Inflation Or Lockdown Whiplash?

Inflation or Lockdown Whiplash

Mainstream analysis sees rising consumer prices and looks for a monetary cause. Also, when it sees an increase in the quantity of dollars, it looks for rising consumer prices.

It is a fact that the quantity of what the mainstream calls money (i.e. the dollar) has risen at an extraordinary rate. The M0 measure has nearly doubled since the start of Covid. It is also a fact that many prices have jumped up significantly.

So only one question is open for debate. Is inflation transitory as Fed apologists claim? Or is it now running away, as Fed critics worry?

The wrong question about inflation

We think this is the wrong question. Bear with us as we review some ideas we’ve discussed previously (though in a new light). We will add some new ideas and then get back to the present question about prices.

We have written a lot of material about nonmonetary forces that drive up prices. We coined a term for the most common one: useless ingredients. This is when a regulator forces producers to literally or figuratively add stuff to their products, which consumers do not value (and often do not even know about).

For example, a baker bakes bread using the well-known ingredients of flour, water, and yeast. But a regulator forces him to add a preservative. Presto, the price of a loaf jumps 10%. The consumer price index also jumps 10% (assuming that regulators of the other goods in the basket measured by the index are also adding useless ingredients). People say “aah, inflation” and point to a chart of M0 or M3 or whatever, and nod sagely.

This is not a monetary phenomenon.

Inflation is always and everywhere a monetary phenomenon Milton Friedman

It was not caused by the Fed. The Fed should not do anything differently from what it was previously doing (ceding, for argument’s sake that the Fed should ever be doing anything, or even exist at all). Interest rates should not change. Investors should not demand higher returns (assuming they weren’t disenfranchised in our regime of irredeemable currency). One should not say that the dollar’s purchasing power is lessened. The dollar is buying just as much as it did before. Only now, some of what it buys is stuff that the consumer does not want, and may not even know is in the bread, i.e. calcium propionate.

We have written that when interest rates fall, it both enables and forces producers to borrow more to increase production. For example, the interest rate is 5%. The baker does not think it will be profitable to borrow to buy more ovens to bake more bread. Then the interest rate drops to 4%. Now it is profitable. So the baker borrows and expands. Unfortunately, so do his competitors. Unless the public increases its appetite for bread, the price must inevitably drop.

The same thing happens with oven manufacturers and every other producer of goods. Lower interest rates are an incentive to borrow more to build more plants to produce more goods.

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Disclaimer: The content in this article is provided as general information and for educational purposes only and should not be taken as investment advice. We do not guarantee the accuracy ...

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