I have been getting the questions a lot on my weekly market update threads about election risk in the coming months. I think a lot of those concerns come around increases in taxes. One of the things I have come around to is increasing taxes may actually be the best thing for the long term health of our economy. This is coming from a lifelong small government, low tax-even lower spending, fiscally conservative, free market capitalist.
Why would I want to see higher taxes? Well, the old Milton Friedman quote “There is no such thing as a free lunch” sums it up for me. Whether it’s through taxes, higher interest rates, or inflation… We The People will always be on the hook for paying for the mistakes of They The Government.
This is a big topic and has many parts. So I am going to break this into a few posts and we can discuss each item individually and then in a few weeks we can put all of the pieces together. I am not all knowing and look forward to feedback and disagreement. I hope I am even open to changing my mind. I am going to call this the weekly macro update.
This week will start with the root of the problem.
Inflation- Part 1 What is Inflation, Really?
I think most people understand the idea of inflation. Simply put, it’s the decreasing purchasing power of your money. A dollar doesn’t go as far as it used to as they say. Too many dollars chasing too few goods. Everyone understands that. What I think most people don’t understand is what causes inflation. I think even fewer appreciate how slippery of a slope this can be once it starts.
There are two ways to look at inflation in my mind. There is a narrow and broad view. We can take a narrow view of TV’s and say without much research needed that we can get a whole lot more TV for the dollar today than we could 20 years ago. So it would be fair to say that we have seen deflation in TV’s. At the same time, it doesn’t take any research to know that you are paying a lot more for college tuition than you did 20 years ago. That would be less bang for your buck or inflationary within that narrow economic vertical.
The broad view of inflation is when we combine most if not all of the narrow views and try to determine how much the cost of living has gone up overall relative to the dollar. I am especially interested in inflation since 2008. The financial crisis and subsequent quantitative easing or QE (AKA money printing) had the potential to greatly exacerbate inflation. But did it? We will get into it in deeper detail in a few weeks, but not according to our government. In fact, according to the Bureau of Labor Statistics (BLS) official calculation, we have only experienced about 17% inflation since 2008. So, to replace a $65,000 a year income from 2008, you would need to make $76,485 today to maintain the same quality of life. In comparison, according to the inflation calculations from the BLS, if you made $65,000 in 1996 the equivalent income in 2008 would have been $90,419 . So from 1996-2008 official inflation increased 39% vs 17% for the next 12 years… Does that feel right to you?
Like most of economics, in its simplest form, inflation comes down to supply side and demand side influences. Supply side (referred to as cost-push inflation) is simple. It costs me more to produce my product, so I pass the cost on to my customers. Demand-side inflation is also pretty self explanatory, there is demand for more product than I can produce, so I raise prices until demand balances with what I am capable of supplying. It’s not a difficult concept to grasp. But it's extremely difficult to execute. These forces happen first in a narrow view first. But because the economy is so intertwined, when a few market segments start to experience inflation or deflation, it spreads to other areas.
Possibly the purest form of supply side/demand side economics takes place in commodities. Just look at the gas pump prices to see how the prices yo-yo back and forth once the balance gets out of whack. When there is a shock to the system (war in the Middle East, global pandemic), supply and demand are disrupted. Then the industry has to ramp up or ramp down production. The idea is as Gretzky would say, skate to where the puck is going to be not where it is… But in practice, commodity markets almost always overshoot and over correct supplies one or two times before balance is found again. Because of how hard it is to stop and restart operations, this cycle can take years.
So that’s what causes inflation in a narrow point of view. Increasing costs and increasing demand. Simple right. Well not really. What is so perverse is that when one industry is seeing a demand side inflation it will often cause a cost side inflation down the supply chain or vice versa. For instance: During the lockdown everyone wants hamburger meat from Kroger because they are now cooking at home. Demand increases to the point that Kroger first raises prices to balance supply. Then they try to order more from the meat packer, but the meat packer is getting the same demand from Albertsons and Walmart too. So they raise prices. But it doesn’t slow down demand, cause people gotta eat. Well to increase production the meat packer has to bid up the price of beef and pay workers overtime. This causes their costs to go up and they have to pass this on up the supply chain. Net result, beef prices increased 15% from April to June in the US. That’s a narrow view of inflation.
But how does it become broader? If we all had a finite budget, that never expanded, when prices go up in one area, we would be forced to either buy less of that item or spend less elsewhere. This would create balance and would not ever allow for the creation of broad inflation… So long as supply never decreased in the aggregate. Now if you and everyone else had an increasing amount of money to spend every year, you would be able to increase how much you spend on all the items you currently buy if you so chose. When this happens across the entire population and economy, it causes inflation.
Yawn. I just covered (with mistakes I am sure) freshman level economics that most everyone on this board understands.How we should be thinking of it is output vs active money supply. So I like to point at a simplified version of Milton Friedman’s definition of inflation. Inflation is a more rapid increase in the quantity of money than output. The single most inflationary thing we can do as a society is produce less goods and services and increase the active money supply artificially. This will do nothing more than drive up the everyday cost of living for the society as a whole. Any idea on why I might be concerned about an increase in the money supply and a decrease in output these days?
Next week I will post on the money supply and how the Fed manipulates it. Other topics to follow that address my opinion of how inflation has been massively under reported recently, how interest rates and taxes figure in, and what the next few years may look like.
