It’s Monetary Inflation, Stupid
The kinds of theories politicians, news organizations, and others are coming up with to explain why prices are going up are mind-blowing. Some are blaming it on Russia, others on price gouging by corporate America (or corporate Europe or corporate whatever), some on the supply disruptions that stemmed from the pandemic, etc. The most imaginative conspiracy theorists think Gazprom, the Russian gas company that supplies the European market, deliberately depleted European storages so as to soften up those countries’ politicians ahead of the invasion of Ukraine—the idea being that they would think twice before getting involved on the side of the Ukrainians. Gazprom, therefore, sparked off the energy crisis that was then accelerated by rising Chinese demand and pushed other prices up. Although some of these factors and others have played a part, they are by no means the primary cause of the price inflation we are seeing.
Price hikes were hitting households well before Putin’s act of aggression and after many of the supply disruptions connected to the pandemic were resolved. The Consumer Price Index was already above the Federal Reserve’s inflation target (2 percent) one year ago and there has not been a single month since then in which it has not increased—all the way to the recent 8.5 percent figure for March 2022.
Europe’s inflation rate has also been higher than the European Central Bank’s target since June 2021. Not to mention that these are averages that conceal the price hikes of individual items, in many cases by two digits, and whose various components are weighted in a way that does not reflect the actual spending priorities of millions of households. In the last year, house rents have gone up by 17 percent and used cars by 35 percent in the U.S., for instance.
As for supply disruptions, some markets are signaling there may actually be the opposite problem—a demand issue. For instance, containership rates from Shanghai to the West are falling!
Although prices are obviously influenced by the demand and supply dynamics of specific products (for instance, oil and gas have seen an increase in demand not matched by increases in production), as a general rule relative prices are being affected by the unprecedented amounts of money that governments around the world have printed in recent years. Given the history of the twentieth century, one would think that people would know the connection between monetary policy and prices by now.
The Fed’s balance sheet has almost reached $9 trillion and the money supply as measured by the M2 aggregate has gone up 40 percent since the beginning of 2020. About six out of every ten dollars of the existing money supply have been generated by the monetary authorities in the last fourteen years—i.e. since the financial crisis that in 2008 triggered the relentless monetary expansion. Do you remember when we were told that the extraordinary measures taken by the Fed, including massive asset purchases, would be temporary? They have lasted one decade and a half. The consequences were not felt for a while because money creation does not immediately impact prices. The demand for money, and not just the supply of money, plays a critical role.
If a lot of money is created out of thin air but people don’t want to borrow it and spend it, and banks don’t want to lend it, price inflation will take some time to manifest itself. But eventually, the animal spirits will be back and the monetary chickens will come home to roost, as they now have.
The era of high inflation is upon us and although no one can know at this point how high prices will go and what the relative prices will be in the future, we know for sure that things will get worse and this era, whatever central bankers tell us, will last for quite a while. We did everything in our power to bring it about. Here it is.