Saturday, November 13, 2021 ... Deutsch/Español/Related posts from blogosphere

Larry Summers vs inflation deniers

Some media have concluded that Larry Summers has been vindicated and indeed, we can already say that the inflation wasn't "transitory" as way too many Western economists, including those at the Federal Reserve, have been saying for a very long time.

Summers – who explained his success by pointing out that the things are trivial for brilliant brains such as his and the other economists are just way too dumb aßholes (my quote isn't precise) – describes the ongoing inflation as "entrenched". Of course, it may accelerate further.

In the Bloomberg interview above, Summers said that it was easy to see that the inflation would be pretty big. Basic economic models were enough for that. Maybe he wrote it quantitatively but I haven't seen it yet. In reality, I often use my intuition and it is tempting to talk about "models" even though the predictions are pretty much just qualitative in nature. It is hard to make hard-precision predictions, especially at the beginning when it was still possible that there would also be a lasting decrease of the aggregate demand etc.

You know, I did use a very simple model that you may completely master. As Tucker Carlson recently pointed out, the U.S. money supply grew 36% by some measures, between March 2020 and the last month. You know, it's just the relative increase of the amount of cash that is around. When the cash gets equally divided everywhere, which is a simple model of the restoration of the equilibrium, there will be 36% more cash corresponding to anything. So prices, salaries etc. will be 36% higher.

This can't occur instantly, or within a year, but I think that those 36% are the following: they are the lower bound on the overall inflation that would have to materialize after some time (i.e. that is already in the pipeline) if the monetary conditions (interest rates and/or QE) remained as loose as they were in March 2020. Without a counter-action, the inflation would keep on accelerating (it will for a while, anyway), and the minimum relative increase of the prices of an inflation basket would be those 36%! If the conditions remained loose, the actual "total or integrated inflation" would be much higher than 36% in a few years because people would be getting used to the higher, and perhaps accelerating, inflation rates.

I think that the qualitative outcome has been clear to Summers, like it was clear to me, already in Spring 2020. The truly hysterical reaction to the virus was guaranteed to end. At that moment, the market would gradually notice that the lowering of the interest rates was really counterproductive. A recovery was guaranteed and during the recovery, it would already be clear that the "crisis" was actually a drop in supply, not in demand, combined with the generous donation of the money to everyone, so the right reaction should have really been the opposite! The interest rates should have increased with the first billions of dollars in the helicopter money that were poured to the economies. Of course, it was politically unrealistic and I was sure that the central banks would initially lower the rates and governments would pour the billions and then trillions.

But the consequences are obvious. It was claimed that people and businesses were just compensated for the restrictions. In some cases, it wasn't enough to cover the government-caused losses (and shutdowns of businesses). But in most others, it was actually more than enough. The governments got used to being more generous than needed, so lots of people got more cash than they expected or than they deserved! The psychological feeling of material well-being is much better now than it was before Covid. And they can just spend the money; or use the excessive cash for investments which is a good idea because the value of the cash is guaranteed to drop.

OK, I think that Summers has understood these basic qualitative facts, like the fact that it was supply that dropped and the demand that increased by the generous packages, and therefore the inflation would follow, and therefore it was a good idea to invest in March 2020, as I told you at that time and I hope that many of my readers have earned billions (and don't send me a penny via PayPal). In my opinion, Summers isn't just an excellent theorist in economics, he is also a practical man, so he probably increased his exposure to investments during the deep Covid era, and recommended the same to his relatives or friends. Am I wrong, Larry?

As the Bloomberg discussion indicates, Summers found himself disagreeing with Paul Krugman, whom he knows extremely well not only because they co-authored numerous papers. Krugman was one of the people who were denying (and are still denying) the persistent inflation that was coming and that will continue for quite some time. As I repeatedly said (in the real life; in blog posts; and comments under them), the arguments concluding that "the inflation was transitory because it's just some technical glitches in transportation etc." were always fundamentally wrong and are still wrong.

These claims totally conflate two different variables: the overall growth of prices i.e. the actual inflation rate; with the change of the relative prices (price ratios) i.e. the growth of some prices and the decrease of some other prices. The really elementary point that these (often very famous) economics crackpots misunderstand is that the shortage of some component or commodity means that the price of it goes up; but the prices of the other things go down if the inflation conditions remain constant! The price of the basket remains constant. Well, the previous sentences are really tautologies because the unchanged inflation means that if some prices go up (or go up more quickly), others must go down (or must go up less quickly).

