With the recent spike in the 10 year bond yield, many are talking about the prospect of increasing inflation in the very near future.
Goldbugs and permabears have been predicting Weimar Germany-levels of hyperinflation since 2009, and while they’ve been continually proven wrong for over a decade, this time, they claim, they’re right: we’re about to see massive inflation in the US.
Maybe not hyperinflation, but the bottom line, they say, is that the chickens will soon come home to roost for all this money printing and stimulus.
Are they right? Only time will tell, obviously, but I wanted to get into the concept of inflation before looking into the original question.
Most people know that inflation is simply generally rising prices over an extended period of time that causes the dollar’s value to weaken, in other words it means dollars don’t go as far anymore.
But in practice, inflation is not an equal rise in prices across the board. It’s not like everything in the economy goes up in price by the same percent when inflation is “happening.” It’s uneven, and oftentimes as certain things are going up in price, other things are actually getting cheaper over time.
Take college tuition for example: college tuition prices since 1977 have far outpaced the rate of inflation over the same time period, meaning college has gotten significantly more expensive over the past 43 years in real terms.
This is what I’m talking about: inflation in and of itself isn’t necessarily a bad thing, but when the price of a specific good or service outpaces inflation, then this is a bad thing.
True inflation is when something has increased in price by more than the actual inflation rate itself, like college tuition.
Here’s another example: tickets to Disney World. By 2022, the average price of a one-day ticket to Disney world will be $135. In 1971, a ticket to Disney World cost $3.50.
Now, of course we all know that $3.50 in 1971 went a lot further than $3.50 today. So I went on the inflation calculator website and found that $3.50 in 1971 is equal to $22.61 in 2021 dollars. So in today’s terms, a ticket to Disney World used to cost about $22.
So the inflation rate since 1971 has been about 545%. But the price of a ticket to Disney World has gone up over 3,700%. Now, of course Disney World today is a whole different experience than it was in 1971. But the point is that Disney World is supposed to be a destination for middle class families; it’s suppose to be attainable. But nowadays it costs an arm and a leg to go to Disney World.
So what we’re really concerned with here is which goods and services have gotten more expensive in real terms over time. Which goods and services have outpaced inflation, and which haven’t?
And why would some things get cheaper over time while other things get pricier?
Productivity and innovation are deflationary forces against price inflation. When something can be mass-produced cheaply, it goes down in price. And in the industrial age, we as a society have figured out how to produce many essential goods and offer essential services in mass quantities and at low cost.
Take clothing, for example. This is an area where something got significantly cheaper over the years. Clothing is incredibly cheap in America nowadays–even nice clothing, which you can get on discount at a place like TJ Maxx. Walmart and Target have very affordable clothing.
In 2021 America, you have to be really, really, really poor to be wearing rags and not own a pair of decent shoes.
According to this very helpful website which tracks inflation rates in virtually every category of goods and services, clothing has gotten 70% cheaper over the long term.
This doesn’t seem likely to change anytime soon, either, because these days it is so easy to produce mass quantities of clothing extremely cheaply.
In other words, it’s difficult to imagine a situation where clothing suddenly becomes unaffordable for a large number of Americans.
So here’s the results:
What I did here is I took the inflation-adjusted price of a particular good or service over a given period of time (the website has different dates for when it started tracking prices, so I just went as far back as they allowed) and then I divided it by the overall inflation rate, and converted it into a percentage, in order to get the real change in prices of that particular good or service. In the ones where it says, “(item)/2000” it’s the change in real prices since 2000.
The consistent theme here is that things that we have become more efficient at producing have gotten cheaper. Cars, clothing, electricity, TVs, appliances, airfare, coffee–they’re all cheaper today than they were in the past.
And with many of those items, on top of being cheaper, quality and safety are vastly higher today–cars most notably. Not only have cars gotten significantly more advanced technologically, they’re way safer nowadays, and they get much better gas mileage–even though the price of gas is only slightly higher than it was in the 1970s.
What’s really remarkable is that food prices are only up 3.4% since 1913 despite the US population more than tripling.
So then where does all the inflation come from? As I briefly touched on above: the real killers are medical care and college tuition. All items minus medical care are actually down in price by 7% over the long term. Yet overall inflation is up over the long term.
Since 1935, medical care has increased in price by 5,019% against an overall inflation rate of 1,809%. That means medical care has gotten more expensive in real terms by 168% since 1935.
What about in recent decades? The price is still up 38% going back to 1995.
Inpatient medical services have seen a real price increase of 108% just since 1996.
