Why I Was Wrong About Inflation


Back in 2007, I was much more interested in finance and trading than I was in macroeconomics. When the crisis — and the government’s macroeconomic response to the crisis — began in 2008 what was really needed to get a strong grasp of the situation was an understanding of macroeconomics, which I did not have as it was a topic I only really began studying in depth at that time. This led to some misconceptions, particularly about inflation. I mistakenly assumed — as did many at the time, and as do many today — that the huge expansion of the monetary base would lead to stronger inflation than the timid and low inflation we have seen in years since the programs began. While I strongly doubted the claims of individuals like Peter Schiff that hyperinflation might be nigh — as I understood that most historical hyperinflations occurred due to a collapse in production, not solely due to money printing — I thought a strong inflationary snapback was likely, Why? A mixture of real effects and expectations. If central banks are printing money at a higher rate, people will fear that money is becoming less scarce. If having more money in circulation does not begin to bid prices upward, producers will soon begin to raise prices to anticipate any such rise. Simply, I thought that central banks couldn’t print their way out of disaster without some iatrogenic side-effects. I assumed the oncoming pain was unavoidable, and that the onset of inflation was the price that would be paid. As Ludwig von Mises put it: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

So why did that not occur? After all, plenty of internet goldbugs — and very serious people following the advice of people like John Taylor, Eugene Fama, and Niall Ferguson — were talking about the potential for a strong inflationary shock. The gold price was soaring — hitting a peak above $1900 an ounce in September 2011 — as people anticipating inflation sought to buy insurance against it. Well, for a start it seems like the public did not really buy into the notion of an oncoming inflationary shock. Expected inflation as measured by the University of Michigan has remained very close to the post-1980 norm since the crisis:


But above and beyond this, the real monetary effects were not the ones I first assumed them to be. The total money supply — most of which is generated not by the Fed but in the private sector through lending — has been stagnant, even while the Federal Reserve is expanding the monetary base. So while the financial sector is flush with cash and has bid the stock market up above its pre-recession nominal peak, other goods in other sectors just have not had enough of a bid behind them to send inflation strongly upward because other areas of the economy (for instance housing, consumer electronics and real wages) have continued to deflate in the context of continued deleveraging, accelerating offshoring driving down wages and the receding effects of the 2008 oil shock.

Yet even more importantly the supply of goods in the West — flowing as it does from East to West, from the factories of the Orient to the consumers of the West — has remained strong and stable. There has been no destabilising, chaotic Chinese crash or revolution, even though many wished there would be in the wake of the Arab spring. And for all the talk by the Chinese and Russians of bond vigilantism, starting a new global reserve currency and dumping the dollar, that has not happened either. And why would it? Certainly, the Asian bond-buyers might have suffered a few years of negative real interest rates. This might have pissed them off. But undermining the Western recoveries further (which have been quite pathetic thus far) when such a high proportion of their assets — dollars and treasuries and increasingly real assets like land and industrials — are related to the economic performance of the West would be to cut off their nose to spite their face, while simultaneously risking conflict with the American military, whose capabilities remain unmatched. The Chinese and Russian talk of de-Americanisation and a post-American world is all bluff and bluster, all sound and fury signifying very little. In the long run, America will have to accept a world where it is no longer the sole global superpower, but there is no incentive for America’s competitors to hasten that way with the kind of aggressive economic warfare that might cause an economic shock.

On the other hand, it is certainly true that much of the new money entering the system is sitting as excess reserves. Is that a symptom of the inflation simply being delayed? Until the middle of last year I thought so. Now I very strongly doubt it. The existence of excess reserves in the system is not a symptom of stored-up future inflation, but a symptom of the weakness of the transmission mechanism for quantitative easing. Simply, the system is in a depression. The banking system is infected with a deep paranoia, and would prefer to sit on risk-free cash instead of lending money to businesses. If the money was lent out, there would be an increased level of economic and business activity. Therefore there is no guarantee of any additional inflation as the money is loaned out.

