Defending inflation

It looks like infla­tion has re-entered ~the pop­ular eco­nomic dis­course~ and will remain there for a while. It bothers me that the term is so often used in a vague, scolding way, with the inten­tion of (it seems to me) stopping conversations — investigations — rather than sharp­ening them. So, I wanted to share some tools for thinking about infla­tion that I’ve found useful: not as a pundit, econ­o­mist, or investor — I am none of those things — but simply a curious, crit­ical citizen.

The infla­tion defender has LOGGED ON.

(Parts of this newsletter are drawn from a pre­vious post on the same subject, but most of it is new.)

What inflation isn’t

The apho­ristic econ 101 def­i­n­i­tion of infla­tion is “too many dol­lars chasing too few goods”, which is actu­ally pretty useful.

Infla­tion scolds tend to focus exclu­sively on the first part of that formulation, “too many dol­lars”. Some will tell you that an increase in the number of dol­lars cir­cu­lating is infla­tion, full stop. This fac­tion is reflex­ively crit­ical of new dol­lars, espe­cially the kind “printed” (electronically) by cen­tral banks, which they see as unfairly, even ruinously, diluting the value of all existing dol­lars.

And honestly, there’s some­thing seduc­tive about their breezy assertion: “If you print more dol­lars, each one is worth less.” I mean … it sounds axiomatic, doesn’t it?

But, give it two sec­onds of thought, and you’ll realize it’s not true, because it pre­sumes a kind of auction-house uni­verse that doesn’t actu­ally exist. The real economy isn’t a crowd of con­sumers with fist­fuls of cash bid­ding up the price of a fixed number of goods on display. It’s much more dynamic than that: a dance between demand and supply, in which the pres­ence of new dol­lars becomes pow­erful incen­tive to pro­duce new goods. That dance is complex, and it changes depending on all sorts of factors, many of them non-eco­nomic. Think pol­i­tics; think weather; think, even, of etiquette. In many contexts, it is simply not cool to sud­denly raise your prices. Can such a flimsy social con­tract really have any power in the cold-blooded economy? It can. It does!

The key, I believe, is to under­stand infla­tion not as an abstract axiom but a phys­ical process that unfolds unevenly in time and space. Maybe that’s why I appre­ciate “too many dol­lars chasing too few goods”; the verb “chasing” almost forces you to imagine a dynamic activity (with per­haps a bit of Wile E. Coyote in it?) rather than a fixed relationship.

So, yeah, I’m not sure I can improve on the apho­ristic def­i­n­i­tion, other than to insist that both parts are crucial: “too few goods” as much as “too many dol­lars”.

And what’s the result of this process? I would say you’ve expe­ri­enced infla­tion when the same number of dol­lars gets you fewer of the things you want from the real world. This sounds uni­formly bad, but, as we’ll dis­cover, it’s not.

A specter is haunting the op-ed page

A neat def­i­n­i­tion isn’t enough, though, because in the pop­ular eco­nomic dis­course of the United States, “infla­tion” oper­ates less as a tech­nical term and more as a dark word of power, intended to con­jure a par­tic­ular period in Amer­ican his­tory; indeed, a par­tic­ular view of that par­tic­ular period.

I mean, you know this: an infla­tion scold cannot finish a sen­tence without invoking the specter of the 1970s, raising the revenant of the “bad old days” before Reagan. It’s not real eco­nomic his­tory they are offering; rather, a kind of scary “cultural memory” groomed into a pow­erful rhetoric tool.

It’s a ghost story, truly.

Of course, there really was high infla­tion in the 1970s! But it wasn’t driven only, or even primarily, by gov­ern­ment spending; there were also severe “supply shocks” caused by oil pro­duc­tion pol­i­tics and a poor global grain harvest. There’s your “too few goods”. The “too many dol­lars” came into play as the U.S. gov­ern­ment bor­rowed money into existence, only to dis­cover it couldn’t change the under­lying reality of those short­ages.

