I am old enough to have lived through the '70s and spent the '60s working in Brazil, which was undergoing an inflationary instability: we played Monopoly using real money for fun. What is not included in most present analyses is the dynamic effect, i.e., the huge delay times between effectively creating excess money and observable inflation. It is like filling a dam. You see no change in the flow down stream for quite a while. Then, suddenly, the dam overflows, floodwater is released and the dam itself may be destroyed in the process.
The feds have been creating money equivalents for years, but being a reserve currency has allowed the dollar to pile up with little apparent inflation or interest rate effects. This has come at the cost of effectively negative interest rates and decreases the real value of the dollar. These lower-value dollars are chasing real-value goods and are finally revealing the heretofore not apparent inflation. This inflation will accelerate, as everyone tries to off-load their increasingly less valuable cash by converting it to "real value goods". This causes the system to go unstable. A decrease in world trade will decrease the demand for dollars and add to the torrent of dollars entering the market. In Brazil, people horded steel reinforcing bars, because they had real value. The government paper money and economic activity so distorted the value of the currency that the military took over: a new currency was issued. Everyone caught with cash lost 90% or so.
It took huge interest rates (Fed funds rate 21% in '81) and a depression to handle the '70 money printing cycle and dollar devaluation. What will it take this time? Little 0.5% increases in interest rates with a 7+% inflation still makes a negative 6.5% real interest rate, and you pay taxes on the imaginary 0.5% interest income.
In the case of Brazil, we could still do some economic planning (building factories) by using dollars in the plans, but if the value of the dollar is unstable, how can one make rational economic decisions to invest in the future, given no idea of the value of the dollar a decade from now?
Arnold, you seem to be saying the inflationary 70s are calling. But a huge difference is that not just money was chasing goods, but new Baby Boomers entering the economy were chasing real goods. Houses and furnishings for those houses, and cars, and clothes for work.
The fact that most production has a significant energy cost component means that higher energy prices look like generally higher prices, which is what inflation is defined as - same as 70s energy price shocks.
"the ratio of paper wealth to GDP got too high" seems likely true. Since the end of the 2008-9 recession ended, lots and lots and lots of money creation has been going into stocks & bonds, and Bitcoin, and houses. We've had high asset inflation (almost-hyper) throughout Trump, with low normal consumption inflation, excluding housing in good areas (such housing is becoming a rich only good; housing in high crime areas remains affordable but undesirable).
The pandemic, plus other Dem policy messes with the supply, especially energy, pushed a reduction in production, and thus an expected increase in prices. Biden is also blaming Putin's war, now, which is certain to disrupt many trade expectations and make some large price/supply changes in some areas like wheat & neon (used in semi-conductors, made in Ukraine).
There has been quite a bit of price stickiness against increasing prices, and losing customer loyalty (?), but as general inflation goes up over 8%, this seems to allow the really reduced supply products to go up by 20, 50, 100%, or whatever the new real supply-demand market clearing price is. (I like "market clearing price" rather than "equilibrium"; one of the reasons I'm sure Kling is more correct more often than other economists.) In this respect, the supply shocks will be 6 - 24 month long "temporary" price increases, not quite inflation - but embedded within and being somewhat hidden by real general price inflation.
Looking at a NYT chart of prices since 1980, we started getting a stock boom in '92, as part of the "peace dividend", and possibly as part of too many middle class investors were chasing too few shares (of good S&P 500 companies):
This advisor chart is adjusted to June '21 dollars, and is consistent but with the added alarmism of hugely increasing margin debt, from just under 200 billion in '97 to a 2018 peak of 660, drop back to 500 in 2020, then exploded again to 860 by June 2021.
So I looked for more Margin Debt, here is a good article from Feb, 2022 (see title):
"The only measure of stock market leverage that is reported monthly is margin debt at brokers, via FINRA. Much of the stock market leverage isn’t reported, such as Securities Based Lending, and even banks and brokers that fund this leverage don’t know the leverage in the overall market, or even the leverage of their client if that client is levered as well at other banks."
Later they explain its importance:
"Margin debt is the great accelerator on the way up because it creates buying pressure with borrowed money, and on the way down because it creates forced selling pressure."