If the price changes could be blamed on particular glitches in the supply chain or transportation, it would be unavoidable for most other prices to go down so that the inflation wouldn't be affected! Why is it so? It's simple. Imagine that you create products ABC such that you need components and commodities A,B,C to be inserted. Now, A isn't delivered (chips?) so the production of ABC slows down. Many producers badly need A which is why the price of A goes up. But the funny thing that the crackpots overlook is that the price of B,C goes down simply because they're not needed. Relatively to A, too much of B,C is being delivered, the supply exceeds the demand, and therefore their prices go down! Almost equivalently, or perhaps on top of that, the buyer who paid more for A has less cash left for B,C which is why he is only willing to pay less for B,C. In average, the price of the inflation basket remains the same.

I am saying a very trivial thing that these crackpots, often celebrated crackpots, just don't get. The inflation is always the growth of the whole basket i.e. some weighted average of the price increases; while the isolated shortages only affect independent or orthogonal variables, the relative prices (or price ratios).

Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
Someone may refuse to be a Milton Friedman's fan or a monetarist but it is really a symptom of utter stupidity to deny this important conclusion. The point is that inflation is the growth of prices of the overall basket of products, something that is as independent of the identity of particular products, components, commodities, or services as you can get! That is why the inflation rate or its very existence just cannot be explained by any "specific" products, components, commodities, or services. Inflation may be said to be the property of the money (in circulation) itself (this "universality" of the conclusion is completely analogous to the physicist's claim in the special theory of relativity that all distances are contracted by motion, not just the lengths of some particular objects) and it simply means that the potential buyers have more cash to buy all possible things than what they would cost at constant properly averaged prices. That is why the "overall or aggregate" demand exceeds the "overall or aggregate" supply which is why the "average prices" must go up i.e. a nonzero inflation rate (or increased one) appears!

When inflation adds another 2.2%, it will be at zero again, Czech analysts joked.

The people who try to blame inflation on some irrelevant technicalities in the markets with particular things (on problems with chips or the transportation involving Chinese ships) just don't get the point that we are dealing with another coordinate here, one that is purely monetary which is why it simply cannot be explained by particular products and why it cannot be summarized by "nothing to be seen here".

Summers mentioned a possible explanation why so many economists have been denying the obvious, namely that the inflation was coming: motivated reasoning. Motivated reasoning is the situation when some people buy their own delusions because they are incentivied not only to persuade others about their falsehoods; they are incentivized to devour their own bullšit, too (because that makes them more persuasive manipulators)! Motivated reasoning is just a euphemism for dishonesty (a very "disciplined" kind of dishonesty where you need to deceive not only others but also yourself) and self-delusion (as Feynman said, you are the simplest person to be fooled by yourself).

Why are all these Krugmen motivated to produce all this amazing BS? I think it is clearly caused by their being Big Government Bolsheviks. In reality, they actually believe – or they want everyone including themselves to believe – that money is for free and grows on the politically correct trees. You can make a nation rich just by printing and distributing trillions, by adding increasingly stupid and counterproductive huge government projects such as the insanities that the inhabitant of the White House who is a dementia sufferer is introducing these days. Because money is for free and it's enough to print and to government-spend trillions of dollars, these Krugmen implicitly and sometimes explicitly say, this wonderful strategy can't have any bad consequences or disadvantages. In particular, it can't cause high inflation because high inflation is bad, they ludicrously claim!

But of course, the reality is different and the smarter kids in the kindergarten already know what the correct answer is, and it is not what the economics Nobel Prize winner shoves down the stupid viewers' throats. If and when you print trillions and pour them from the helicopters (and for the overall or aggregate quantities, it doesn't mean too much whether the helicopters are dropping to road menders who build useless roads to protect you from a non-existent extraterrestrial invasion; or whether you donate lots of money while you treat hundreds of millions of recipients as miserable people who badly suffered in the Covid era even though most clearly didn't), you simply do create inflation that may be estimated in various ways (I described the truly simplest one, the money supply-based estimate, at the beginning).

A distorted capitalism is worse than the proper capitalist system. But a wonderful feature of perturbatively distorted capitalism is that the revived inflation is the only bad consequence of similar excessively loose and fiscally irresponsible policies. So the only bad thing that happens when the governments and central banks are irresponsible is that things generally get more expensive. Inflation is not really an existential problem. It is just an aesthetic problem that forces us to rewrite price stickers often; it is a time-dependent change of the "units of wealth" that becomes more quickly time-dependent when the inflation rate is high (in Venezuela, the prices are effectively in inches in November and will be in centimeters in December).