So I was wrong to worry that inflation could become an imminent problem. But I was wronger than this. The entire paradigm that I was basing these fears upon was flawed. Simply, I was ignoring real and present economic problems to worry about something that could theoretically become a problem in the future. Specifically, I was ignoring the real and present problem of involuntary unemployment to worry about non-existent inflation and non-existent Asian bond vigilantes. The involuntariness of unemployment is a very simple fact — there are not enough jobs for the number of jobseekers that exist, and there hasn’t been enough jobs since the crisis began. Currently there are just over three job seekers for every job. So unemployment and underemployment are not simply things that can be dismissed as a matter of workers becoming lazy, or preferring leisure to work. Mass unemployment has insidious and damaging social effects for individuals and communities — people who are out of work for a long time lose skills. For communities, crime rises, and health problems emerge. And there are 25 million Americans today who are either unemployed or underemployed as a practical matter it is not simply a case of sitting back and allowing the structure of production to adjust to the new economy. And worse, with unemployment high, spending and confidence remain depressed as the effects of high unemployment create a social malaise. This is a mass sickness — and in the past it has led to the rise of warmongering political figures like Hitler. So while it may be preferable for the private sector to be the leading job creator under ordinary conditions, while the private sector is engaging in heavy deleveraging this is impractical. Under such an eventuality the state is the only institution that can break the depressionary trend by creating paying jobs and fighting back against the depressionary tendency toward mass unemployment. Certainly, centralised bureaucracy can be a troublesome and distortionary thing. But there are many things — like mass unemployment and underemployment, and the social problems that that can bring — worse than centralised bureaucracy. And no — this kind of Keynesianism was not the problem in the 1970s.

By worrying over the potential for future inflation or future bond vigilantism due to monetary and fiscal stimulus, I was contributing to the problem of mass unemployment, first of all by not acknowledging the problem, and second by encouraging governments and individuals to worry about potential future problems instead of real-world problems today. As it happened, a tidal wave of evidence has washed these worries away. It is clear from the economic data that inflation is not a concern in a depressionary economy, just as Keynesian-Hicksians heuristics like IS/LM suggested.

Of course, if the depression ends of its own accord then inflation could become a problem again.  If the United States were to experience a strong unexpected spurt of growth sustained over a year or so, pushing unemployment significantly down and growth significantly up, inflation could rise appreciably. The Federal Reserve would have to quickly taper both its unconventional policies and probably begin to raise rates. Of course, that is rather unlikely in the present depressionary environment. But certainly, it is a small possibility. That would be the time for the Federal Reserve to start to worry about inflation. A strong negative energy shock — like the one experienced by the UK in 2010 and 2011 — could push inflation higher too, yet that would be a transitory factor in the context of the wider depressionary environment, and would most likely fall back of its own accord.

If the Fed was engaging in actual helicopter drops — the most direct transmission mechanism possible — there would likely be a stronger inflationary response than that which we have seen thus far. Yet ultimately, this might prove desirable. After all, if the private sectors of the entire Western world have a very large nominal debt load which they are struggling to deleverage, some stronger inflation would certainly begin to minimise that. Yes, that is redistribution from lender to borrower. No, creditors will not be happy about this. But in the end, creditors may find it easier to take an inflationary haircut than face twenty years of depressionary deleveraging as Japan has done. Although the West certainly does not have the same demographic troubles as Japan, such an outcome is possible unless people — governments, entrepreneurs, individuals, society — decide that unemployment and a lack of demand in the economy must be tackled, and do something about it. Then can we confidently expect to climb out of the lip of the deleveraging trap.


“Get Your Money Out While You Can”

One can only wonder how long it will take before Europeans particularly in Spain, Greece and Italy, begin to take that advice.

The Euro system amplifies shocks. Monetary union without fiscal union, economic integration without high levels of interstate mobility, enforced austerity in the weakest economies. And now the precedent of deposit confiscation. The only indicator that seems to be rising throughout the Eurozone is the number of protest signs comparing Angela Merkel to Hitler.