Few analyst journalists follow margin debt, but it's hugely important on the trend driving margin.
Please keep in mind that there are about 70 million retirees in the U.S. trying to live off their investment portfolios. This is a major underlying reason for the bubble in the first place - Boomers were trying to save for their futures and bid the stocks up to ridiculous heights (i.e. asset price inflation). Now that they're retired, they're all trying to cash out at the same time and the inflation is spreading to the real economy.
The problem is beyond financial solution. When tens of millions of highly skilled workers stop working, the economy produces less and the nation becomes poorer. No combination of tax and fiscal policy can make the boomers young again.
Excellent piece. I can see people running for bitcoins and gold or other commodities if your analysis comes to pass. One of your recent pieces also showed why TIPs might be a bad safe harbor. The current world is uncomfortably like the late 70s. It might be worthwhile to think about how the current time is different or really the same as what Carter & Volcker faced.
Why would prices have to fall for inflation to fall? Just following the logic here (I expect prices to fall) inflation would drop if markets were flat for a sustained period of time.
"Government debt is not expanding as fast as it did in 2020 and 2021, and you can thank Joe Manchin for that. But it is not receding, either."
While the level of government debt is not receding, the debt to GDP (https://fred.stlouisfed.org/graph/?g=OFFl) has fallen substantially since mid 2020. FRED says public debt held by the public to GDP has dropped about 12% of GDP. Yes, raising rates could change the cost of a fixed debt to GDP ratio. But we don't have evidence of that yet either. Federal debt servicing costs have fallen from 1.75% to 1.53% of GDP (https://fred.stlouisfed.org/graph/?g=OFFl) over that same period.
I am old enough to have lived through the '70s and spent the '60s working in Brazil, which was undergoing an inflationary instability: we played Monopoly using real money for fun. What is not included in most present analyses is the dynamic effect, i.e., the huge delay times between effectively creating excess money and observable inflation. It is like filling a dam. You see no change in the flow down stream for quite a while. Then, suddenly, the dam overflows, floodwater is released and the dam itself may be destroyed in the process.
The feds have been creating money equivalents for years, but being a reserve currency has allowed the dollar to pile up with little apparent inflation or interest rate effects. This has come at the cost of effectively negative interest rates and decreases the real value of the dollar. These lower-value dollars are chasing real-value goods and are finally revealing the heretofore not apparent inflation. This inflation will accelerate, as everyone tries to off-load their increasingly less valuable cash by converting it to "real value goods". This causes the system to go unstable. A decrease in world trade will decrease the demand for dollars and add to the torrent of dollars entering the market. In Brazil, people horded steel reinforcing bars, because they had real value. The government paper money and economic activity so distorted the value of the currency that the military took over: a new currency was issued. Everyone caught with cash lost 90% or so.
It took huge interest rates (Fed funds rate 21% in '81) and a depression to handle the '70 money printing cycle and dollar devaluation. What will it take this time? Little 0.5% increases in interest rates with a 7+% inflation still makes a negative 6.5% real interest rate, and you pay taxes on the imaginary 0.5% interest income.
In the case of Brazil, we could still do some economic planning (building factories) by using dollars in the plans, but if the value of the dollar is unstable, how can one make rational economic decisions to invest in the future, given no idea of the value of the dollar a decade from now?
Arnold, you seem to be saying the inflationary 70s are calling. But a huge difference is that not just money was chasing goods, but new Baby Boomers entering the economy were chasing real goods. Houses and furnishings for those houses, and cars, and clothes for work.
The fact that most production has a significant energy cost component means that higher energy prices look like generally higher prices, which is what inflation is defined as - same as 70s energy price shocks.
"the ratio of paper wealth to GDP got too high" seems likely true. Since the end of the 2008-9 recession ended, lots and lots and lots of money creation has been going into stocks & bonds, and Bitcoin, and houses. We've had high asset inflation (almost-hyper) throughout Trump, with low normal consumption inflation, excluding housing in good areas (such housing is becoming a rich only good; housing in high crime areas remains affordable but undesirable).
