Inflation Doomsayers and Downplayers

25 Friday Jun 2021

Posted by pnoetx in Inflation, Monetary Policy

Tags

Consumer Price Index, Core CPI, Cryptocurrencies, Deficits, Energy Policy, Federal Reserve, Financial Velocity, Fisher Effect, Helicopter Money, Housing Costs, Import Prices, Inflation, Inflation Premium, Irving Fisher, M1, Median CPI, Monetary policy, Monetization, Shrinkflation, Trading Volume, Trimmed CPI, Velocity of Money

There’s a big disconnect between recent news about escalating inflation and market expectations of inflation. In fact, there’s a big disconnect between market expectations and what we’re hearing from some conservative economists. The latter are predicting more inflation based on the recent spurt in prices and the expansionary policy of the Federal Reserve. Can these disparate views be reconciled?

Market Predictions

Market interest rates are considered pretty good predictors of inflation, at least relative to surveys and macroeconomic models. That’s because a fixed interest return is eroded by inflation, and fixed income investors will bid up interest rates to incorporate a premium to compensate for perceptions of increased inflation risk. This is known as the Fisher Effect, after the economist Irving Fisher. In fact, investors should bid rates up more than one-for-one with expected inflation, because the inflation premium will be taxed. A higher return must compensate for both higher expected inflation and taxes on the increased inflation premium.

After rising by about 1.2% from last summer through mid-March, interest rates on Treasury notes have declined slightly. The earlier run-up anticipated a strengthening economy, but if the increase was due to higher expected inflation, we could say it represented an added premium of about 1%, and that’s roughly in-line with changes in some other market-based gauges of expected inflation (ignoring pandemic lows).

Recent Inflation News

Meanwhile, measured inflation certainly has increased in 2021. I say “measured” because 1) “true” price changes are measured imperfectly, and 2) there is a difference between real inflation, which is a continuing process, and month-to-month changes in prices. Here, we’re really talking about the latter and hoping it doesn’t turn into a bad case of the former!

The green line in the chart below is the percent change in the consumer price index (CPI) from a year earlier. After declining during the pandemic, it rebounded sharply this year to almost 5% in May. The purple line is the increase in the CPI excluding food and energy prices, otherwise known as the “core” CPI. The jumps shown in the chart are well in excess of the market’s assessment of inflation trends.

Both versions of the CPI have jumped in the past few months, but it turns out that durable goods like washing machines, TVs, and (probably) Pelotons have jumped the most sharply. Most of the weakness in prices during the pandemic was in non-durable goods, which stands to reason because so many activities away from home were curtailed. Also noteworthy about these price movements: when measured over a span of two years, prices excluding food and energy have risen at an annualized rate of only 2.6%.

There are two other lines in the chart above that demonstrate much less alarming changes in prices: the orange line is so-called “median” inflation, which is the price change in the median component of the CPI. That is, half of all price components included in the CPI rose faster and half rose slower than the median. It has barely accelerated this year and stood at only about 2.1% higher in May than a year earlier. The blue line is the so-called “trimmed” CPI, or the average price change of the middle 84% of all CPI components. While it has accelerated in 2021, the year-over-year increase was only 2.6% in May.

Thus, the breadth of the jump in prices was limited. The Federal Reserve and a lot of market participants insist that the uptick is narrow and temporary — a transitional phenomenon related to the sluggish recovery of supplies in the post-pandemic environment.

But again, the accuracy of price measures is always in question. For example, the housing cost component of the CPI was up only 2.2% in May from a year ago, but it is calibrated to actual survey data only twice a year, the survey is a weak data source, and we know home prices and rents have risen aggressively. Quality and quantity adjustments are always in question as well. An old approach for businesses dealing with rising costs is to reduce package size, which has been called “shrinkflation”. It seems to be back in vogue.

