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Musings Report 2020-20 5-16-20 Why High Inflation Is Baked In
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Why High Inflation Is Baked In
Money is usually understood as 1) a store of value and 2) a means of exchange. But these traditional descriptions obscure its primary role: money is a claim on real-world resources and assets.
Let's explore this idea of "money as claims on real world resources" by using a very simple economic model of loaves of bread--a real-world resource--and money.
In an idealized economy, if five loaves of bread are produced, there are 5 units of money that are each a claim on a loaf of bread, meaning that each unit of money can buy a loaf of bread.
To keep things simple, let's say a loaf of bread costs $1, and each unit of money is $1.
Throughout time, a rough balance between the supply of money and the supply of goods/resources was needed to maintain commerce. If there were too few goods, or too little money, then commerce was limited.
In ancient economies, the supply of gold and silver coins--money--was limited, and so paper money was created in China for small local-economy purchases, and in the Arab and Medieval European economies, bills of exchange acted as a medium of exchange, much like paper money except that the bill of exchange "expired" once the trade between buyer and seller was completed.
(This is a simplification of a complex system, but it's enough for the purposes of this discussion.)
In other words, when there wasn't enough money to grease exchanges between buyers and sellers, human ingenuity found ways to expand the supply of money to match the expansion of goods available for sale/trade.
So if there are five loaves of bread for sale, but only $1 of money, then there is only one claim on one of the loaves. The other four can't be traded due to a lack of money. (They can of course be bartered, but money was created to simplify barter by establishing a means of exchange everyone could use.)
The solution is to create an additional $4 of money, by either mining more silver, issuing copper coins, printing paper money, or creating a system of credit (bills of exchange).
What happens when the money supply expands far beyond what goods are available to exchange in the real world? In other words, what happens when 10 $1 claims are created but there's still only five loaves of bread?
In our example, the first five dollars are traded for loaves of bread, and then there's nothing left for the remaining five dollars to buy. They are worthless.
Alternatively, there is a bidding process for the five loaves of bread. Each dollar is a claim on a $1 loaf of bread, but since there aren't enough loaves to satisfy all 10 claims, then the value of the claim must adjust downward: due to the surplus supply of money in relation to what's available to buy, each dollar is now only a claim on half a loaf of bread.
This is devastating to everyone who can't create new money or get access to the newly created money. Where $1 once bought a loaf of bread, now it only buys half a loaf.
It's much easier to create new claims on bread than it is to produce more loaves of bread. Thus there is an irresistible temptation for those who can create new money to create extra claims on the bread and buy it all up with the new money before the other holders of money catch on to the oversupply of money.
But eventually the imbalance between the supply of money and bread is rebalanced by reducing money's claim on loaves of bread. We call this inflation.
If enough surplus money is created, then eventually $1 is only a claim on one slice of bread.
This holds true even if the new money is silver coins. When the Spanish plundered the gold and silver of the new world, this vast influx of new money caused inflation in Europe, as the supply of goods for sale did not increase as fast as the supply of new money.
If ten new $1 silver coins are minted and there's only five loaves of bread, the value of the new silver coins falls--and this is the important point--when measured in loaves of bread.
In our era, trillions of units of money have been created out of thin air, and the net result is assets have skyrocketed as it now takes far more money to buy what's limited in the real world: houses, land, etc. in desirable locales.
Since only a trickle of these trillions reached the bottom 95% of households, inflation in real-world goods has been (as officially measured) muted: as the world produced more goods and resources, the imbalance between the supply of money in the hands of the bottom 95% and the supply of real-world goods they could buy with their money was more than enough to cause significant inflation in services such as healthcare, higher education, rent and childcare, but costs have not risen rapidly enough to alarm the public (i.e. the boiled frog syndrome).
Secondarily, people have no choice but to accept inflation in essentials such as food and shelter; one cannot go without food or shelter, and so we're forced to swallow the declining purchasing power of our earnings: we need shelter and food and have to do whatever it takes to buy them.
Now that globalization and financialization have reached extremes and imploded, it's becoming more difficult to produce loaves of bread (real-world goods and services) while at the same time, claims on those real-world goods (new money) are exploding as central banks create trillions out of thin air. Shortages due to the collapse of supply chains will only exacerbate this dynamic.
The supply of real-world goods is shrinking while the supply of claims on those goods--money--are exploding. The value of each claim will have to fall drastically to rebalance the widening imbalance generated by the explosion of new money.
The more trillions that are created out of thin air while production stagnates, the greater the eventual inflation. Thus high inflation is already baked in (pun intended). We know this, but we don't know the extent or the timing; that depends on each currency and conditions in each nation and region.
It's very tempting to indulge in magical thinking about this very simple supply-demand dynamic. So it's not surprising that people willingly accept the notion that "governments can't go broke because they can print as much money as they want."
While this is true in terms of money, this is not the same as claiming governments can print as much oil, bread, etc. as they want. A central bank can print or borrow $1 trillion into existence, but those are just claims on the oil and bread that are currently available.
We all want a free lunch, and creating money out of thin air is the ultimate free lunch. But once we accept that money is only a claim on resources, then we understand that printing more of it does nothing but decrease the amount of real-world goods that all money--existing and newly issued-- can buy. Arguments claiming otherwise are sophistry.
Highlights of the Blog
Globalization and Financialization Are Dead, and so Is Everything That Depended on Them 5/15/20
The Collapse of Main Street and Local Tax Revenues Cannot Be Reversed 5/14/20
What the Pandemic Revealed: a Morally Bankrupt Culture 5/13/20
The Way of the Tao Is Reversal 5/12/20
The Fed Is Fueling a Revolt That It Cannot Control 5/11/20
AxisOfEasy Salon #4: What comes after the failure of Neo-Liberalism? (57:51) podcast
Best Thing That Happened To Me This Week
My 89-year old Mom-in-law went out yesterday for the first time in two months and we felt she was safe due to zero new cases of the virus on the island.That won't last, of course, but it's a nice respite.
From Left Field
Efficiency Is Biting Back: Decades of streamlining everything made the U.S. more vulnerable.
How many jobs do robots really replace? (via Tom D.)
Why Liberal Californians Don’t Want to Go Back to Normal
The Coronavirus Is Rewriting Our Imaginations
It is time to take seriously the link between Vitamin D deficiency and more serious Covid-19 symptoms
How Machiavelli was misunderstood
We are living through the first economic crisis of the Anthropocene'
Review: 'Planet of the Humans' documentary
Beginning with the End (via GFB)--The persistent appeal of false apocalypse is a problem
The Small-Business Die-Off Is Here
The Bailout Miscalculation That Could Crash the Economy (via David G.)
Life in the Time of Cholera: Lessons on a Pandemic (via GFB)
A Deep Dive into How and Why the Beatles Really Broke Up
68 Bits of Unsolicited Advice (Kevin Kelly, co-founder of Wired magazine)
"Following your bliss is a recipe for paralysis if you don’t know what you are passionate about. A better motto for most youth is 'master something, anything'. Through mastery of one thing, you can drift towards extensions of that mastery that bring you more joy, and eventually discover where your bliss is." Kevin Kelly
Thanks for reading--
charles |
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