(There was another impor­tant factor, the end of the wage and price con­trols insti­tuted by the Economic Sta­bi­liza­tion Act of 1970, but, candidly, I don’t under­stand the details, so I’m not going to like, read the Wikipedia page and pre­tend I’m an expert.)

Let’s exor­cise this ghost at last. In the 1970s, the sup­plies of two foun­da­tional goods, oil and grain, were ter­ribly con­strained — not by eco­nomics, but by pol­i­tics and weather, respectively. Too few bar­rels, too few bushels. Yet, somehow, through the caresses of selec­tive memory, it’s the demand side, the money chasing those bar­rels and bushels, that has become the bogeyman.

(For curious nerds, this analysis of that period by Alan Blinder in 1982 is very good, and this paper from 1978 dis­sects the food supply prob­lems in detail. This more recent review from the Fed­eral Reserve is also useful.)

Let me now remind you that the 1970s were fifty years ago. The global economy has been utterly remade in the time since. Fifty years ago, there wasn’t any internet; busi­nesses didn’t even use fax machines. Fifty years ago, China’s pro­duc­tive capacity hadn’t come online; Mao was still alive!

I guess what I mean to say is, when you encounter someone who, rather than engaging curi­ously and cre­atively with the par­tic­ularities of the present, anchors their warning about infla­tion in the 1970s — “we don’t want to go back to THAT, do we?”—you should take that as a warning: a sign that they are, some­what literally, trying to cast a spell on you.

A physical process

For ten years, no matter what cen­tral banks have done, no matter how much money they’ve printed — and they have printed a lot — infla­tion hasn’t left its steady orbit around 2%, the target these insti­tu­tions osten­sibly struggle to maintain. For ten years now, there has been no struggle. This really stresses cen­tral bankers out. Why is infla­tion so low??

My per­sonal (crackpot?) theory is that the answer has to do with (a) the dig­i­ti­za­tion of more goods and ser­vices — demand for Net­flix can’t sud­denly out­strip supply, because Net­flix can repro­duce its ser­vice instantly and infinitely — along with (b) the “perfection” of phys­ical supply chains.

In late 2019, the real economy could, in a way unimag­in­able in the 1970s, spin up addi­tional pro­duc­tion of many goods very quickly. This was espe­cially true of electronics, which con­sti­tute so much of the world’s con­sump­tion these days. You want twenty mil­lion flat-screen TVs? They’re already on a boat!

But it’s not 2019; we live in a dif­ferent world now, and the pan­demic has dis­rupted those “perfect” supply chains. The pro­duc­tion of lumber is a well-publicized example; as I’m writing this, sawmills don’t have the capacity to keep up with surging demand. It takes a while to build new mills and, in the meantime, the lumber that is avail­able is being sold at shock­ingly high prices. This is, to be clear, an example of real infla­tion! (If you’d like to learn more about these lumber supply woes, this deep explainer is exquis­itely detailed.)

(An update, sev­eral months later: the price of lumber fell as rapidly as it had risen.)

There are plenty of other exam­ples, chronic and acute. Bay Area housing has suf­fered from run­away infla­tion for decades, the result of polit­i­cally con­strained supply. The latest gen­er­a­tion of snazzy GPU cards has suf­fered from both rationing and (resale price) infla­tion, because their pro­duc­tion hasn’t kept up with demand that has been mul­ti­plied by a cryp­tocur­rency boom. (Snazzy GPUs can be used to play video games; they can also, unfortunately, be used to mine Ethereum.)

But these spe­cific exam­ples in spe­cific mar­kets only rein­force the point: infla­tion is a phys­ical process that unfolds unevenly in time and space.

