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Nov 9, 2022Liked by Arnold Kling

There are several aspects to: "at some point the ratio of nominal wealth to productive capacity will be low enough to suppress inflation".

1) We are decreasing the real wealth of all US dollar holders around the world with negative real interest rates, but this doesn't impact the internal nominal wealth.

2) The theft of value by negative real interest may be locally significant to an individual's retirement, but that is a trivial amount relative to big factors like government deficits or imaginary "investments" like crypto as part of nominal wealth. With M2 at 21 T$ levels and -3% real interest rate, you are only decreasing nominal wealth by 0.6 T$/yr with inflation while the imaginary crypto market is about 1 T$ market cap that could crash overnight by government actions.

3) The 9 T$ California housing market is an unstable oscillating market that can easily decrease up to 20 to 40% or 2 to 4 T$ in nominal wealth decrease. This would be a large reduction of nominal wealth. California is no longer adding population, and that phenomenon is combined with our unstable housing market created by the required time delays of government/regulation. Our very slow supply responses to demand increases make California the most likely to lead the parade of nominal wealth loss. https://www.dropbox.com/s/7go8mum7wmgljsg/Realestate%20oscillation%20Ca.pdf?dl=0

4) A 10-20% or so decrease in the total value of stocks could decrease nominal wealth by 5 T$ which would make a good hit on nominal wealth / production ratio.

5) Perhaps a better way to solve inflation would be to increase production. Allowing pipelines to be completed is truly shovel ready and will increase energy supply putting pressures on OPEC. Fast tracking permissions on critical materials mines (Lithium, rare earth minerals, etc.) would be of great help, as would making activists and regulators liable for delays created by law suits and rules which legally fail or are proven to be junk science. A recent example is the attempt to get permission to build a desalinization plant in water-short Southern California. Even after 14 years of paying ex-senators, lawyers, and lobbyists, in addition to making massive political contributions, they were denied permissions and lost all their risk money. However, even had the permission been granted, the costs of that time and the permission risk required the developers to charge 3 times the world price for the same system with the same design and equipment as other countries. Such bureaucratic hurdles are undeniably diminishers of nominal wealth.

6) Innovation is the key to long term wealth generation, but innovation as measured by economists is not just good ideas but ideas which can be turned into reality. We have evolved into being a society which won't grant permissions for anything. We have become a "vetocracy" in which the "stakeholders or regulators have veto power". Silicon valley didn't require permission to make a new chip design, and wealth expanded accordingly. But try to coax the California Costal Commission to permit anything innovative, such as a large fish farm floating in the ocean out of sight of land. That particular wealth-generating innovation is taking place outside the US. We import 90% of our seafood, half of which are products of aquaculture.

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Arnold quoting Ip:

"Japanese savers are willing to lend to their own government at rock bottom interest rates, which makes future debt service and deficits less burdensome."

How much of the government's debt do Japanese savers actually hold after 20 years of QE and yield curve control? Something on the order of 4-5 trillion dollars of US government debt has been financed by the Fed over the last 13 years, and one can't help but suspect this number will be 20-25 trillion in another 13 years. We are f*****, we just don't see the ultimate effect yet. I used to think I would be dead before the currency's demise, but I now think there is a 50% chance I live to see it happen.

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founding

Arnold makes a case that deregulation and deficit-control are crucial to getting back to the good regime (low inflation).

In the current fiscal circumstances, would deficit-control require austerity (reduction in gov't expenditures)?

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People feel rich or at the very least quite safe because they have unprecedented equity in their home and I don’t expect hosing prices to fall.

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founding

Can someone explain why the difference between M2 and M1 completely collapsed (from 12.2 to 1.6 billions of dollars) in May 2020? There seems to be some accounting difference:

"""

Before May 2020, M2 consists of M1 plus (1) savings deposits (including money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than $100,000) less individual retirement account (IRA) and Keogh balances at depository institutions; and (3) balances in retail money market funds (MMFs) less IRA and Keogh balances at MMFs.

Beginning May 2020, M2 consists of M1 plus (1) small-denomination time deposits (time deposits in amounts of less than $100,000) less IRA and Keogh balances at depository institutions; and (2) balances in retail MMFs less IRA and Keogh balances at MMFs. Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.

"""

so it looks that savings deposits were moved from M2 to M1 - am I right? Is that what caused the difference collapse?

https://fred.stlouisfed.org/graph/?g=9aV#0

I am asking because some people are using the M1 graph to show how enormous the covid money printing was - but that does not look right.

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A huge part of the weakness of both 70s & 90s "macroeconomics" is the failure to have economist consensus on the relations between fiscal policy & monetary policy in their influences on inflation. As well as the failure to include asset inflation (which we've seen since 2009) as part of total inflation, rather than just CPI inflation, which has been so low for so many years.

There's also the inconsistent lag problem. Noah Smith gloats that Trump called for de-coupling from China and moving manufacturing back to the USA - but it is only happening now, under Biden; it didn't happen under Trump. Deciding to move a factory, then planning to make the factory, then getting permissions to build the factory, all take time. With some regulations, a LOT of time. Much more time than to set up a mobile phone app that goes viral.

Part of the power of PSST is that when there is a bigger focus on change, and changing patterns, it becomes more clear that most regulations make such adjustments slower. So patterns are improved more slowly, after more costly, wealth reducing mistakes.

It seems that fiscal vs monetary influence, as well as gov't spending vs tax reduction, are too complex for the 90s high math folk to calculate precisely such relationships - so we get almost nada. John Cochrane is usually fine, but most of his math stuff seems barely relevant, if any.

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You still fail to discuss the two types of inflation we have been observing in the U.S. and other countries post-WWII. One type is inflationary financing of government deficits: governments can finance their deficits (= G-T where T represents all coercive payments to government) by borrowing or printing money. The problem with borrowing is that eventually its cost starts to rise sharply and if government cannot eliminate the deficit, printing money is the only alternative. As the experience of Argentina has shown many times since 1951, there are many ways to reach the default point. Tom Sargent has analyzed extreme experiences of this monetary financing, those leading to hyperinflation.

The second type is inflationary accommodation. In market economies, large, “shocking” changes in relative prices which generate increases in price indexes also disrupt both incomes and expenditures and governments are pressed to contain the disruption, often by reducing taxation or/and increasing spending. To the extent that the new deficit is financed by printing money we call it inflationary accommodation (indeed, any subsidy intermediated by the central bank or other lenders but not reported as government spending is government spending).

In the past two years both types of inflation have been observed in many countries. COVID policies led to inflationary financing. Later the attempt to mitigate global warming by forcing a fossil energy shock led to the inflationary accommodation of the change in relative prices. Unfortunately we will never be able to identify the inflationary consequences of the two sets of policies which have varied greatly across countries.

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founding

Arnold - this makes a lot of sense. I know you eschew overly mathematical economics, but could you point out a couple of basic metrics to monitor in order to see this convergence between productivity and wealth?

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A fiscal rule in which expenditures have to have NPV =>0 in a monetary regime with an inflation target will produce Keynesian results. As the central bank's monetary policy raises/reduces borrowing costs as it tries to reduce/increase inflation back to target government deficits move countercyclically. Any fiscal rule sufficiently far from optimum for long enough will eventually make central bank inflation targeting impossible.

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