“I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments.”

— Friedrich August von Hayek

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

— John Maynard Keynes

“It is a way to take people’s wealth from them without having to openly raise taxes. Inflation is the most universal tax of all.”

— Thomas Sowell

“Continued inflation inevitably leads to catastrophe.”

— Ludwig von Mises

“Inflation is always and everywhere a monetary phenomenon.”

— Milton Friedman

“Inflation is not caused by the actions of private citizens, but by the government: by an artificial expansion of the money supply required to support deficit spending. No private embezzlers or bank robbers in history have ever plundered people’s savings on a scale comparable to the plunder perpetrated by the fiscal policies of statist governments.”

— Ayn Rand

“Monetary inflation not only raises prices and destroys the value of the currency unit; it also acts as a giant system of expropriation.”

— Murray Rothbard

“Increases in money supply are what constitute inflation, and a general rise in prices is the symptom.”

— Walter E. Williams

Inflation seems to be at the top of many folks minds these days. Prices going up on almost everything essential – food, fuel, rent/mortgage. Economists define “inflation” as a sustained general increase in price levels – affecting virtually everything, but they classify price increases in relatively few items as simply local market price situations, typically transient, not inflation.

This view separates broad-scale monetary effects – caused by whatever it is that government does monetarily – from narrowly-impacting market effects – caused by whatever it is that producers and sellers may be doing.

Rarely do market effects impact an extremely broad array of goods and services. Producers and sellers (and buyers) are generally adept at dealing with adverse market effects, at least where competition is significant.

Persistent inflation, then, seems to be the result of monetary imbalances, better known as excessive money printing and distribution. As noted in an earlier post, more money by itself doesn’t cause mischief unless it somehow gets into spenders’ and investors’ (and borrowers’) hands.

So, what do we have today – inflation, or just market price situations?

Unfortunately, the answer today seems to be an emphatic both.

Government via the Federal Reserve Bank (the “Fed”) has been on a money printing binge for years. And, since the recent unpleasantness from COVID in early 2020, we have had no end of price-and-supply-affecting market-specific situations that seem to be having an increasingly broad impact.

Money supply growth in principle should reflect the population-growth-driven economic growth. In the chart below, this relationship seems to hold, at least roughly, until 2020. The recent peak is nearly 27% annual money supply growth. This just has to cause some serious economic mischief.

Money supply growth vs. inflation
My favorite chart of how well money supply growth (black) and inflation (red) are correlated. Data from Federal Reserve Bank of St. Louis:

In any case, together these two fundamental price-affecting mechanisms are causing immense, and probably permanent, economic and social calamities, and tragedies. It is hard to imagine a worse combination.

Oh yes, and we seem to have yet another major participant in all of this mess and pain: global political and economic disruption and restructuring. Not to mention wars and rumors of wars everywhere.

None of this appears likely to be fixable within any reasonable time period or without extended and huge suffering from now inevitable changes.

How about hyperinflation?

Well, at least this catastrophe flavor seems quite unlikely – so far as I can see. Investopedia offers this definition of “hyperinflation”:

“Hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.”

This extreme version of inflation typically occurs when the population as a whole loses faith in the currency so that it becomes effectively worthless. It is a kind of endpoint for currency (money) devaluation. Think Venezuela.

Okay then, maybe we’re in for serious “stagflation” – whatever that is

Another definition is needed here. According to Wikipedia:

“In economics, stagflation or recession-inflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.”

“The term, a portmanteau of stagnation and inflation, is generally attributed to Iain Macleod, a British Conservative Party politician who became Chancellor of the Exchequer in 1970. Macleod used the word in a 1965 speech to Parliament during a period of simultaneously high inflation and unemployment in the United Kingdom. Warning the House of Commons of the gravity of the situation, he said:”

“’We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of ‘stagflation’ situation. And history, in modern terms, is indeed being made.’”

The government’ toolbox is very limited

For dealing with economic growth and inflation, the government (i.e., Federal Reserve Board) can increase or decrease primary interest rates, and it can increase or decrease the money supply. In highly-simplified terms, the mechanics are as follows:

Bank reserve requirements. Reserve requirements are the amount of funds banks must hold against customer deposits in bank accounts, which is currently set at 0%. This means that banks can lend to consumers and businesses up to 100% of bank deposits, which creates in effect new money that can be spent. Increasing reserve requirements reduces the amount banks can lend and so decreases the effective money supply.

Open market operations. The Fed buys or sells government securities in the open market. To increase the money supply, it buys government bonds from securities dealers, typically using newly-printed money. To decrease the money supply, the Fed sells government bonds from its inventory, thus removing the proceeds from circulation.

