Mystery of Low Inflation? Nonsense

In the aftermath of the Great Financial Crisis in 2008 which brought money markets to a standstill, central banks embarked on a voyage of discovery with a series of formerly unorthodox actions.  Zero Interest Rate Policy (ZIRP), in which central banks pegged the short term interest rates under their control at zero or below.  Quantitative Easing (QE) in which they purchased scads of sovereign debt in secondary markets (cough, cough) – or in the case of the European Central Bank (ECB) also corporate debt (!!!), and in the case of the Bank of Japan (BoJ) also equities or equity indices (!!!!!) – in a bid to create loads of excess reserves, which here in the US. the Fed kept from entering the real economy in conjunction with the execrable Interest on Excess Reserves (IOER).  So there was all this technical talk about managing rates using a floor approach or corridor approach which is not germane to the present issue.  Finally they set an explicit inflation target of 2% or more in order to get up or anchor inflation expectations which they have stated they believe is a key aspect of their inflation management toolkit.

Recently, several paragons of monetary officialdom have come out and said that continued low inflation is a mystery.  The head of the International Monetary Fund called it a mystery at a Milken Global Conference very recently.  How a person who is supposed to know such things could call it a mystery is a mystery to me.  The Fed Chief, Jerome Powell, recently said that there is “no easy answer” to explain why price rises have been so subdued.  Well gee guys, let me explain it to you then.  Surprisingly, there is a Bloomberg piece that gets many of the elements in place titled “Low Inflation Is Federal Reserve’s Maddening Unsolved Mystery”, though it doesn’t really lay things out fully.

The first thing to note in any discussion of inflation is what kind of inflation are we talking about here.  The inflation that is a “mystery” apparently to the Fed and the IMF is regular old goods and services inflation – the kind that Volker tried to tame in the late 1970s and early 1980s when he took the Fed Funds rate over 20% and that the Fed in the Greenspan era tried to combat with their approach of “opportunistic disinflation”.  Note that inflation means that a given unit of currency buys less than it did before, the value of the currency declines over time (h/t to Shedlock).  There is of course notable inflation in asset prices and art markets, which these officials mostly ignore.  There is also heart-stopping inflation in the prices of education, health care and health care insurance which is decimating the middle class even as the richest get even more rich through the asset inflation caused by central bank policy (they own the bulk of the assets which are inflating due to time value of money as well as money supply effects).

To get to the meat of the matter baffling the world’s most powerful and highly paid and feted monetary policymakers, the main causes of persistently low goods and services inflation are three, with a few others rounding out the case.  The first cause is the conscious creation of Chimerica by American fiscal policy makers during the Clinton era.  The accession of China to the GATT/WTO in 2001 and the runup to it has caused a truly massive deflationary impulse around the world as the globalization of the labor market impinged labor market pricing power.  The impact of this is difficult to stress highly enough.  Adding a billion or more people in Asia to the labor market for goods consumed by the West at wages much lower than those enjoyed by laborers in the West was one prong of the creation of Chimerica.

The other prong was to be the slaying of inflation.  Producing the world’s goods using labor in Asia means that the goods produced can be had for much lower prices by everyone in the West, including the laborers whose jobs were replaced.  That was the bargain.  We will give you (China and Asia generally) the jobs, and you give us (America, Europe) cheap goods.  Well mission accomplished.  Inflation has been low both because goods prices are lower than they otherwise would be and because the price of labor has been kept on a tight leash.  This dynamic has, however, largely run its course.  The labor market in China is now shrinking and most of the labor that was going to be transplanted to Asia has already been transplanted.  Labor prices have hit their low point and will either slowly rise or stay roughly the same until something (the conscious dismantling of Chimerica) causes power to swing from corporations to labor and then labor prices to rise.

The second primary cause of low inflation is demographics.  The low birth rates in Europe are well known.  Germany and Italy have declining native population (one of the reasons Merkel was eager to import northern African and middle eastern migrants, despite the cultural cost).  Japan’s population is declining.  Without the constant influx of immigrants, even the population of America would be flat to down.  Adding to the general lack of new babies, the creation and presence of which uniquely promote growth, the aging of the baby boomers (a pig in the python demographically) has meant a shift of spending patterns downward as people consume less as they age and their fewer children are grown and strike out on their own.

The third major cause as I see it is the vanquishing of collectivist legal frameworks by the Anglo Saxon model, which has resulted in the collapse of organized labor and the tilting of economic power toward corporations.  As a result, shareholders now reap more of the economic pie relative to labor than they have in generations.

There are a few other contributing causes, though less important than the secular forces described above. Technology and technological artifacts like computers and phones play a more important role in modern life and the cost per unit of power of these items tend to decrease over time (among other things giving rise to the dangerous notion of hedonic adjustments in gauges of inflation and output or GDP).  The price of oil has been fairly low since the great spike in 2008.  Hydraulic fracturing and other technical improvements allowing previously untenable fields to produce oil at reasonable cost has kept a lid on prices.  Oil is one of the most closely correlated price series with inflation over time.  Finally as Mike Shedlock has posited, competitive devaluation of currencies means no nation gets a leg up in the inflation race (a devalued currency vis a vis others is ceteris paribus inflationary as it means prices of foreign produced goods rise in local currency terms and hence prices of locally produced goods can also rise).

So there it is.  Mystery solved.  So does that mean I am a better choice to run the IMF or the Fed than the current occupants?  I guess so.  At the least when you hear someone talk about the mystery of persistent low inflation you realize they are either a fool or charlatan or both.  Consider for a moment what it would take to truly reverse the main secular forces at work that really are causing low inflation.  First break up Chimerica.  That would mean kicking China out of the Free Trade Club.  Trump has already sort of done this with the institution of tariffs, whether legally justified or not.  But to really break it up would mean higher prices for goods and services.  The Fed would see its 2% inflation target breached in short order and jobs would come back home to some extent.  We would all pay a good deal more for stuff at the store however.  So monetary leaders cannot be expected to really embrace this solution, which means they have an incentive not even to recognize it (so charlatan I guess more or less).

Another means to solving the low inflation conundrum would mean having more babies.  Not a palatable prospect for the eco left and not really something in the wheel house of the esoterically trained university economists one finds at central banks.  So not much hope there.  Finally it might mean tilting the legal field back toward labor and away from laws that benefit the corporate world.  It would take a disaster on the scale of the Great Depression to do that (as it did last time).  Not a healthy prospect at all.  Of course if central banks really wanted to see inflation they could produce as much as they wanted, though not probably in a controllable way, simply by printing money and letting it get out into the real economy instead of bottling it up in money center banks.  I remember the Treasury sent out checks to everyone after the dotcom crash.  Helicopter money.  It is probably coming in some form (see all the mention of MMT lately).  But we will have to wait for TSTHTF first.

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