You could make the argument that medical care has improved in quality dramatically over the long-haul, and that would probably be true if you’re talking about 1935-2021. But since the mid 1990s? I doubt medical care has improved enough to warrant the massive real increase in price.
Prescription drugs have decreased by 10% in real terms since 1935, but increased by 21% since 2000.
The point I’m illustrating here is that inflation is not equal across the board. Even though overall inflation goes up, many goods and services actually get cheaper over time.
So we should be more specific about what we mean when we talk about inflation, because there are certain sectors that are more or less immune to it.
There’s inflation, and then there’s real prices. Inflation is where something that costs $10 in 1960 now costs $100. Real prices are how many units you can buy at the same price. Say in 1960 I could buy three widgets for $10. If I can buy three widgets for $100 in 2021, the real price of a widget has not actually increased.
But if I can now buy 5 widgets for my $100 in 2021, then the real price of a widget has actually decreased even though inflation has increased. If I can only buy 2 widgets with my $100 then real price of a widget has increased.
What really matters, i.e. what truly makes people poorer, is if wages don’t increase along with inflation. If inflation goes up in a really short period of time to the point where three widgets go from costing $10 to $100, it only matters if your wages do not go up by a commensurate amount. If widgets go up in price tenfold and my wages also go up in price tenfold, then it’s all good. But if widgets go up in price tenfold and my income does not go up tenfold, then we have a serious problem.
Real world prices are remarkably effective at adjusting to the money supply. If there is a sudden excess of cash in the economy, prices will jump accordingly. It’s not some delayed reaction like the goldbugs and fear-mongers are saying. Money printing in 2009 will not cause hyperinflation in 2021. This is because if people suddenly have excess cash, we’ll see the effects almost immediately if they decide to spend it. If all the money printing in 2020 hasn’t caused inflation by now, it’s unlikely it ever will.
So what happened to all the money that was printed, then? It had to have some sort of inflationary effect somewhere, right?
There are two areas of the economy where we saw massive increases in prices in 2020: the stock market and the housing market. It’s logical to conclude that most of the new money printed by the Fed in 2020 went into the stock market and real estate. We’re not going to see consumer prices start skyrocketing because the vast majority of that money the Fed printed was never going to end up circulating in the “real economy.”
The monetary stimulus went into the stock and housing markets, we’ve got that established. But what about the fiscal stimulus, i.e. the “stimmies” checks the government has sent to people? Those either went into the stock market or towards bills like rent, mortgage, etc. That’s what a study from last year found: 35% of recipients paid down debt, 36% put it in savings, while 29% used it for consumption. This means the vast majority of stimulus money wasn’t just spent frivolously. Of course, some of it undoubtedly was, but most people were smart about it.
I believe the next round of stimulus checks will be a similar story: people will use them to pay down debts, or save.
But even if Americans did use their stimulus checks to spend, would that even be a bad thing? So many businesses in the country have been hurting for the past year. Many have closed down entirely. Would it really be so bad if Americans helped out these ailing local businesses?
And even if people do use their stimulus checks to buy frivolous/”luxury” items like new iPhones, TVs, gaming PCs, clothing, toys, and sporting goods, all that is is pulling future spending into the present–meaning people are buying stuff now they were planning on buying in the future. It’s a one-time surge or spike in consumer spending. That’s not going to send the economy spiraling into runaway inflation.
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Okay, so we’ve established that money printing just inflates the stock and housing markets. And we’ve established that stimulus checks are mainly used to either add to savings or pay down debts, thus having very little effect on inflation. Inflation in 2020 was only 1.4% despite all the money printing and stimulus, after all!
Then what’s the real concern? Obviously “the market” isn’t dumb, people know stimulus won’t send inflation skyrocketing, so why the concern over Biden’s $1.9 trillion stimulus package?
The concern is over-stimulating the economy. A lot of people think $1.9 trillion is too much in light of all of the stimulus from last year. The country will soon be reopening, which is going to be a natural boon to the economy in and of itself, but the fear is that the Biden stimulus will get the economy running too hot, sending inflation up quickly, which will in turn cause the Fed to raise interest rates.
Mr. Biden is motivated in part by Democrats’ belief that former President Barack Obama’s $831 billion stimulus in 2009 was too small. Mr. [Larry] Summers, who helped design Mr. Obama’s package, acknowledges it was only about half the gap between the economy’s output and its potential. Yet Mr. Biden’s is equal to about three times the gap, which Mr. Summers said is “entirely unprecedented territory.”