So I don’t mean to sug­gest that cit­i­zens of the United States ought never to be wor­ried about infla­tion; all three short­ages men­tioned above are causing real prob­lems, real pain. (Well, two out of three. The GPU shortage might just be an annoyance.) Rather, I think those wor­ries ought to be focused on clogs in phys­ical pro­duc­tion and distribution, not merely the cir­cu­la­tion of new dol­lars.

Because I am strongly in favor of the cir­cu­la­tion of new dol­lars.

Pick a side

Here’s where things get some­what sharper.

As you think about and dis­cuss infla­tion, and how much of it is tol­er­able and/or desirable, I encourage you to cul­ti­vate a bit of “class consciousness”.

A person with, say, a mil­lion dol­lars in the bank, plain liquid cash, might rea­son­ably be con­cerned about dollar infla­tion, even a modest amount.

But I am, uh, not such a person, and I don’t really care about their con­cerns. I don’t think you should, either! One strange fea­ture of the pop­ular eco­nomic dis­course is that the rar­i­fied trou­bles of the very rich often get dis­cussed as if they were “normal”, but: they are extremely not normal.

The mil­lion-dol­lars-in-cash-havers can fend for themselves.

Going further: if you are a person with a mort­gage or a stu­dent loan, when it comes to infla­tion, your inter­ests are directly at odds with Mr. Monopoly up there. Modest infla­tion is good news for you, because your debt is counted out in dol­lars, and it would be nice to pay it back in dol­lars worth less than the ones you were loaned. (The polit­ical econ­o­mist Mark Blyth has pointed out that the high infla­tion of the 1970s was, in this respect, a gift to Amer­icans with mort­gages at that time: a dis­count on the price of their homes.)

If you have more debt than assets, infla­tion is like the wind filling your sails: it pushes in the right direction. There are a lot of people in the United States for whom that first state­ment is true, and it’s like … folks, show a little self-interest!

Finally, if you live pay­check to pay­check — part of a class whose con­cerns I care about much more than I do the mil­lion-dol­lars-in-cash-havers — modest infla­tion is basi­cally neutral. Prices go up slowly over time, but so do wages. (This process is, again, uneven in time and space, and I acknowl­edge that wage infla­tion can lag behind price infla­tion, which is not good. A tight labor market helps in this regard; workers can be more selec­tive, insist on higher wages. For more on this, see the addendum.) Over time, you pay inflated prices with dol­lars equally inflated, and the urgent eco­nomic ques­tions of your life don’t have much to do with infla­tion at all.

The underrated specter

For the past twenty years or so, econ­o­mists have wor­ried about defla­tion as much as infla­tion. It’s not part of the pop­ular eco­nomic dis­course in the United States, though, so many Amer­icans can’t describe it — or even imagine it, really. Here’s a quick scenario.

First: I want to buy a ham­mock. It is summertime.

Second: overnight, some cryp­to­coin with a fixed supply becomes the offi­cial cur­rency of the United States. The infla­tion scolds cheer; at last, “hard money” reigns supreme!

Suddenly, every trans­ac­tion in the economy requires the use of this cryp­to­coin. Strong and growing demand bids up its value steadily, and it becomes clear to me that, rather than buy a ham­mock today, I can wait a month, allow defla­tion to work its magic, then buy a luxury ham­mock with the same number of cryp­to­coins. Another month and I can buy a luxury ham­mock and an auto­matic banana peeler!

Seems pretty sweet for me … but what about the ham­mock fac­tory? Sales plummet. What’s the deal? It’s ham­mock season! Ah, but Sloan and the other ham­mock-wanters are all out there waiting, waiting … and by the time we deign to part with a few of our pre­cious cryp­to­coins, the ham­mock fac­tory has gone out of business, sent all its weavers home.

I am rich with defla­tionary cur­rency in a hollowed-out, ham­mock-free economy.

