The Inflation Conundrum

 (c) by Mark Dempsey

Myths are often at the foundations of nations. For example, George Washington actually didn't cut down a cherry tree and confess, "I cannot tell a lie." That's fiction, not history. Perhaps one of the most persistent current fictions is Milton Friedman's declaration that "Inflation is always and everywhere a monetary phenomenon." Like most of Friedman's economics, this is plausible, but false.  

Consider the dynamics of inflation. In an inflationary environment, people compete for something, bidding up the price. The more money they have, the higher that price can go. Missing from Friedman's proclamation: the scarcer the thing people are bidding for, the higher the price can go, especially if it's essential. So supply, not just demand is at least a factor.

And the plausible part of Friedman's declaration is the presence of a lot of money when inflation goes hyper. Take a look at a guy from Weimar Germany going to buy a loaf of bread:

 

That's a lot of (government-issued) cash! 

But the hyperinflationary "over-printing" is not the whole story. The thing that initiated the inflation in Weimar Germany was not a central bank printing too much money. Before that occurred, French soldiers shut down the German industrial heartland, the Ruhr, because France objected to the Germans' tardiness in paying some WWI reparations. 

Germany already had a balance of payments problem from those reparations, and then they had their big manufacturing center shut down.  Those things--a shortage of goods and a balance of payments problem  predated the printing. (For more details about the Weimar inflation, read this.)

Something similar occurred in the other bout of hyperinflation often cited. Zimbabwe became independent, renaming itself from Rhodesia, and redistributed land previously farmed by its colonial masters. But agriculture in Africa isn't trivial. For example, unless you have an effective tsetse fly eradication program, European cattle die from sleeping sickness, the parasite tsetse flies carry. 

So because of their inept farming, Zimbabwe lacked food, and tried to import enough to feed its population. A shortage of goods accompanied by a balance of payments problem predated any excessive currency printing.

In fact, if you consult the (right-wing, Koch-funded, libertarian) Cato Institute, record of 56 hyperinflations throughout history, you'll find that such hyperinflations were never started by a central bank printing too much money.

Even the steepest recent US inflation--the 1970s--follows this pattern. Pre-fracking peak oil for the US occurred in 1971. The price of oil in 1971: $1.75/bbl. At that time, the US imported roughly 30% of its oil from OPEC. Following the 1973 Yom Kippur war, the Arabs decided to use the "oil weapon," and reduced their exports to the US. 

Because of a shortage the US couldn't overcome with domestic production, the price of oil quadrupled virtually overnight, peaking during the Reagan administration in 1982 at $42/bbl (about the pre-Iran-war price when adjusted for inflation). Reagan got lucky because shortly after that peak, Alaska's North Slope oil production came on line, and the price receded.

As for affordability, here's Corbin Trent's comment: 

"Affordability is not a regulatory problem. It’s a production problem. The Abundance answer is that markets respond to scarcity by adding capacity. The COVID lumber spike showed they don’t. Prices ran from $400 per thousand board feet to over $1,500 by May 2021. The classical story says producers reopen mills, build new ones, expand supply. None of that happened at scale. Mills shuttered after the Great Recession did not reopen. The producers pocketed the margin, ran the buybacks, and went back to bed. Lumber came back down only because demand cooled, not because supply caught up. Capacity today is what it was twenty years ago.

"[We] have to bring prices down, not wait for the market to add capacity at the price it likes. The way we have actually brought prices down on things that mattered has never once been through deregulation. It has always been a mission. The Arsenal of Democracy. The New Deal. The Space Race. Oak Ridge. The Manhattan Project. The TVA dam system. Rural electrification. During World War II, the Defense Plant Corporation financed over 2,300 industrial facilities worth $9.2 billion, roughly two-thirds of all new private industrial capacity added before and during the war. The Reconstruction Finance Corporation worked as a public bank, funding what private capital wouldn’t. We trained millions of nurses and welders and electricians as capacity build-outs, not funding rounds.

"Then we killed it. Successive administrations sold it off and called it efficiency. CEOs offshored the factories and called it shareholder value. Wall Street bought the husks and called it growth. None of this happened by accident. It happened on purpose, by people we can name, in service of a class of beneficiaries who are still cashing the checks.

"A handful of people are arguing for getting it back. Saikat Chakrabarti, running in California’s 11th, has published the cleanest version in a document called Mission for America. It calls for restoring the Reconstruction Finance Corporation as a public bank to finance the build-out we need. He’s also calling for public ownership of AI....Everything I’ve said so far would be true if AI didn’t exist. AI just sets the deadline.....

[Local note: Sacramento is now starting a public bank, and the Bay Area and other West Coast regions (Los Angeles, Seattle) are starting public banks too. Remember, by extending credit, banks create money, not necessarily inflation, especially if they lend for productive activities rather than speculation.] 

"If we lose another massive fraction of the workforce to displacement and the only tool we have is checks, those checks will chase the same scarce housing, the same scarce health care, the same scarce energy. The prices that are already crushing people will go ballistic.

"You cannot subsidize your way out of scarcity. Pour more money into a market with constrained supply and you don’t get more supply. You get higher prices. Health care subsidies don’t make Americans healthier. They make UnitedHealthcare and Aetna and CVS more and more powerful. Housing subsidies don’t make homes cheaper. They get capitalized into the asset, and Blackstone and Invitation Homes and Pretium take the spread.

"We have to make things. And we have to own the things that make the things. Otherwise Wall Street and the commodities markets bleed us dry, taking an exorbitant share for doing next to nothing. Public banking. Public capacity. Public ownership is the base everything else rests on.

"What America has in abundance is zeros in the bank accounts of a tiny minority. The things we need are scarce. The richest nation in the history of the world has built its wealth on stock prices, asset prices, and home equity. None of that produces a transformer or trains a nurse or frames a house. The wealth is there on paper but it’s absent in the physical world.

"We cannot solve the affordability crisis until we solve the scarcity crisis. Affordability and scarcity are incompatible."

So it's not as though there hasn't been inflation. Scarcity is at its root, though. As economic historian Michael Hudson observes "The guiding fiction in the idea that rising interest rates will slow price inflation by reducing bank credit creation and thus investment and employment. The fiction is based on the myth that banks help the industrial economy by creating credit to lend to companies to expand the economy. But that is not what banks do under [our current system of] finance capitalism. They lend against assets already in place and available to be pledged as collateral, for the purpose of buying more real estate, bonds and stocks. The effect of these loans is to inflate asset prices, not consumer prices."