Romano Prodi famously noted that the Euro system was weak, and that necessary reforms would be made when the time came in order to make it sustainable. Well, the Cyprus bailout and deposit levy, the national and international outcries and the subsequent “no” vote in the Cypriot parliament are all signs that in the wake of all the bailouts of the periphery that Europe is far from fixed. The necessary measures have not been taken. While the ECB may have taken measures to lower government borrowing costs in the periphery, the situation is in many ways — especially unemployment — still deteriorating. In fact, it seems like Eurocrats are trying to enforce the opposite of what might be necessary for sustainability — rather than installing a mechanism to transfer money to weakened economies suffering from high employment, Eurocrats seem to be trying to do everything to drive unemployment higher in the periphery, spark bank runs, as well as aggravate tensions with Russia.

This is a crisis of institutions and a crisis of leadership as well as a crisis of economics. Merkel cannot lead Europe and Germany at the same time, because taking steps to revive the ailing Southern economies hurts her standing with the German and Northern public.

The Eurocrats have asked for a bank run by demanding depositor haircuts in Cyprus. The public would not be at fault for giving them one. Farage’s advice is wise.

The Face of Genocidal Eco-Fascism

I am not exaggerating.

This is Finnish writer Pentti Linkola — a man who demands that the human population reduce its size to around 500 million and abandon modern technology and the pursuit of economic growth — in his own words.

He likens Earth today to an overflowing lifeboat:

What to do, when a ship carrying a hundred passengers suddenly capsizes and there is only one lifeboat? When the lifeboat is full, those who hate life will try to load it with more people and sink the lot. Those who love and respect life will take the ship’s axe and sever the extra hands that cling to the sides.

He sees America as the root of the problem:

The United States symbolises the worst ideologies in the world: growth and freedom.

He unapologetically advocates bloodthirsty dictatorship:

Any dictatorship would be better than modern democracy. There cannot be so incompetent a dictator that he would show more stupidity than a majority of the people. The best dictatorship would be one where lots of heads would roll and where government would prevent any economical growth.

We will have to learn from the history of revolutionary movements — the national socialists, the Finnish Stalinists, from the many stages of the Russian revolution, from the methods of the Red Brigades — and forget our narcissistic selves.

A fundamental, devastating error is to set up a political system based on desire. Society and life have been organized on the basis of what an individual wants, not on what is good for him or her.

As is often the way with extremist central planners Linkola believes he knows what is best for each and every individual, as well as society as a whole:

Just as only one out of 100,000 has the talent to be an engineer or an acrobat, only a few are those truly capable of managing the matters of a nation or mankind as a whole. In this time and this part of the World we are headlessly hanging on democracy and the parliamentary system, even though these are the most mindless and desperate experiments of mankind. In democratic coutries the destruction of nature and sum of ecological disasters has accumulated most. Our only hope lies in strong central government and uncompromising control of the individual citizen.

In that sense, Linkola’s agenda is really nothing new; it is as old as humans. And I am barely scratching the surface; Linkola has called for “some trans-national body like the UN” to reduce the population “via nuclear weapons” or with “bacteriological and chemical attacks”.

But really he is just another freedom-hating authoritarian — like the Nazis and Stalinists he so admires — who desires control over his fellow humans. Ecology, I think, is window-dressing. Certainly, he seems to have no real admiration or even concept of nature as a self-sustaining, self-organising mechanism, or faith that nature will be able to overcome whatever humanity throws at it. Nor does he seem to have any appreciation for the concept that humans are a product of and part of nature; if nature did not want us doing what we do nature would never have produced us. Nature is greater and smarter than we will probably ever be. I trust nature; Linkola seems to think he knows better. As George Carlin noted:

We’re so self-important. Everybody’s gonna save something now. Save the trees. Save the bees. Save the whales. Save those snails. And the greatest arrogance of all, save the planet. What? Are these fucking people kidding me? Save the planet? We don’t even know how to take care of ourselves yet. We haven’t learned how to care for one another and we’re gonna save the fucking planet?

There is nothing wrong with the planet. The planet is fine. The people are fucked. Difference. The planet is fine.

Linkola and similar thinkers seem to have no real interest in meeting the challenges of life on Earth. Their platform seems less about the environment and more about exerting control over the rest of humanity. Linkola glories in brutality, suffering and mass-murder.