Inflation Drivers

It’s not yet clear how much wage pressure is occurring now. The economy-wide average hourly earnings data has been distorted over the past 15 months by the changing mix of employment, first shifting toward greater concentration in high-wage (work-at-home) occupations and now shifting back toward lower-wage jobs as the economy reopens. But we know many employers are facing a labor shortage, due in large part to extended unemployment benefits and other pandemic-related aid, so this puts upward pressure on wages. In 2021, minimum wage rates are undergoing substantial increases in 17 states, and a number of large employers such as Amazon have increased their minimum pay rates. That creates competitive pressure for smaller employers to boost pay as well.

The fundamental cause of an “honest-to-goodness” inflation is “too much money chasing too few goods”. The Federal Reserve has certainly given us enough to worry about in that regard. The basic money stock (M1) increased by four-fold in the late winter and early spring of 2020, just as the pandemic was spreading. Today, it is almost five times greater than in early 2020, so growth in the money stock remains quite fast even as the recovery proceeds. No wonder: the U.S. Treasury is issuing about $1 trillion of new debt every four-to-six weeks, and the Fed is essentially monetizing these deficits by purchasing a huge chunk of that debt.

That’s a lot of “helicopter” money… new money! But are there too few goods for it to chase? Or is it really chasing anything? Is it just sitting idle? First, GDP is likely to exceed its pre-pandemic level in the second quarter, despite the fact that private payrolls are still down by about 7 million employees. Of course, that doesn’t eliminate the ostensible imbalance between money and goods, and one might expect a veritable explosion in price inflation under these circumstances.

So far that seems unlikely. The so-called velocity of money (its rate of turnover) has plunged since the start of the pandemic, with no discernible rebound through the first quarter of 2021. That means a lot of the cash is not being used in transactions for real goods, but financial transaction volume has been quite strong in 2020-21. Daily stock trading volume was up by more than 50% in 2020 from 2019, and in the first quarter of 2021 it stood another 34% higher than the 2020 average (though volume tapered in April). This is to say nothing of the increased frenzy in cryptocurrency trading. So, while some money is turning over, the expansion of the money stock remains daunting and pressure might well spill-over into goods prices.

Caution Is a Virtue

So long as the Fed keeps printing money, and assuring investors that it will keep printing money, the equity markets are likely to remain strong. There are mixed signals coming from Fed officials, but the over-riding message is that the recent uptick in prices is largely temporary and limited in scope. That is, they assert that certain prices are being squeezed temporarily by rebounding demand for goods while suppliers play catch-up.

Market expectations of inflation seem to agree with that view, but I have strong trepidations. There are cash reserves held in the private sector to support more aggressive spending. Large companies, consumers, and banks are still holding significant amounts of cash. The Biden Administration is doing its best to spend hand-over-fist. This administration’s energy policy is causing fuel bills to escalate. Home prices and rents are strong. The dollar is down somewhat from pre-pandemic levels, which increases import prices. Finally, the Fed is reluctant to reverse the huge increase in the money supply it engineered during the pandemic. If the recent surge in prices continues, and if higher inflation embeds itself into expectations, it will be all the more difficult for the Fed to correct.

The market and the Fed might be correct in predicting that the spike in measured inflation is temporary. The recent data show that these worrisome price trends have not been broad. Just the same, I don’t want to hold fixed income investments right now: if higher expectations of inflation cause market interest rates to rise, the value of those assets will fall. Stock values should generally keep pace with inflation barring stronger signals of tightening by the Fed. Unfortunately, however, many would suffer in an inflationary environment as wages, fixed assets, and benefits are devalued by rising prices.

Note: This post also appears on The American Reveille.

