The Phenomenon

The Big Picture

“Inflation is always and everywhere a monetary phenomenon” – Milton Friedman

Milton Friedman was a famed Nobel prize economist who contributed greatly to monetary theory. Friedman proposed that inflation was caused by the policy decisions around the money supply. An increase in the supply of money, all else equal, generally led to inflation, or a rise in prices.

Have we witnessed broad inflation over the last decade? Not quite. In certain areas for sure, healthcare and education come to mind. Wide spread inflation has remained elusive. While many expected materially higher, even hyper, inflation due to monetary policy actions taken, in many areas the opposite has occurred. Deflation, has remained the primary concern.

Has the corner been turned? Recently we have seen a fairly significant increase in inflation. Should we expect rising and continued inflation from here?

Have a Plan and a Process!

From the Trenches

“Inflation is policy” – Ludwig Von Mises

No truer statement.

I have discussed in rantings-past the policy goals with inflation. Inflation plays a critical role in our current economic and monetary system. Without it the system has problems. While it seems pretty intuitive that lower prices would be preferred by consumers, deflation wreaks all kinds of havoc on the system.

There are a few types of inflation. Demand driven, supply driven, and last but certainly not least, monetary driven (policy), or the phenomenon as some like to say.

Supply and demand are easy. Not enough supply and high demand, we see prices increase. Either side of the equation can originate the problem. Like most aspects of economics, a balance must be maintained.

What type of inflation are we seeing today? I would call this a supply issue, and it is a “supply shock”. Due to the COVID pandemic, production was disrupted or was off-line, and we are seeing inflation due to this event. There are backlogs of goods, materials, and even services across the economy. It will take some time to correct this imbalance.

The inflation we are seeing today is a supply-shock. Due to COVID, production in many areas slowed or stopped, and we are seeing prices increase.

Everything from microchips, bicycles, chicken wings, and even labor is in short supply. One particular item that has caused a lot of headlines and heartache is a shortage of lumber. Once the pandemic struck, production of lumber was affected, both intentionally and unintentionally. This caused the price of lumber to increase over 300% since last year. The average cost of building a home in the U.S. has increased by nearly $36,000 (NAHB).

From Twitter: “Not even one police escort.”

So to the last and most crucial question. Will inflation become a problem for economic growth going forward? And will we face high or even hyper inflation on an extended time frame? 

Based on the causes of the inflation we are seeing, supply shock, I do not see this as a significant concern at present.

Bottom Line: A supply shock is an unexpected event that effects supply, resulting in a rapid change in price. 

The Weeds

“By continuing the process of inflation government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.” – John Maynard Keynes

Is the government stealing from you? 

Loaded question I know…

Inflation is a very controversial subject. Many believe that inflation is a tax on citizens or a theft of the wealth of the citizenry. I understand the argument. However there is a bit more to this story.

If you look at the top of a dollar bill, notice it says “Federal Reserve Note“. A note is a form of debt instrument! A Federal Reserve Note, today’s dollar, is a liability of the Federal Reserve Bank and an obligation of the US government. So is a dollar a counterfeit receipt as depicted above? No, it is exactly what it states it is on the “receipt!” There are debates over our current monetary system as well as monetary theory.

The way to think about fiat currencies, or currency solely backed by the issuer, is they are a tool to facilitate transactions in the economy. Fiat currencies are managed by a monetary authority, usually a central bank, such as the Federal Reserve. Inflation will slowly, at times rapidly, erode the purchasing power of a fiat currency.

Dollars today are not a store of value. Holding dollars for longer periods of time is likely a losing proposition. 

A last note regarding the growing attention to “crypto currency”. Is crypto a currency? Is it money? Is it an asset class worthy of investment? I first addressed crypto some years ago and it has gained additional allure since. However, have there been any developments that are new and noteworthy? To the point: Is “crypto currency” the answer to our monetary concerns? Coming shortly!

Bottom Line: Our monetary system remains fairly misunderstood. Inflation is a policy goal of the Federal Reserve. Inflation is necessary, while controversial, under our current monetary system.