Welcome to inflation chaos.

Central bankers have been trying to “restart the party” ever since the 2007-8 financial crisis. They invented quantitative easing (printing money to buy financial assets), pushed interest rates to zero and below, and pursued other means of making money so cheap (from the supply side) that it would stimulate the economy.

What they wanted was spending and investing in ways that would raise employment and productivity.

What they got were crypto bubbles, government deficits, and asset inflation.

Price inflation happens on the “pull” side when people demand a product with limited supply, which leads to higher prices. Examples: tickets to a popular show, or tickets out of Russia.

Asset inflation happens on the “push” side when too much money is chasing too little product. It also tends to occur for many products at once. For market goods, a slower supply response means more push inflation, so push inflation is weak for goods whose supply responds quickly (either through production or trade), and it’s stronger for assets.

Financial assets are often limited in supply (by definition). Physical assets like houses are not easy to build quickly — especially in places where NIMBYs stand in the way (self-interestedly, since their houses are worth more in shortage).

I was not alone in looking for inflation (“Inflation is always and everywhere a monetary phenomenon,” said Milton Friedman in 1963), and it showed up in housing prices* long before Covid-chaos increased demand (all those handouts) and decreased supply (all the supply chain problems) for many products, leading to today’s widespread inflation (this May 2021 column was written just as it was taking off).

What are the magnitudes? US CPI-inflation for the 15 years from 2007 to Aug 2022 was 42% in total (2.8% per year). For the 15 years prior (1992-2007), it was 47%, or 3.1% per year. Now it’s at least 8 percent per year.

So inflation has arrived. What does that mean?

  • Markets are going nuts, with prices rising and (mostly) falling, as traders and investors move away from risk and towards safety.
  • House prices are falling (or rising less quickly), as mortgage rates rise and “how much house you can afford” is falling.
  • Wages are rising as workers (still benefitting from relative labor scarcity) exercise market power and negotiate cost-of-living allowances (COLA).
  • Businesses and individuals with too much debt are facing bankruptcy. Those who can still earn more than they pay might do better if their wages rise with inflation but their debts (paying fixed interest rates) do not. People with fixed income and variable-interest debts are in trouble.

My one-handed conclusion is that we’re going to have a lot of chaos and adjustment as people (many of them facing inflation for the first time in their lives) try to balance between rising interest rates, fluctuating prices and chaotic asset markets.

And that’s before you include the impacts of Covid, climate chaos, wars, etc.

Fun times.


*Amsterdam housing prices peaked in Summer 2008, bottomed out in Spring 2013 and blew through the 2008 peak in Spring 2018. They are now at record highs, or 95% higher than the 2013 low (11% increase per year, since the bottom).

 

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Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

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