This isn’t just a cute story: it really happens. It has been a deep and recur­ring problem for Japan over the past twenty years. In 2016, the gov­ernor of the Bank of Japan defined “defla­tion” as

a sit­u­a­tion in which prices of a broad basket of goods and ser­vices declines in a con­sis­tent manner, thereby causing all con­sumer prices to con­tin­u­ally fall. When looking at the overall economy, defla­tion causes a decrease in sales, and there­fore profits, which spurs employee lay­offs and/or wage decreases. Con­sumers then hold back on spending as the future looms with uncertainty. Subsequently, com­pe­ti­tion between firms becomes fiercer, causing price races to the bottom. Defla­tion is thus self-perpetuating: the economy falls into a “bad equilibrium, in which eco­nomic activity is shrinking.” This has been the state of Japan’s economy for 15 years [ … ]

This is a really, really bad sit­u­a­tion; it deserves as much worry and con­ster­na­tion in the public imag­i­na­tion as run­away infla­tion.

Modest infla­tion is a good thing for an economy. It encour­ages people to spend their money today, not next month. Anyone who pro­duces or sells any­thing ought to be rooting for it.

In other words: where are my defla­tion scolds??

To summarize

• Infla­tion is not caused axiomat­i­cally by an increase in the number of dol­lars cir­cu­lating; it’s a phys­ical process that unfolds unevenly in time and space — in the real economy.

• Modest infla­tion is good for people who pro­duce and sell things.

• More-than-modest infla­tion is prob­ably good for people who hold debt.

• Infla­tion scolds don’t have the same inter­ests as you, and you should gen­er­ally ignore them.

The infla­tion defender has LOGGED OFF.

Addendum

Many of the replies I received from sub­scribers poked at this idea of wages and prices slowly rising together, basi­cally asking some form of the question: do they really? Because, of course, if they don’t, more-than-modest infla­tion becomes a bigger problem for the person living pay­check to pay­check.

This is a very fair question, informed by the reality of gen­eral wage stag­na­tion in the U.S. over the past twenty years.

Here’s a view from the Atlanta Fed. I chose this one so we could focus on the first and second quartiles, the workers earning the lowest wages:

If you com­pared a graph of price infla­tion over the same time period, you would see it hov­ering in roughly the same range. (The excep­tion is 2008-2009, when infla­tion spiked to about 5%, then dipped below zero before returning to the 2-3% zone.) So, wages have been growing, slowly, in dollar terms; it’s just that they’ve been bal­anced by infla­tion, leaving their real value basi­cally flat. For decades!

(If you’re interested, I rec­om­mend exploring the other view options; it’s a really rich, useful visualization.)

The thing to consider, I think, is that usually, the “too many dol­lars” con­tributing to infla­tion — stimulus checks, infra­struc­ture projects, unem­ploy­ment insur­ance payments, loans to busi­nesses, etc. — are also tight­ening the labor market, which allows workers to be more selec­tive and demand higher wages … 

 … which is, I acknowl­edge, a little bit hard to imagine against the back­drop of the past twenty years. It is rea­son­able for an Amer­ican to feel skep­tical that wage nego­ta­tion even like, happens. But it does! There’s evi­dence it’s hap­pening right now; it will be inter­esting to see how wages look in a year.

It’s worth saying again that the process is uneven in space and time. I think, for example, of the min­imum wage increase recently voted into law in Florida, which will take it to $15 gradually. That rep­re­sents a mean­ingful increase for a lot of people whose wages have been lag­ging for decades. It will show up on the Atlanta Fed’s graph, above, as a shallow rise over the next six years, the Florida $15 diluted in the national numbers; it will look smooth, gradual, continuous; but of course, it will have been the result of a dis­tinct event in space and time, a kind of state-level “negotiation” long overdue.

None of this is meant to wave away the question; if you’re going to keep any con­cern front and center, this is the one. Talk about “cultural memory”, though; I think the United States has maybe never known (?) what a truly tight labor market looks and feels like. The appeal of “full employment” isn’t only, or even mainly, that everyone has a job; it’s that everyone has the power to turn down a job.

May 2021