Daniel Lacalle – October 24, 2021
No government looking to massively expand its size in the economy and monetize a soaring deficit is going to act against rising prices, despite claiming the opposite.
One of the things that surprises citizens in Argentina or Turkey is that their populist governments always talk about the middle classes and helping the poor, yet inflation still soars, making everyone poorer.
Inflation is the gradual erosion of the purchasing power of the currency. Governments will always use different excuses to justify inflation: soaring demand, “supply chain disruptions,” or evil corporations’ greed. However, most of the times these are excuses. Inflation is always a monetary phenomenon. Prices soar because money supply rises massively above real output and real money demand.
How can there be “shipping bottlenecks” driving a 100 percent rise in freights when the shipping industry was burdened by massive overcapacity in 2019? How can anyone say that natural gas and oil have soared due to supply chain disruptions when supply has perfectly followed demand? The reality is that some of those factors may explain a small proportion of the price rise, but the Global Food Index and Bloomberg Commodity Index are not at multiyear highs due to these problems.
What happened in 2020 was that massive money creation in the middle of an economic lockdown created monetary inflation in nonreplicable and relatively scarce goods and services. Why did this not happen before?
Well, it did. Before, we saw a massive rise in asset prices. Inflation is created where the excess of money goes, be it soaring equity, and high yields in bond markets or all-time high housing and private equity valuations. More money chasing the same number of goods. Furthermore, there was also massive inflation in essential goods and services. The prices of housing, healthcare, and education rose significantly above the official Consumer Price Index (CPI) print.
Why has it burst so aggressively now? First, massive money printing in the middle of a lockdown kept asset valuations elevated but also started to generate fund flows to scarce—so-called value—sectors. And what are “value sectors”? Those that suffered overcapacity and weakening demand growth in the past decade. So, more money flowed to oil, natural gas, even coal or aluminum, where the industry was plagued by excess capacity in the decade of cheap money.
Inflation does not happen the next day you print money. It is a slow process of gradual erosion of the purchasing power of the currency that started years ago and culminated with the insane decision to implement monster demand-side policies (huge government spending and money printing) in the middle of a lockdown.
But why do governments ignore it? Why do they not act? Surely it is in their best interest to keep prices low and consumers—voters—happy. The answer is simple: because governments are the biggest beneficiaries of inflation. They collect more receipts from indirect taxes and their soaring debt is slowly eroded by inflation.
Furthermore, governments never act against inflation, because they benefit from it and, more importantly, can blame it on everyone except their policies. Even in Argentina, where inflation is higher than 50 percent and ten times higher than in neighboring countries, citizens are slowly convinced that there must be other causes than money printing. Even when presented with the evidence of a central bank that has raised money supply more than 120 percent in two years with diminishing demand, the press and politicians blame inflation on “multicause” effects. A joke.
Take the recent comments about soaring prices in the United States from the US administration.
White House chief of staff Ron Klain said that inflation was a “high-class problem” and, when confronted, Jen Psaki, press secretary, replied that people buying more things than ever before were the cause of inflation. However, in the latest figure, real consumer spending is down to 1 percent annualized in the United States, according to Capital Economics.
National Economic Council director Brian Deese said that if you deducted the rise of beef, pork, and poultry, price increases were normal. “If you take out those three categories, we’ve actually seen price increases that are more in line with historical norms.” So, if you deduct the price increase of the things you eat every day and eliminate the price of the things you buy, there is no inflation, right?
All are using the usual excuses. Blame businesses for higher prices (evil pork and chicken farmers, evil shippers and port managers), blame consumers (you buy too much too fast), and smile, saying they really care and are working on it … Printing and spending more.
The rhetoric about “transitory” inflation remains, both in governments, who are unwilling to reduce massive spending, and in central banks, who are caught between a rock and a hard place, as they have to monetize soaring deficits from highly indebted governments and at the same time defend their strategy of “price stability.” Between those two, guess what they have decided to opt for? Yes, keep printing and say some day it will pass.
The problem of the “transitory inflation” argument is that it is a fallacy when you look at accumulated inflation. If the Consumer Price Index rise is 5 percent in 2021 and, say, 3 percent in 2022, they will say that inflation is down, but you and I will have seen our real wages and savings eroded by more than 8.1 percent. Even worse, if inflation rises above 6 percent in 2021 and comes in below 2 percent in 2022, you and I will have lost also more than 8.1 percent in purchasing power, but central banks will say they have to print more to “combat deflation risks.”
Interventionist governments are unwilling to cut spending or reduce deficits substantially, so they will use the inflationary tax knowing that they can use the usual excuses: 1) say there is no inflation if you eliminate the prices that rise, 2) say it is transitory, 3) blame businesses, 4) blame consumers, 5) present themselves as the solution with “price controls.”
Inflation is taxation without legislation, as Milton Friedman said. There is no such thing as “multicause” inflation. It is a lot more money going to the same number of goods. And the inflation tax is increasing the size of government in the economy both ways: through massive deficit spending and eroding the purchasing power and savings of the private sector through currency debasement.
Originally published at Mises.org. Daniel Lacalle, PhD, economist and fund manager, is the author of the bestselling books Freedom or Equality (2020), Escape from the Central Bank Trap (2017), The Energy World Is Flat (2015), and Life in the Financial Markets (2014). He is a professor of global economy at IE Business School in Madrid.
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