain disruptions and sundry related issues are playing havoc. All we can say with certainty is that the US economy is woefully out of balance.

The debate has thus morphed into a war of words between those who insist too much demand, triggered by monetary and fiscal largesse, is the source of the problem, and those who argue that one way or another, it’s a supply-side issue.

Spoiler alert: It’s neither. I mean, don’t get me wrong. It’s both. But ultimately, it’s a pandemic issue. That simplest of simple assessments now routinely gets short shrift, to the detriment of my (and your) sanity.

Never before have I witnessed a scenario in which almost everyone on both sides of a vociferous debate became so lost in the fog of theory that the presence of an existential, epoch-making event is summarily relegated to the backburner. It’s as if this were 1942 and the War doesn’t get a mention.

This might seem obvious, and thus scarcely worth highlighting. But apparently it isn’t anymore. Fed officials dutifully nod to the virus, but articles about inflation and on-air debates featuring policymakers, economists and politicians almost invariably characterize COVID as a kind of supporting actor. As though anyone would be having these discussions were it not for the pandemic.

America’s current bout of inflation isn’t the inevitable result of wayward policy choices made over the past several decades. Nor is it some kind of comeuppance for our refusal to abide by economic “laws” or the flouting of any divine dictates. No, it’s the result of a head-on collision between,

  1. A hyper-globalized system that’s heavily dependent on specialization and thus assumes the free movement of goods and services across borders;
  2. A US economy which, as it turns out, is intrinsically unstable, and prone to “a chain reaction of collective insolvency,” because it relies on a fragile system of cashflows predicated on the never-ending collection of “small installments of rent from a large segment of the population,” to quote Deutsche Bank’s Aleksandar Kocic; and
  3. An exogenous shock in the form of a (literal) plague that severed supply chains, closed borders and, in the US context, disrupted the system of cash flows that sustains late-stage capitalism

Solving the inflation problem isn’t as simple as hiking interest rates. Cutting people off from monthly income streams (e.g., enhanced unemployment benefits and reimagined tax incentives) won’t do the trick either. An across-the-board onshoring push may relieve some supply-side pressures in the near-term, but it’ll likely be inflationary in the long run, as it’ll drive up the cost of goods given relatively expensive US labor.

As unsatisfying as this is, inflation, as it’s currently manifesting in developed economies, is just going to have to work itself out. This isn’t a crisis of confidence in currencies. It’s the product of a once-in-a-generation shock. It’s not “solvable.”

I don’t expect the debate to change, though. The battle lines are drawn. This is the opportunity of a lifetime for economists. Finally, somebody cares what they have to say. Ironically, this is the time when what they have to say matters least.

Speak your mind

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10 thoughts on “The Real Cause Of Inflation

  1. Being in the eye of a hurricane seems like you’re not in a hurricane but there is always another side.
    The eye is a time to see the major damage. Pretending the other side is a whole different storm is a little silly.

  2. “An across-the-board onshoring push may relieve some supply-side pressures in the near-term, but it’ll likely be inflationary in the long run, as it’ll drive up the cost of goods given relatively expensive US labor.”

    Sure, but i don’t think anybody is suggesting an across-the-board push. Expanding domestic capacity in particular components (like chips, which the military would happily subsidize if congress let them) in which labor is not the primary cost wouldn’t be inflationary, and those components are currently the ones mostly driving supply constraints. Any other targeted spending that increases capacity would help sustain demand without being inflationary, too — like universal childcare, which would put more adults into the workforce.

    I mostly agree, though — ultimately this all stems from the fact that we shut down factories in 2020 and paid everyone to stay home. So, we had lots of money chasing too few goods. Now that people have mostly gone back to work, and the fiscal stim has been turned off, we have the opposite problem looming: less money, more goods. Yet here we are, with everyone arguing about how to stop inflation. It’s like turning off the tap and pulling the plug and still worrying about the tub overflowing.

