I will try to provide a combined response to Wendy and Leap1 since there are overlapping factors related to some of their questions.
First, Wendy’s question referred to “secular inflation”, a term used to distinguish between influences stemming from millions of individual decisions of people IN an economy from the influences controlled by a relatively small number of policy makers and central bankers controlling “knobs” on the overall machine. The “secular” factors are thought of as providing reinforcing feedback as expectations of future inflation are incorporated into labor contracts, material contracts, interest rates on bank loans, etc. These secular factors thus contribute to inflation by trying to keep up with it. Because of this, when I hear the term “secular inflation”, I presume people are referencing inflation present for years because of those baked in human expectations which are very difficult to counteract.
The point of my post was that what might normally be analyzed as one-time “physical” shocks are likely to become an ongoing source of upward inputs into overall inflation. Rather than thinking of the inflation number at any point in time as ONE number due to ONE cause, we need to think about inflation in layers. Each layer’s thickness will vary over time but tackling the entire inflation number as though purely caused by faulty monetary policy (money’s too easy, raise rates) or caused purely by supply / demand shocks (spending stimulus) will worsen the situation.
The original post addressed two of the biggest factors getting people’s attention related to inflation – energy prices and wage rates. The news runs trite stories about “pain at the pump” and restaurants having to pay $15-19/hour to get anyone to show up to work, triggering price spikes for dining, etc. Those have very direct causes which have nothing to do with the hundreds of billions pumped into the economy by covid recovery programs. They stem from the supply of something being drastically reduced (shutdown of wells or fracking sites or people leaving specific job functions due to poor conditions, stress, etc.) or hundreds of thousands of workers DYING and being unavailable at any price in the labor market.
There are other factors at work which I expect will also contribute to ongoing higher inflation. As a worst case example, the worst kind of shock shifts BOTH supply and demand curves. Wars are a perfect example of this type of shift. The war in Ukraine is increasing the demand for steel in the short term (for use in weapons) and in the longer term (for eventual reconstruction of homes, businesses and infrastructure for at least 10 million people). But the same war is reducing supply for steel by destroying steel plant capacity in Ukraine and dislocating workers in the entire supply chain required to produce it. If you take the classic upward sloping demand curve and downward sloping supply curve and move them both to reflect an across the board increase in demand AND reduction in supply, the equilibrium price goes up.
Here in America, the skyrocketing pump prices have more people considering electric vehicles when they might not have previously when gas was $2.40/gallon. Can everyone suddenly interested in getting an electric car who was already in the market for a new car obtain one? Not at all. There is still a finite manufacturing capacity for the underlying battery packs and there are underlying supply issues for the rare earth metals needed by those battery plants. There may be enough capacity in those systems to go up 50% or 100% but probably not 5x or 10x. Until those supply issues for raw materials are corrected, what’s a car maker going to do if they only have enough batteries for (say) 400,000 cars? Do they put them in the $27,000 car for high mileage commuters and new grads that have profit margins of maybe $2000 per car? Or do they put them in the $80,000 luxury SUVs that have a profit margin of $15,000 per car and buyers who can afford following the price curve up? They put them in the highest margin cars with the least price sensitivity and there you go… Average car prices skyrocket.
The US car market is about 15 million new vehicles per year. If ALL of those buyers wanted to buy a new electric car and the cars were available, do we have enough electricians to spend a day installing a charging port in the garage of each of those new car buyers? There are 625,000 electricians in the US today but they’re already pretty busy on home construction and existing work. If the volume of electric car sales skyrockets and electrician rates jump to attract more electricians into the field to do the work, that will look like inflation but has nothing to do with monetary policy.
Wendy pointed out a couple of interesting statistics. First, the jump in the M1 money supply reflected in monthly statistics after the covid relief programs were passed showed that many Americans didn’t go out and chase new toys with handout money, they simply banked it. One reason we didn’t see prices spike immediately in March/April of 2020 was that businesses were burning off existing inventories which, while thin by design, still provided some slack to handle demand for 4-6 weeks. Remember, everyone thought lockdowns would only last a few weeks, right? Instead of driving up prices for tangible goods, having that money in checking / savings accounts gave it to banks to chase short term asset plays trying to find something they could use to make easy money with OPM (Other People’s Money).