Many forecasts assume that because social distancing restrictions limit how much people spend, each dollar of Mr. Biden’s stimulus will generate less than a dollar of GDP — that is, the “multiplier” will be less than one. But Olivier Blanchard, former chief economist at the IMF, says the multiplier could easily be much more because the stimulus favors lower-income families, who spend more of their income. Add to that $900 billion of stimulus enacted in December and $1.6 trillion in savings that households have on hand, he says.
“This would be an increase in demand that I have not seen in my lifetime, ” said Mr. Blanchard, an academic who has taught and written extensively on macroeconomics since the 1970s. Indeed, it could drive unemployment down to 1.5%, he estimates.
A 1.5% unemployment rate would equal a roaring economy. So many people would be, in the words of Jean-Ralphio from Parks and Rec, flush with cash that inflation would pick up in a major way.
But Fed Chair Jerome Powell has consistently said that he’s not worried about inflation running too high, he’s worried about the economy returning to full employment, which he projects will happen by about 2023. Until the economy is at full employment and consistently running inflation at 2% or more, the Fed won’t raise rates.
Look, there’s definitely going to be a spike in spending and economic activity once the economy reopens. But I think the idea that it’s going to cause inflation to run out of control is pretty ridiculous. I think it’ll be a temporary spike after reopening, and then things will gradually normalize.
Even if reopening plus Biden’s stimulus do send unemployment down to 1.5%, it’s still not a truly accurate measure of the labor force: it’s not counting the “long-term discouraged” workers who have completely exited the workforce. The U-6 rate will still be fairly high. I think people are overstating the effects a possible 1.5% unemployment rate will have on inflation. A lot of those jobs lost in the recession aren’t coming back; with every recession of the past 20 years, the labor force participation rate goes down permanently even after unemployment returns to decent levels:
So an unemployment rate of 1.5% nowadays is different than an unemployment rate of 1.5% back in say 2004, when labor force participation was much higher.
We have to be realistic about our fears of inflation. Being too concerned about inflation is bad for the economy:
[Jerome Powell] recently noted that unemployment had fallen to 3.5% just before the pandemic. This “did not result in unwanted upward pressures on inflation, as might have been expected,” he said in a speech. “In fact, inflation did not even rise to 2% on a sustained basis.”
Adam Ozimek, chief economist at freelance job site Upwork, estimates that the Fed, by raising interest rates starting in 2015 based on an overestimate of the natural rate of unemployment, cost the U.S. a million jobs.
That sort of cost now weighs heavily on the Fed’s thinking. “We should be less fearful about inflation around the corner and recognize that that fear costs millions of jobs — millions of livelihoods, millions of hopes and dreams,” Mary Daly, president of the Federal Reserve Bank of San Francisco, said in February.
The fixation on inflation often leads to neglect of the unemployment rate. Is it really worth it to sacrifice jobs in order to continually ensure inflation remains low? We’re so scared of inflation running over 2%, but for most of the 1990s, inflation was well over 2%, and it was great for stocks and the overall economy:
A lot of people are afraid that if inflation runs at over 2% then it’ll inevitably get out of control, but where’s the evidence of that? We’ve consistently run over 2% inflation for the past 40 years and in only one year, 1990, did inflation ever get up over 5%. 1990 was the only year since 1981 where inflation was over 5%.
Inflation over 2% will mean the economy is going strong; profits will be rising. Stocks will be going up. Inflation averaged well over 2% in the ’80s and ’90s and it was great for the stock market and the economy.
I think we’ll see a spike in inflation this year, but it’ll be temporary, and only because inflation plunged during the Covid pandemic. It’ll be like a rubberband effect: the further you stretch a rubberband, the harder it snaps back when you let it go. Inflation won’t get out of control because long-term, prices of the most important goods and services (excluding healthcare) are going down due to mass-production and innovation.
The Fed has already assured us rates won’t be rising anytime soon. But investors are still panic selling tech stocks. In my view, people were just looking for an excuse to dump stocks after the massive run-up we saw this past year. When stocks are richly valued like they are now, investors get jittery, fearing the bubble bursting.
We haven’t seen troublesome levels of inflation in 40 years. That means we’re either due, something structurally has changed and now the economy is largely immune to runaway inflation, or the Fed has learned from its past mistakes and now knows how to get inflation under control.
I really don’t think these inflation fears will become reality. For one thing, headline inflation rates are misleading because, as we went over above, inflation varies across different sectors of the economy. For most of the important goods and services, I think they’re pretty much protected from inflation.