Short-term interest rates. The Fed can alter short-term interest rates by lowering (or raising) the discount rate that banks pay on short-term loans from the Fed. Interest rates affect spending through the costs of borrowing. High rates discourage borrowing for both investments and consumer credit (credit cards, mainly). Small rate changes don’t do much but big rate moves can have a huge impact. See below for the classic example of Fed Chairman Paul Volcker.

And that’s it for the Fed’s toolbox.

The real trick: Balancing economic growth against inflation

Money supply and interest rate levels have a huge impact on economic growth and prices. They interact: Too much money available for a given amount of demand for goods and services allows prices to rise (inflation). At the same time, higher prices tends to reduce demand.

You can easily see that too much money coupled with very low interest rates is a potentially lethal combination. Like we have today. Prices and interest rates both going up rapidly will eventually stifle demand, causing growth to slide into recession or worse, and unemployment to rise.

Taming inflationary pressures by increasing interest rates and decreasing the money supply will generally reduce economic activity – demand, causing stagnation or recession, which will cause unemployment to rise. The latter is probably not good in an election year.

This is a very complex, large-scale system to manage successfully. The Fed unfortunately has an abysmal record in this respect. The likeliest outcome is large swings in inflation and unemployment as political pressures against one or the other change unpredictably.

Fed Chairman Paul Volcker had a solution – a monetary sledgehammer

Volcker’s solution, which worked but generated a huge amount of flack and pushback, was the following, via Wikipedia:

“Inflation emerged as an economic and political challenge in the United States during the 1970s. The monetary policies of the Federal Reserve board, led by Volcker, were widely credited with curbing the rate of inflation and expectations that inflation would continue. US inflation, which peaked at 14.8 percent in March 1980, fell below 3 percent by 1983. The Federal Reserve board led by Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. The prime rate rose to 21.5% in 1981 as well, which helped lead to the 1980–1982 recession, in which the national unemployment rate rose to over 10%.”

There are unfortunately no Paul Volcker’s anywhere to be seen today.

Paul Volcker, Federal Reserve Board Chairman in the 1970’s
Paul Volcker, Federal Reserve Board Chairman in the 1970’s

Inflation – as stagflation – will get fixed as always: the hard way

Managing the economy during a period of serious stagflation is a very tough job, especially in highly turbulent times such as we have today. The odds of success here seem to be extremely remote. The hard-way “fix” is almost certainly in our near-term future. What might a “hard-way” fix look like? My take:

An obsessive focus on inflation seems likely for a while at least. Untamed inflation will simply lead to a more serious economic downturn (recession or depression) further down the road. Better to act on inflation now.

Inflation, as noted above, gets addressed by increased interest rates, money supply reductions (“quantitative tightening”, or QT), and possibly reduced lending through bank reserve requirements increases.

Economic activity seems almost certain to take a major hit, despite election year concerns. The offset here may be the hit occurring largely post-election. Unemployment will increase but this may be given a higher priority once the real beast of inflation is under control (and the election is over).

So much for my sense of the “real story on inflation”. What do some experts have to say about all of this? A sample:

What some experts have to say

Brandon Smith writing in ZeroHedge summarizes the current situation:

“There are certain sectors of the economy that will indeed see deflationary pressures. Real GDP, for example, is witnessing declines. Retail sales are in decline. US wages are stagnant in comparison to prices. Housing sales are now falling rapidly. Manufacturing is dropping. Yet, prices continue to remain high. Clearly there is a mix of inflationary and deflationary elements within the same economic crisis. In other words, it’s a stagflation event.”

Stagflation is here today, surely. Prices are likely soon to reach levels that cause major reductions in demand for essentials like food, fuel, and housing. People will at some point be forced to shift their spending so as to stay within their earning and borrowing limitations. This doesn’t happen immediately, but it must and will happen. It has begun.

Our standard of living is likely to take a big hit as this essentials-demand downsizing gets seriously underway. Pressure on wages and salaries is going to be intense, but employers can only respond within limits. Demand is going to decrease inevitably. But prices may well continue rising despite demand decreasing.

Kristoffer Hansen via The Mises Institute describes “The Great Crash of 2022”:

“Whatever happens next, one thing is clear: the crisis is already upon us. Stock market declines and financial market chaos are really epiphenomena, headline capturing though they may be. The damage has already been done.”

“In all likelihood, the Fed is not going to stay the course. Pressure from finance and from government is likely to force it back into inflation, but this inflation can’t prevent the bust. As Ludwig von Mises pointed out, you can’t paper over the economic crisis with yet another infusion of paper money; the crisis will play out, whatever the central bank decides to do. What the Fed can do is continue funding the government and bailing out the financial system when they come under pressure. Both will be very inflationary.”