Now Linkola is just one fringe voice. But he embodies the key characteristic of the environmental movement today: the belief that human beings are a threat to their environment, and in order for that threat to be neutralised, governments must take away our rights to make our own decisions and implement some form of central planning. Linkola, of course, advocates an extreme and vile form of Malthusianism including genocide, forced abortion and eugenics.

But all forms of central planning are a dead end and lead inexorably toward breakdown; as Hayek demonstrated conclusively in the 1930s central planners have always had a horrible track record in decision making, because their decisions lack the dynamic feedback mechanism present in the market.  This means that capital and labour are misallocated, and anyone who has studied even a cursory history of the USSR or Maoist China knows the kinds of outcomes that this has lead to: at best the rotting ghost cities of China today, and at worst the mass starvation of the Great Leap Forward resulting in millions of deaths and untold misery.

Environmentalists should instead pursue ideas that respect individual liberty and markets. There is more potential in developing technical solutions to environmental challenges than there is in implementing central planning.

If we are emitting excessive quantities of CO2 we don’t have to resort to authoritarian solutions. It’s far easier to develop and market technologies (that already exist today) like carbon scrubbing trees that can literally strip CO2 out of the air than it is to try and develop and enforce top-down controlling rules and regulations on individual carbon output. Or (even more simply), plant lots of trees and other such foliage (e.g. algae).

If the dangers of non-biodegradable plastic threaten our oceans, then develop and market processes (that already exist today) to clean up these plastics.

Worried about resource depletion? Asteroid mining can give us access to thousands of tonnes of metals, water, and even hydrocarbons (methane, etc). For more bountiful energy, synthetic oil technology exists today. And of course, more capturable solar energy hits the Earth in sunlight in a single day than we use in a year.

The real problem with centrally-planned Malthusian population reduction programs is that they greatly underestimate the value of human beings.

More people means more potential output — both in economic terms, as well as in terms of ideas. Simply, the more people on the planet, the more hours and brainpower we have to create technical solutions to these challenges. After all, the expansion of human capacity through technical development was precisely how humanity overcame the short-sighted and foolish apocalypticism of Thomas Malthus who wrongly predicted an imminent population crash in the 19th century.

My suggestion for all such thinkers is that if they want to reduce the global population they should measure up to their words and go first.

The Great Crunch

From Bloomberg:

[Today[ U.S. stocks fell, capping a fourth straight weekly slump for the Standard & Poor’s 500 Index, as the cheapest price-earnings ratios since 2009 failed to lure investors amid concern the global economy is weakening. The yen touched a post-World War II high against the dollar.

The S&P 500 dropped 1.5 percent to 1,123.53 at 4 p.m. in New York, after rising as much as 1.2 percent. The Stoxx Europe 600 Index fell 1.6 percent to its lowest close since July 2009. The Japanese yen reached 75.95 per dollar, its strongest postwar level as investors sought refuge in the currency. Oil fell 0.1 percent as it also swung from gains to losses. Gold futures topped $1,880 an ounce for the first time. Ten-year Treasury yields were unchanged after reaching a record low yesterday.

Citigroup Inc. and JPMorgan Chase & Co. lowered their growth forecasts for the U.S. economy. German Chancellor Angela Merkel stepped up her rejection of jointly issued euro-area bonds, following speculation the European Union will start joint bond sales. Technology stocks in the S&P 500 retreated 2.8 percent, the most among a group of 10 in the index, as Hewlett- Packard Co. slumped 20 percent, its biggest drop since at least 1980.

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Market Massacre

Just yesterday, this publication concluded:

The key theme [in identifying contemporary economic problems and solutions] is that these are structural and systemic failures, and not ones that can be addressed by panicking and “saving the system”. No matter how much money we inject into markets, unless bad ideas are allowed to fail, and good ones to prosper, unless bad investments result in losses, and good ones in gains, unless bad decisions result in failure, and good ones in reward, then all of that money is wasted. If anything, we need bad systems to break. We should take the consequences, and start rebuilding more robust systems.

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