Well, this is just the "aggregate" description of the consequences of inflation. Inflation also has consequences that differ according to your situation: it devours the savings of the savers which is bad for the savers (especially if they ignore even the insufficient interest rates); but it also devours the pre-existing debt (whose interest rates have been fixed for a long enough time in the coming future) which is good for the subjects in debt! Of course people, companies, and, indeed, governments with giant debts love the combination of high inflation and low interest rates. Because the real interest rates are by definition the nominal interest rates minus the inflation rate, they get hugely negative in conditions such as the current ones. Savers lose a big time and the subjects with huge debts are the "counterparty" that greatly benefits instead!

On one hand, it is possible that moronic Bolsheviks such as Krugman genuinely don't understand that "printing trillions for government subsidies and projects" isn't a road to paradise. On the other hand, they probably know very well that this view is utterly idiotic and these "generous Big Government techniques" can't make the society wealthier at all. If you make sure that everyone has 10 times more money than before, it just means that the society will be the same and all the prices will have an extra zero. Indeed, these policies cripple societies instead. But even if he realizes that the Big Government policies are no good, he still loves them and he wants to help them. An elevated or huge inflation is a consequence of the overly loose or generous fiscal and monetary conditions (there may also be "more natural" causes of inflation but the huge stimuli almost certainly trumped them in recent years). But that is not the only relevant causal relationship of this type. There is also a quasi-opposite relationship here: a high inflation with low interest rates create conditions in which the irresponsible behavior of the government and central banks (with the printing of trillions) becomes easier to justify because it seems easier to repay the debt. When the real interest rates are hugely negative, the debt is dropping in the real terms quickly, and it looks more sustainable (or the repayment may even be unavoidable asymptotically). Of course, the creditors (whose interest rates can no longer be increased) are the main victims of these policies.

The creditors are the people (or their descendants etc.) who have previously shown some ability to earn the money, so if the government robs these people, it probably kills much of the creative engine of the society, and the society is going to the toilet as a whole. But imagine that you find it OK to screw the people who have been successful and who happen to have lots of cash, and I am sure that the Krugman-like Bolsheviks would be willing to liquidate almost all those. Can the government achieve the near-elimination of its debt while it robs all the other people, the creditors?

Well, it really cannot achieve even this (devastating but more modest) goal. The truly rich people really have their wealth in investments. They own companies or their stocks which are really immune towards inflation (from the viewpoint of a stockholder, the money is just some children's banknotes or a liquid that flows in between the company and others and that is quickly converted to something useful, and you don't need to know the units in which the liquid is measured and the units' evolution). In fact, the investments are doing better than without the inflation because 1) even the profit margins are arguably up in 2021 because companies find it easier to increase the prices above the threshold needed to keep the profit margin fixed, 2) people with the extra cash want to protect the cash against inflation which is why they need to join the stock market and elevate the prices, 3) mankind's net equity is positive so the positive assets trump the debts, and because they go down in real terms because of the suffering savers, the remaining positive assets such as stocks and real estate must go up in real terms. So the government can't really rob everyone by the negative real interest rates.

It is only robbing people like the savers with lots of cash. But even those are impossible to be robbed in the long run because the inflation rate ultimately becomes so high (and it gets reflected to the interest rates that the lenders demand for the new bonds in the future!) that even the rewriting of the price stickers becomes so annoying that people demand a fix (through high interest rates that cools the conditions); or they switch to a new currency which doesn't suffer from this excessive inflation. Once this process of healing (suppression of the inflation) is introduced, all the conditions of 2021 are turned upside down and the real interest rates actually become huge and the huge debts start to look unavoidable, and some bankruptcies appear!

The inflation is already really high and it will grow a bit higher. But at the end, it will reach the maximum and will start to drop. But I think that it will only start to drop after the real interest rates actually exceed some historical average. The tightening of the monetary conditions is an absolutely necessary condition for the taming of the inflation. What is it? Well, the nominal interest rates are normally 3% in average and the inflation rate is 2% in average, so the historical average of the real interest rates is something like 1% (plus minus half a percent, this is no high-precision figure). In Czechia, we currently stand at minus 2.5%. So the interest rates will have to increase at least additional 3% or so, for the real interest rates to become positive. But because the inflation is likely to accelerate further, because of the real interest rates' still being negative, the interest rates will have to go higher, too. I really think that the inflation won't be substantially tamed before the interest rates beat the inflation rates! And because the inflation is already compable to 6% in the U.S., Czechia, and many other countries, I find it rather obvious that the interest rates will have to go this high, too. I estimate the peak of the Czech inflation and interest rates rather close to 10%. It is better for them to get there relatively quickly because the peak inflation will occur earlier and will be lower, too. Except for hyperinflation which would be a terrible thing, there is nothing you can gain by badly postponing the massive increases of the interest rates that are needed to tame the inflation.