Bernie Sanders: Just a Regular Looter

17 Thursday Sep 2015

Posted by pnoetx in Free markets, Poverty, Socialism

≈ 1 Comment

Tags

Bernie Sanders, Capital-Labor Substitution, Citizens United, Donald Trump, Economic illiteracy, Ed Krayewski, Energy Policy, Feel the Bern, infrastructure, Kevin D. Williamson, Minimum Wage, Police Brutality, Poverty, Racial exclusion, Socialism, Universal Health Care, War on Drugs

Economic illiteracy is getting to be a central theme in the early stages of the 2016 presidential race. The two candidates with whom the public and media are most fascinated at the moment are Bernie Sanders and Donald Trump. Both are veritable case studies in delusional economic reasoning. I have already devoted two posts to Trump, the current frontrunner for the Republican nomination (both posts appear at the link in reverse order). At the time of the second of those posts, I recall hoping desperately that someone or something would rescue my blog from him. I have managed, since then, to resist devoting more attention to his campaign. In this post, I’ll focus on Senator Bernie Sanders of Vermont, currently the top rival to Hillary Clinton for the Democrat nomination.

It’s ironic that Sanders, a self-proclaimed socialist, shares several areas of acute economic illiteracy with Donald Trump. There is a strong similarity between Sanders and Trump on foreign trade (and both candidates are pro-Second Amendment). Like Trump, Sanders demonstrates no understanding of the reasons for trade, as Kevin Williamson notes:

“The incessant reliance on xenophobic (and largely untrue) tropes holding that the current economic woes of the United States are the result of scheming foreigners, especially the wicked Chinese, “stealing our jobs” and victimizing his class allies…. He describes the normalization of trade relations with China as “catastrophic” — Sanders and Jesse Helms both voted against the Clinton-backed China-trade legislation — and heaps scorn on every other trade-liberalization pact. That economic interactions with foreigners are inherently hurtful and exploitative is central to his view of how the world works.“

Sanders lacks an understanding of trade’s real function: allowing consumers and businesses to freely engage in mutually beneficial exchanges with partners abroad, and vice versa. Trade thereby allows our total consumption and standard of living to expand. It is not based on “beating” your partners, as Sanders imagines. It is cooperative behavior.

Opposition to free trade nearly always boils down to one thing: avoiding competition. That goes for businesses seeking to protect or gain some degree of monopoly power and for unions wishing to keep wages, benefits and work rules elevated above levels that can otherwise be justified by productivity. The result is that consumers pay higher prices, have access to fewer goods and less variety, and have a lower standard of living. It is no accident that trade wars deepened the severity of the Great Depression domestically and globally. But Sanders, like Trump, has failed to learn from the historical record.

Another area of Sanders’ deep economic ignorance is his position on wage controls. He advocates a mandatory $15 federal minimum wage with no recognition of the potential damage of such a change. Kevin Williamson has this to say:

“Prices [and wages] in markets are not arbitrary — they are reflections of how real people actually value certain goods and services in the real world. Arbitrarily changing the dollar numbers attached to those preferences does not change the underlying reality any more than trimming Cleveland off a map of the United States actually makes Cleveland disappear.“

The minimum wage was the subject of a recent post on Sacred Cow Chips. A higher minimum is a favorite policy of well-meaning leftists and social justice warriors, but they fail to address the realities that the least-skilled suffer adverse employment effects, that a higher minimum wage hastens the substitution of capital for unskilled labor, and that the policy often benefits non-primary workers from middle and upper-income households. It’s a lousy way to help the impoverished. Moreover, minimum wages were originally conceived as a tool of racial exclusion and in all likelihood still act that way. Most of the research supporting minimum wage increases focuses on short-run effects or on sectors that are less capital-intensive. Findings about long-run effects are much more negative (see here, too). It’s a given that Sanders understands none of this.