Massive money printing and distribution will continue.

A ”crisis” – a time of intense difficulty, trouble, or danger – seems surely to be upon us today. Not coming, but now.

Responses to crises range from decisive and effective, which are unfortunately quite rare, to indecisive and/or ineffective, which are far too common. The latter typically results in a “hard-way” type of fix that often fixes nothing much but instead leads to yet another crisis.

Paul Craig Roberts, economist, author, and Secretary of the Treasury for Economic Policy for President Reagan, argues that recent actions by the Fed in particular will cause extremely serious trouble: “The United States Has Committed Economic Suicide”:

“The common tendency is to think of inflation as caused by too much money. In this way of thinking, the reason to raise interest rates is to make credit more expensive, thus causing less demand for loans and in this way reducing the growth of the money supply which, in turn, reduces inflation.”

“It is true that the US has had amazing money growth. However, very little of this money got into consumer prices. The Fed created the money (QE, Quantitative Easing) to bail out the large banks from their bad investments. In other words, the Federal Reserve created $8.2 trillion dollars with which to purchase bad investments that threatened banks’ balance sheets with insolvency. This money found its way, not into consumer prices, but into the prices of financial assets, such as stock and bond prices, and into real estate prices. Home prices were driven up, but the low interest rates lowered the carrying cost of mortgages.”

“The enfeeblement of the US economy began with jobs offshoring. High value-added, high productivity jobs were moved offshore at far lower costs, thus raising the profits and share values of offshoring corporations, but reducing the income growth of the working population. ‘Globalism’ was a cover for this desertion of American workers and the tax bases of cities and states, which to survive began selling off public assets to private interests. The question before the US is how does a country recover when it has placed so many of its own high income jobs into the economies of foreign countries. As far as I can tell, the Western world has committed economic suicide.”

Roberts has many very serious credentials in this area, making his views worthy of careful consideration.

A relentless focus on price stability?

Former president of the Federal Reserve Bank of New York, and vice-chair of The Fed Bill Dudley has a different but also crisis-based view of the current situation: “Former NY Fed Chief: ‘Welcome To The Recession’”:

“Second, the new focus on price stability will be relentless. Fed officials recognize that failing to bring inflation back down would be disastrous: Inflation expectations would likely become unanchored, necessitating an even bigger recession later. From a risk management perspective, better to act now, whatever the cost in terms of jobs and growth. Powell does not want to repeat the mistakes of the late 1960s and the 1970s.”

Inflation comes first, in his view. If it causes a recession and higher unemployment, that’s too bad. The Fed will choose this “lesser of two evils”.

Michael Hudson, an American economist, Professor of Economics at the University of Missouri–Kansas City and a researcher at the Levy Economics Institute at Bard College, former Wall Street analyst, political consultant, commentator and journalist, weighs in on the Fed’s struggles: “The Fed’s Austerity Program to Reduce Wages”:

“The Federal Reserve Board’s ostensible policy aim is to manage the money supply and bank credit in a way that maintains price stability. That usually means fighting inflation, which is blamed entirely on ‘too much money.’ In Congress’s more progressive days, the Fed was charged with a second objective: to promote full employment. The problem is that full employment is supposed to be inflationary – and the way to fight inflation is to reduce employment, which is viewed simplistically as being determined by the supply of credit.”

“So in practice, one of the Fed’s two directives has to give. And hardly by surprise, the ‘full employment’ aim is thrown overboard – if indeed it ever was taken seriously by the Fed’s managers.”

“The Fed’s Junk Economics of What Bank Credit Is Spent On. The pretense behind the Fed’s recent increase in its discount rate by 0.75 percent on June 15 (to a paltry range of 1.50% to 1.75%) is that raising interest rates will cure inflation by deterring borrowing to spend on the basic needs that make up the Consumer Price Index and its related GDP deflator. But banks do not finance much consumption, except for credit card debt, which in the United States is now less than student loans and automobile loans.”

“Banks lend almost entirely to buy real estate, stocks and bonds, not for consumer purchases of goods and services. Some 80 percent of bank loans are real estate mortgages, and most of the remainder are loans collateralized by stocks and bonds. The main price effect of less bank credit and higher interest rates is on asset prices – deterring borrowing to buy homes and arbitragers and corporate raiders from buying stocks and bonds. So the main price effect of less bank credit and higher interest rates is to reduce stock and bond prices and demand for home mortgages. Home ownership takes a large hit.”

Bottom line:

Today, we have both general inflation where almost everything is increasing in price, and price inflation where only a few big things – like food, fuel, and housing – are increasing painfully in price. General inflation gets addressed by government and its allies. Price inflation gets addressed by providers of affected products and services and by consumers via competition – assuming of course that the government et al stays out of the way, however unlikely this may be. The big question pretty clearly is how the government will respond.