The pandemic, plus other Dem policy messes with the supply, especially energy, pushed a reduction in production, and thus an expected increase in prices. Biden is also blaming Putin's war, now, which is certain to disrupt many trade expectations and make some large price/supply changes in some areas like wheat & neon (used in semi-conductors, made in Ukraine).
There has been quite a bit of price stickiness against increasing prices, and losing customer loyalty (?), but as general inflation goes up over 8%, this seems to allow the really reduced supply products to go up by 20, 50, 100%, or whatever the new real supply-demand market clearing price is. (I like "market clearing price" rather than "equilibrium"; one of the reasons I'm sure Kling is more correct more often than other economists.) In this respect, the supply shocks will be 6 - 24 month long "temporary" price increases, not quite inflation - but embedded within and being somewhat hidden by real general price inflation.
Looking at a NYT chart of prices since 1980, we started getting a stock boom in '92, as part of the "peace dividend", and possibly as part of too many middle class investors were chasing too few shares (of good S&P 500 companies):
1992 ~ 450 1996 ~ 550 2000 ~ 1500 (peak 1; ~850 bottom 2003) 2004 ~ 1000
2008 ~ 1500 (peak 2; ~650 bottom 2009) 2012 ~ 1300 2016 ~ 2000
2019-2020 ~ 3450 (peak 3 & 4 with ~2250 bottom in 2020 as well);
But the chart doesn't say, so these numbers are nominal (non-adjusted!)
https://www.advisorperspectives.com/images/content_image/data/23/232c41eab9342aee28ea566d025bc1f4.png
This advisor chart is adjusted to June '21 dollars, and is consistent but with the added alarmism of hugely increasing margin debt, from just under 200 billion in '97 to a 2018 peak of 660, drop back to 500 in 2020, then exploded again to 860 by June 2021.
So I looked for more Margin Debt, here is a good article from Feb, 2022 (see title):
https://wolfstreet.com/2022/02/18/margin-debt-plunged-as-stocks-tumbled-and-highest-fliers-got-crushed-but-its-still-gigantic-long-way-to-go/
[Chart peak is over 900, "WTF"]
"The only measure of stock market leverage that is reported monthly is margin debt at brokers, via FINRA. Much of the stock market leverage isn’t reported, such as Securities Based Lending, and even banks and brokers that fund this leverage don’t know the leverage in the overall market, or even the leverage of their client if that client is levered as well at other banks."
Later they explain its importance:
"Margin debt is the great accelerator on the way up because it creates buying pressure with borrowed money, and on the way down because it creates forced selling pressure."
Few analyst journalists follow margin debt, but it's hugely important on the trend driving margin.
Wolf agrees with my priors, so I believe him!
Please keep in mind that there are about 70 million retirees in the U.S. trying to live off their investment portfolios. This is a major underlying reason for the bubble in the first place - Boomers were trying to save for their futures and bid the stocks up to ridiculous heights (i.e. asset price inflation). Now that they're retired, they're all trying to cash out at the same time and the inflation is spreading to the real economy.
The problem is beyond financial solution. When tens of millions of highly skilled workers stop working, the economy produces less and the nation becomes poorer. No combination of tax and fiscal policy can make the boomers young again.
Excellent piece. I can see people running for bitcoins and gold or other commodities if your analysis comes to pass. One of your recent pieces also showed why TIPs might be a bad safe harbor. The current world is uncomfortably like the late 70s. It might be worthwhile to think about how the current time is different or really the same as what Carter & Volcker faced.
Why would prices have to fall for inflation to fall? Just following the logic here (I expect prices to fall) inflation would drop if markets were flat for a sustained period of time.
"Government debt is not expanding as fast as it did in 2020 and 2021, and you can thank Joe Manchin for that. But it is not receding, either."
While the level of government debt is not receding, the debt to GDP (https://fred.stlouisfed.org/graph/?g=OFFl) has fallen substantially since mid 2020. FRED says public debt held by the public to GDP has dropped about 12% of GDP. Yes, raising rates could change the cost of a fixed debt to GDP ratio. But we don't have evidence of that yet either. Federal debt servicing costs have fallen from 1.75% to 1.53% of GDP (https://fred.stlouisfed.org/graph/?g=OFFl) over that same period.