    1. I concur! lower covid cases (or agreeing that we canhandle it better now) will drive supplies to increase. prices are always sticky….maybe even look for higher profits in Q2 and 3. we already seeing disinflationary data points.

  3. I’m shocked by how our views seem to align on everything from economics to Ray Dalio.

    Many people, it seems, lack the capacity or desire to grasp nuances. It’s easier to view the world through some ideological lens supplied by attention seeking talking heads on the Left or Right since they cater to our (literally) more base emotions and our need for belonging rather than our (literally) higher level capacity to reason and grasp nuances.

  4. There is a cultural variable to all this . It is hard to say anything without someone climbing down your throat over each comment. I’ll risk it once again. ! In a consumer spending fueled economy all that counts is non-essential spending which oils the “profit Machine ” with sometimes no discernible value added. Watch the “boob tube” and see what the incessant adds are selling…A dozen drugs for every potential ailment and of course the insurance of your choice. So who else can afford these adds ? Add the fact that the nightly news is everything but what should be news. So you have a public that emulates “you are what you eat so to say “. Late stage Capitalism maybe??? Great topic for a Sunday but less likely for tomorrow …

  5. A lot of what ails the world is Covid-driven. Inflation, widening wealth gap, political extremism, rising crime rates, etc.

    Our (global, national) failure to attack Covid with full and coordinated effort has had consequences far beyond the healthcare realm. The growing Covid denialism, which is spreading from right-wing loonies to the mainstream and even the BAML FMS panel, means that we will continue failing to address the root cause of many ills.

    Using a hammer to drive a screw is ineffective and damages the screw.

    The entire world could have been vaccinated by now, at a cost of about $100BN. Ongoing boosters to address variants would have cost $30-40BN/yr. Reducing global hospitalizations by some 30-fold and deaths by more than that would have done more to reduce our myriad problems than anything else the world has done or can do.

    Variant BA.1 is now emerging and out competing Omicron in some countries.

  6. a huge part of the equation is the wealth / corporate / power at all costs/ driven dumbing down of society through the degradation of education systems, combined with right wing propaganda masquerading as “news.” The results – a short attention span society who largely lacks critical thinking ability and mainly thinks in black or white terms … until progressive forces confront this more powerfully and successfully we are all in dire straits…

    PS for Americans on this site – I firmly believe Corporate interests were behind Manchin and Sinema killing the desperately needed voting rights salvation bill as democracy and fair and extensive voting is counter the corporate agenda…

  7. A pandemic is a less inflationary version of a war. Supply chains are disrupted, people die, but the physical infrastructure isn’t destroyed. Like the neutron bomb. The problems with China and Russia will cause new supply chains to grow- so the era of shocking cost reductions emanating from the east will be greatly reduced. When George Soros advocated both barrels to save us in 2008 he clearly stated it would worsen inflation and we would have to deal with that…..

  8. If you look around the world, it would be fair to say that it is a combination of stimulating demand a lot and a supply dispruption. Developeed economies that did not have near the same degree of fiscal and monetary stimulation as the US still had pretty high inflation too. But also a big factor is that consumer market baskets shifted massively because of covid- spending went from meals, entertainment, travel, office etc to more “things” durable and non-durable goods- and governement spending shifted as well. As I have been saying for a long time- when you have a shock change to the market basket of goods, not only do relative prices change, but measuring these changes and coming up with an accurate price index becomes a challlenge. It is clear that prices are going up. But as H points out, speaking about inflation in the world without mentioning Covid is downright foolish. It was like those textbooks I used to read that talked about “The War Between the States” in 5th grade without mentioning slavery. I can remember to this day, telling my 5th grade teacher that the textbooks were nonsense- it was about slavery. The textbooks were designed for a national market, so the publishers dutifully ignored historical accuracy so they could sell them in the South. At the beginning of the pandemic Dr. Osterholm of the University of Minnesota predicted 800k plus deaths in the US and that we would not be fully clear of the pandemic for 5 years from the start- so we have until fall of 2024. The guy has been right on the money. So we are about halfway there- the second half will likely be better, but we have some way to go.

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