Other elements of Sanders’ platform are essentially freebies for all: universal health care (see the first link from this Bing search), free college tuition for all, and expanded social security benefits. And of course there is a promise to rebuild our crumbling infrastructure, taking full advantage of the myth that our infrastructure is so decrepit that it must be replaced now. All of these ideas are costly, to say the least, and there is nothing adequate in Sanders’ platform to pay for them. He’ll raise taxes on the 1%, he says. Just watch the capital fly away. Ed Krayewski of Reason discusses Sander’s rich promises and the lack of resources to pay for them in “Bernie Sanders, the 18 Trillion Dollar Man“:

“The Wall Street Journal spoke with an economist at the liberal Center on Budget and Policy Priorities, who acknowledged taxes would have to go up for the middle class too to pay for Sanders programs.“

Middle class tax hikes would undoubtedly be accompanied by a lot more public debt, and ultimately inflation. Freebies for whom? As Krayewski says, Sanders “wants taxpayers to ‘feel the Bern’“.

In fairness, Sanders suggests that some of the needed revenue can be diverted from military spending. Possibly, but the military budget has already been reduced significantly, and it is not clear that much fat remains for Sanders to cut. There will certainly be demands for greater military spending given the significant threats we are likely to face from rogue states.

Sanders’ promise to transform our energy system is another one that will come with high costs. What Sanders imagines is a widespread fallacy that green energy can be produced at little cost. However, we know that renewables carry relatively high distributed costs and their contributions to load are intermittent, requiring base load backup from more traditional sources like fossil fuels or nuclear energy. Like President Obama, Sanders would impose new costs on fossil fuels, but the poor will suffer the most without offsetting assistance. And subsidies are also required to incent greater adoption of expensive alternatives like home solar and electric vehicles. Sanders would authorize this massive diversion of resources for the purpose of mitigating a risk based on carbon-forcing climate models with consistent track records of poor accuracy.

If free speech is your hot button, then Sanders’ promise to “overturn” Citizen’s United won’t make you happy. Why should an association of individuals, like a union or a corporation, be denied the right to use pooled resources for the purpose of expressing views that are important to their mission? Sanders is proposing an outright abridgment of liberty. From the first Kevin Williamson link above:

“… criminalizing things is very much on Bernie’s agenda, beginning with the criminalization of political dissent. At every event he swears to introduce a constitutional amendment reversing Supreme Court decisions that affirmed the free-speech protections of people and organizations filming documentaries, organizing Web campaigns, and airing television commercials in the hopes of influencing elections or public attitudes toward public issues.“

It is hard to take issue with Sanders’ call for an end to police brutality without a clear sense of his attitude toward law enforcement. I believe all fair-minded people wish for zero police brutality, but critics often minimize the difficulty of police work. No doubt there are gray areas in the practice of law enforcement; some police officers take their powers too far, which cannot be condoned. If institutional reforms can help, so much the better. But the police must be given the latitude to do a difficult job without fear of unreasonable legal reprisal.

On a related note, Sanders advocates an end to the war on drugs, a reform that I wholeheartedly support. Go you Bernie!

Finally, here is a more general illustration of Bernie Sanders’ backward views on economics. It is a Sanders quote I repeat from the second Kevin Willamson link above:

“You don’t necessarily need a choice of 23 underarm spray deodorants or of 18 different pairs of sneakers when children are hungry in this country. I don’t think the media appreciates the kind of stress that ordinary Americans are working on.“

Sanders’ complaint about the plethora of choices in consumer goods fails to recognize that they reflect real differences in consumer preferences, as well as an economy dynamic enough to provide for those preferences. Far from causing hunger and poverty, that dynamism has lifted standards of living over the years across the entire income distribution, even among the lowest income groups, to levels that would astonish our forebears. And it created the wealth that enables our society to make substantial transfers of resources to low income groups. Unfortunately, those very transfer programs are rife with incentives that encourage continued dependency. Other government interventions such as the minimum wage have diminished opportunities for work for individuals with little experience and skills. Meanwhile, regulation and high business and personal taxes undermine the continued growth and dynamism of the economy that could otherwise lift more families out of dependency. Sanders would do better to study the history of socialism in practice, and to look in his own socialist mirror to identify the reasons for persistently high levels of poverty.