They are needed because the inflation is already self-enforcing. On top of the 36% that I mentioned as the minimum assuming "no increases of interest rates", there will be the extra inflation (which would only materialize without the braking pedals, however!) that is created by the system's getting used to it. A producer A has to increase the prices because his components got more expensive, but he may add something more. A worker may demand higher wages but he may also demand more than the barely needed minimum, and so on, and so on. The increases are being copied from one place to another, from one type of prices or wages or salaries to another, and everyone tends to add something extra. This only stops after people find it obvious that it will stop. The aggregate demand will stop growing because it will be hard to borrow the money (and the part of the demand that depends on the loans is hopefully large enough to cause the qualitative change of the behavior, the plateau of inflation; well, maybe it's not really necessary to rely on the loans because higher interest rates may incentivize the "positive savers without debt" to grow their savings, too). Because the aggregate demand will be seriously lowered in 1-2 years due to the very high interest rates and the cooled market of loans, we may also expect the growth of prices to slow down etc.

The Czech National Bank turned out to be the most sensible, hawkish bank in the Western countries, and within months, they already got from a technical zero to 2.75% (the 2-week repo rate, the main Czech rate). While many things got bad or so-so in Czechia (we are so far from Scandinavia in the rationality of the Covid response now, so disappointing! But our government is still less Coronazi than those in Lithuania, Austria, Italy, Slovakia, and especially Australia), the central bank is one of the rare entities that I can be proud about.

I have watched recent press conferences of the boss, Governor Jiří Rusnok (once an apolitical prime minister of Czechia), and he was excellent. His explanations were almost as brilliant as if he were an extremely diligent reader of The Reference Frame, and believe me that it is one of the greatest compliments that the boss of a central bank may receive from your very humble correspondent. ;-)

Rusnok and his Magnificent Seven realize that the elevated inflation is in some sense a business-as-usual problem that they are perfectly equipped (and generously paid) to cure; on the other hand, they need to actually do it instead of spreading incoherent fog and doing nothing (which is the monetary policy of the ECB, the Federal Reserve, and many others). They need to acknowledge that those 5.8% CPI is way above their 2% target (Rusnok surely does acknowledge it) and it's been above the target for quite some time and this deviation prevents them from saying that "no action is just OK" (well, just 5 of the 7 bankers are hawks; the remaning two, Michl and Dědek, are hardcore doves who wanted no hikes at all and who resemble the ECB). Once they would say that 5.8% is in the ballpark of 2% and no action is needed (you just need to drink enough wine for the image to be blurred enough to see that 2% coincides with 5.8%), the doors would be open to the claim that 33,000% is also in the ballpark of 2%. Aside from Venezuela Maláčová, our minister of welfare, we could also have a Venezuelan Czech central bank. 5.8% is clearly way outside any tolerable window (1-3% is the window but 3% is still above the target and is wrong if it lasts, Rusnok emphasizes, and we've had near-3% or higher since 2017) and they simply need to deal with the problem of price instability because it's the main struggle that they are paid $200,000/year for (each of them).

Concerning Larry, there have been moments when I thought, oops, he is just another annoying Democrat, a feminist who buys trucks to twin daughters, basically another nutcase. But of course we're back to an epoch in which I feel just the opposite. He is just a sane, rigorous, often brilliant economist with common sense and with conservative inclinations who understands the insanity of many of the far left policies (like the worshiping of the printing of trillions as a cure for all economic problems) and who was just randomly blown next to the likes of Krugman and to pretend that he is their soulmate. It is surprising that Summers disagrees with Manchin who correctly sees Biden's plans as another huge waste of money that will accelerate inflation. Incidentally, in the discussion at Bloomberg, Summers also sensibly said that the splitting of the companies is a good thing because it improves the allocation of the capital by allowing the investors to more accurately decide where they want their money to go instead of forcing them to invest into one of the randomly mixed, nearly identical cheeseburgers (OK, I think that I improved his formulation but he could surely get it, too).

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