The second factor Wendy highlighted for review is the graph of interest rates on 5-year treasures from the St. Louis Federal Reserve. From looking at it, the only thing I can surmise from it is that those rates reflect an assumption that the biggest component causes in inflation right now are politically external (cough… Ukraine/Russia) and will not likely continue on longer than a year. My take is that they are not factoring in rebuilding costs and secondary political upheavals if territory has to change hands and millions require permanent relocation. I further think an assumption of lower inflation five years out is ignoring the possibility of other events I’ll call predictable black swans – economic events with generally large costs that cannot be forecasted exactly in magnitude or time but can be predicted thematically (see below).
While trying to avoid politics, I think there are other causes of inflation that have roots in long-standing policies that have not undergone sufficient review. For example, seeing housing prices (homes and rentals) rise 20% for consecutive years reflects major market failures being exacerbated by incoherent government policies at the local, state and federal levels:
- NIMBY restrictions desired by CURRENT homeowners to limit NEW home construction nearby
- construction labor market constraints due to both covid and immigration policy
- huge quantities of homes being bought up by a new round of flippers / financial speculators
As a different sub-topic, another factor I feel will contribute to longer term inflation is climate change and near-term natural disasters stemming from it. Each new record hurricane or western wildfire that destroys 1,000 or 10,000 or 50,000 homes acts as another supply / demand shock, simultaneously creating a spike in demand while often reducing supplies of materials and labor. Philosophically, it might be a positive to have 50,000 homes that are 50 years old with ancient, inefficient HVAC and insulation replaced with homes filled with state-of-the-art, highly efficient components but imposing that demand as a square wave will always trigger inflation both for the materials and construction of those units and for temporary housing somewhere else in the meantime.
In general, I try to think of these processes like an engineer thinks of control systems with inputs, outputs and positive / negative feedback loops to respond to input changes without immediately halting or generating oscillations that feed upon themselves and eventually destroy the system. Or, I think of these processes like a CFO of a large, complex company, trying to figure out how much cash to retain inside the company to modernize “the plant” versus how much to shovel out to shareholders. Starve the plant of re-investment and the shareholders may be happy in the short term but your products will age and your productivity will decline and you’ll go out of business. Spend too much cash internally covering inefficient operations and the shareholders dump your stock and you cannot attract new investment to eventually modernize when you absolutely need to. You have to find a balance.
Unfortunately, as Leap1 pointed out, perhaps the biggest knob in the machine we can adjust – tax rates on the uber-wealthy – have been left at levels that are insufficient to fund modernization of all of the cogs and wheels inside the machine that produces value for us all. We are running on infrastructure that is 70 to 100 years old. It is failing or completely beyond its capacity (hello Texas electric grid operators!) and we seem to be lacking any recognition that very painful / disastrous / EXPENSIVE failures are days / weeks / months away, not years or decades.
Finally, there is a famous quote in macro / financial circles that “Inflation is always and everywhere a monetary phenomenon…” Most people leave it at that. The full quote from Milton Friedman is “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can only be produced by a more rapid increase in the quantity of money than in output.” In my view, the full quote is wrong. If inflation is measured by tracking the cost of a basket of goods over time and you have non-monetary forces like natural disasters, epidemics and technology advances altering the supply of or demand for goods in that basket, inflation can result without anyone firing up printing presses.
As Wendy pointed out, a key concern now is that the Fed seems intent on doing SOMETHING cuz by golly, their mission in life is to deliver “moderate” inflation (not too low to encourage bubbles, not too high to tank growth). Much of what we will be seeing won’t be caused by monetary decisions. Unfortunately, other players with knobs under their control don’t seem willing / able to tweak those knobs to adjust to the square wave changes in inputs. Since the Fed doesn’t have to run for office and feels more freedom to act, they are turning the only knob they control in the machine and it is likely NOT the knob we need tuned. Or, more charitably, it may help them chase some of the froth out of the economy but it will be insufficient to re-capitalize key segments of the economy to correct systemic imbalances and massive underspend for infrastructure.
WTH