There is a lot here to read, but I look forward to hearing your comments. For a much better explanation, here is a 40 year old video from Milton Friedman that explains inflation and its effects better than anyone else before or since.
Why would I want to see higher taxes? Well, the old Milton Friedman quote “There is no such thing as a free lunch” sums it up for me. Whether it’s through taxes, higher interest rates, or inflation… We The People will always be on the hook for paying for the mistakes of They The Government.
This is a big topic and has many parts. So I am going to break this into a few posts and we can discuss each item individually and then in a few weeks we can put all of the pieces together. I am not all knowing and look forward to feedback and disagreement. I hope I am even open to changing my mind. I am going to call this the weekly macro update.
This week will start with the root of the problem.
Inflation- Part 1 What is Inflation, Really?
I think most people understand the idea of inflation. Simply put, it’s the decreasing purchasing power of your money. A dollar doesn’t go as far as it used to as they say. Too many dollars chasing too few goods. Everyone understands that. What I think most people don’t understand is what causes inflation. I think even fewer appreciate how slippery of a slope this can be once it starts.
There are two ways to look at inflation in my mind. There is a narrow and broad view. We can take a narrow view of TV’s and say without much research needed that we can get a whole lot more TV for the dollar today than we could 20 years ago. So it would be fair to say that we have seen deflation in TV’s. At the same time, it doesn’t take any research to know that you are paying a lot more for college tuition than you did 20 years ago. That would be less bang for your buck or inflationary within that narrow economic vertical.
The broad view of inflation is when we combine most if not all of the narrow views and try to determine how much the cost of living has gone up overall relative to the dollar. I am especially interested in inflation since 2008. The financial crisis and subsequent quantitative easing or QE (AKA money printing) had the potential to greatly exacerbate inflation. But did it? We will get into it in deeper detail in a few weeks, but not according to our government. In fact, according to the Bureau of Labor Statistics (BLS) official calculation, we have only experienced about 17% inflation since 2008. So, to replace a $65,000 a year income from 2008, you would need to make $76,485 today to maintain the same quality of life. In comparison, according to the inflation calculations from the BLS, if you made $65,000 in 1996 the equivalent income in 2008 would have been $90,419 . So from 1996-2008 official inflation increased 39% vs 17% for the next 12 years… Does that feel right to you?
Like most of economics, in its simplest form, inflation comes down to supply side and demand side influences. Supply side (referred to as cost-push inflation) is simple. It costs me more to produce my product, so I pass the cost on to my customers. Demand-side inflation is also pretty self explanatory, there is demand for more product than I can produce, so I raise prices until demand balances with what I am capable of supplying. It’s not a difficult concept to grasp. But it's extremely difficult to execute. These forces happen first in a narrow view first. But because the economy is so intertwined, when a few market segments start to experience inflation or deflation, it spreads to other areas.
Possibly the purest form of supply side/demand side economics takes place in commodities. Just look at the gas pump prices to see how the prices yo-yo back and forth once the balance gets out of whack. When there is a shock to the system (war in the Middle East, global pandemic), supply and demand are disrupted. Then the industry has to ramp up or ramp down production. The idea is as Gretzky would say, skate to where the puck is going to be not where it is… But in practice, commodity markets almost always overshoot and over correct supplies one or two times before balance is found again. Because of how hard it is to stop and restart operations, this cycle can take years.
So that’s what causes inflation in a narrow point of view. Increasing costs and increasing demand. Simple right. Well not really. What is so perverse is that when one industry is seeing a demand side inflation it will often cause a cost side inflation down the supply chain or vice versa. For instance: During the lockdown everyone wants hamburger meat from Kroger because they are now cooking at home. Demand increases to the point that Kroger first raises prices to balance supply. Then they try to order more from the meat packer, but the meat packer is getting the same demand from Albertsons and Walmart too. So they raise prices. But it doesn’t slow down demand, cause people gotta eat. Well to increase production the meat packer has to bid up the price of beef and pay workers overtime. This causes their costs to go up and they have to pass this on up the supply chain. Net result, beef prices increased 15% from April to June in the US. That’s a narrow view of inflation.
But how does it become broader? If we all had a finite budget, that never expanded, when prices go up in one area, we would be forced to either buy less of that item or spend less elsewhere. This would create balance and would not ever allow for the creation of broad inflation… So long as supply never decreased in the aggregate. Now if you and everyone else had an increasing amount of money to spend every year, you would be able to increase how much you spend on all the items you currently buy if you so chose. When this happens across the entire population and economy, it causes inflation.
Yawn. I just covered (with mistakes I am sure) freshman level economics that most everyone on this board understands.How we should be thinking of it is output vs active money supply. So I like to point at a simplified version of Milton Friedman’s definition of inflation. Inflation is a more rapid increase in the quantity of money than output. The single most inflationary thing we can do as a society is produce less goods and services and increase the active money supply artificially. This will do nothing more than drive up the everyday cost of living for the society as a whole. Any idea on why I might be concerned about an increase in the money supply and a decrease in output these days?
Next week I will post on the money supply and how the Fed manipulates it. Other topics to follow that address my opinion of how inflation has been massively under reported recently, how interest rates and taxes figure in, and what the next few years may look like.
There is a lot here to read, but I look forward to hearing your comments. For a much better explanation, here is a 40 year old video from Milton Friedman that explains inflation and its effects better than anyone else before or since.