Will they focus on inflation, or on minimizing the likely recession? An inflation focus first seems most likely. This means a recession (at best) is in the cards near=term.

Related Reading

“The definition of inflation. Here’s a simple way to define inflation:”

“Inflation is the rate at which the general level of prices rise.”

“This intuitively makes sense – we use “inflation” to indicate the idea of the same money getting you less value, whether it’s buying groceries or paying your dentist.”

“However, it’s not strictly accurate. Here’s a more specific definition, from Owen F. Humpage, economist emeritus of the Research Department of the Federal Reserve Bank of Cleveland:”

“Inflation is one of the most misused words in economics. As economist Michael Bryan carefully explained a few years back, the word originally described currency and money, not prices. It referred to a rise in the amount of paper currency in circulation relative to the precious metal (or money) that backed it. Later, the term referred to the amount of money in circulation relative to the amount actually needed for trade. Today, however, people typically use the word to refer to a rise in some set of prices or even in a single price, with no necessary connection to money at all… The unfortunate outcome of this evolution is that the public no longer distinguishes between two very different types of price pressure.”

“The free market allows goods and services to be sold to the highest bidder. When there’s too much money in circulation, well, that gives all the bidders more power to pay higher prices.”

“The end result is the same. Your bills go up, your money buys less. That’s how even people with lots of money can be poor – it doesn’t matter how much money you have, the only thing that matters is what your money can buy.”

“Inflation is the reduction of your money’s purchasing power. Inflation is totally separate from price fluctuations. Here in Texas, in November, all the pecan trees are heavy with nuts. You can buy a one-pound bag of shelled pecans for a dollar. A few months later, out of season, if you want pecans at the grocery store they’ll run you anywhere from $9-$14 a pound! This is not inflation – it’s just seasonal fluctuations in supply. (Incidentally, it’s also why we eat pecan pie after our Thanksgiving turkey.)”

“So, when you’re thinking about a commodity like pecans, more supply means lower prices. Too many pecans all at once means your pound of pecans is worth less money. And when you’re talking about money itself, more supply means higher prices. Too much money all at once means every dollar buys less.”

  • A little more on Paul Volcker and his times via Wikipedia:

“President Jimmy Carter nominated Paul Volcker to serve as chairman of the Board of Governors of the Federal Reserve System on July 25, 1979. He was confirmed by the U.S. Senate on August 2, 1979, and took office on August 6, 1979. President Ronald Reagan renominated Volcker to a second term in 1983.”

“Inflation emerged as an economic and political challenge in the United States during the 1970s. The monetary policies of the Federal Reserve board, led by Volcker, were widely credited with curbing the rate of inflation and expectations that inflation would continue. US inflation, which peaked at 14.8 percent in March 1980, fell below 3 percent by 1983. The Federal Reserve board led by Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. The prime rate rose to 21.5% in 1981 as well, which helped lead to the 1980–1982 recession, in which the national unemployment rate rose to over 10%. Volcker’s Federal Reserve board elicited the strongest political attacks and most widespread protests in the history of the Federal Reserve (unlike any protests experienced since 1922), due to the effects of high interest rates on the construction, farming, and industrial sectors, culminating in indebted farmers driving their tractors onto C Street NW in Washington, D.C. and blockading the Eccles Building. US monetary policy eased in 1982, helping lead to a resumption of economic growth.”

“The US current account was in permanent deficit by the 1990s. Volcker himself tried to remedy the situation by the Plaza Accord in 1986, which called for Germany and Japan to revalue relative to the US dollar.”

“The combination of the Fed’s tight money policies and the expansive fiscal policy of the Reagan Administration (large tax cuts and a major increase in military spending) produced large federal budget deficits and significant macroeconomic imbalances in the U.S. economy. The combination of growing federal debt and high interest rates led to a substantial rise in federal net interest costs. The sharp rise of interest costs and large deficits led Congress to take some steps towards fiscal constraint.”

“Nobel laureate Joseph Stiglitz said about him in an interview:”

“Paul Volcker, the previous Fed Chairman known for keeping inflation under control, was fired because the Reagan administration didn’t believe he was an adequate de-regulator.”

“Congressman Ron Paul, well known as a harsh critic of the Federal Reserve, offered qualified praise of Volcker:”

“Being in Congress in the late 1970s and early 1980s and serving on the House Banking Committee, I met and got to question several Federal Reserve chairmen: Arthur Burns, G. William Miller, and Paul Volcker. Of the three, I had the most interaction with Volcker. He was more personable and smarter than the others, including the more recent board chairmen Alan Greenspan and Ben Bernanke.”