https://www.bundesbank.de/en/tasks/topics/1973-the-end-of-br...
The floating exchange rate helped the USA to hold on to manufacturing jobs, but caused inflation to go higher. This is a big fact to miss.
"What the Great Inflation Taught Us" leans too much on accounts from Paul Volcker and Warren Buffet. It only shares the point of view of the market and investors. It does not include any point of view associated with manufacturing or labor.
The essay doesn't mention the international context, the fact that inflation was often higher in other countries besides the USA. It doesn't attempt to explain some of the anomalies of the era, such as Japan, where inflation peaked at 26% despite the fact that Japan had a strengthening currency.
The inflation of the era was international, and its beginning and end can only be understood in the international context. I made an attempt to look at this era from the point of view of the relationships between the developed and underdeveloped nations, and their currencies:
https://demodexio.substack.com/p/why-did-the-west-deindustri...
Andrew Scott Cooper's The Oil Kings covers that in some detail:
https://www.goodreads.com/book/show/12348743-the-oil-kings
It's very relevant today as the spike in oil prices is fairly similar, and current US tensions with Saudi Arabia are not all that different from similar tensions with the Shah of Iran at the time.
Additionally, I'm a bit skeptical about the author's claim that full employment is the number one cause of inflation.
So what is the real problem with inflation? Is it the economic inequality it brings to those who have to live on fixed income?
I've been following the discussion on US TV and it seems they are saying we need more unemployment. We need economic hard time so that people will not have too much loose money any more. We need more unemployment so that employers don't have to pay bigger wages causing wage-inflation.
To me this sounds counter-intuitive. How can the solution be more unemployment? People will then have even less money after paying the grocery and gas-bills.
> If inflation is caused by people having too much money then it is a self-correcting problem because as prices go up people will no longer have as much money. (...) So what is the real problem with inflation?
Great question. The "real problem" with inflation depends on what type of inflation it is - either demand side, which is what the Fed can control, or supply side, in the form of rising energy or food prices due to external shocks. Right now we actually have both. The latter directly worsens standards of living (it causes prices to rise but wages stay the same), and the former is a bit more subtle; it taxes savings and causes various instabilities through the economy due to the changing value of future money, such as eroding the value of a loan for borrowers. (But in the long term prices and wages do re-adjust, as you point out; the problem is short term.)
> I've been following the discussion on US TV and it seems they are saying we need more unemployment.
The TV is hopelessly confused. We do need a monetary tightening to stop the economy from overheating(demand-side inflation), which will unfortunately worsen unemployment, but that isn't the main mechanism here. The inflation is a consequence of a mistake that has already been made by the Fed - overly expansionary monetary policy since 2021 - and the steps required to fix it will cause unemployment to temporarily rise.
And yes, this is going to suck. But the more the Fed waits, the worse it gets.
Most peeps looking at this situation ignore (or are unaware) of the first level issue. It's it demand side or is it supply side. Demand side can rebalance eventually and is less harmful. Supply side means everyone is now poorer and it's more painful on top of also including a unequal distribution of that pain.
The 1970s was supply side - driven most significantly by the fallout of the oil shocks.
> The inflation is a consequence of a mistake that has already been made by the Fed - overly expansionary monetary policy since 2021
However you miss the next important level of distinction in inflation. Inflation in what? Basic goods and services or investments/ assets?
People have been claiming that the Fed's policy (and QE) would kick off horrible inflation in goods and services now every year since 2009 and it never happened. When did goods and services inflation start? During the supply side shutdowns of Covid when hundreds of economies worldwide began producing less due to people remaining home, getting sick, retiring early, dying and factories and shops closing.
Then goods and services inflation kicked into high gear with yet again the oil spike. Oil price doubled in roughly 18 months, peaking earlier this year. And yet again we see goods and services inflation.
The inflation that's hitting common families is (as usual) supply driven.
Now is you're a crypto investor, or a real estate investor, or looking to buy a house, or own stocks, then yes you have legit complaint about the demand driven asset bubble and subsequent popping due to the Fed's policy of cheap money. But the reason trips to the grocery store, filing up a tank, and every day costs are more expensive now is due to supply side.
Raising interest rates isn’t about causing unemployment (directly at least). It is about causing capital investment to be less lucrative than tying the money up in treasuries, reducing money velocity.
Money isn't tied up in treasuries, money (loosely bank deposits and cash) and treasuries are two distinct concepts. You can trade money in exchange for treasuries, but then the previous holder of the treasuries has the money, and you have the treasuries, it doesn't tie the money up.
The amount of value captured in treasuries is a function of the total government debt outstanding, and a way to increase that value is to issue more Government debt (in which case, the money goes to the Government to then spend, it still isn't tied up), however the Government is actually disincentivised to do this as their cost of borrowing (interest rates) goes up.
> That’s why the last huge injection of money in 2008 didn’t cause inflation.
The "injection of money in 2008" (the creation of central bank reserves) didn't cause inflation because the overall quantity of broad money still fell over that time period (https://fred.stlouisfed.org/series/DDOI07USA648NWDB). This was because of the "credit crunch" occurring at the time, where commercial banks where massively reducing their lending activities. The same is not true now, the creation of additional central bank reserves in the past 2 years has directly translated into more broad money, and we have inflation as a result.
The second is misdirected money supply which steers money towards sweatable assets like property and stock ownership, and away from productive investment, original invention and research, and small business creation.
Effectively this causes an internal supply shock which raises the prices of the sweatable assets for the ownership class and impoverishes everyone else, to the point where essentials like housing become unaffordable and demand starts to seize up. Small businesses are forced to close rather than being encouraged to open.
Inflation has very little to do with money velocity, interest rates, unemployment, wage rises, or any of that other supply side nonsense.
Higher interest rates also lead to less borrowing which reduces the volume of available money. Together with the reduced velocity, this leads to an overall reduced throughput.
That said, why is money velocity, or throughput, reduced when inflation itself is a self-correcting problem?
If money velocity causes inflation forcing people to use less efficient methods of exchanging money should stop it.
in addition to capital investment there's also a lot of impact by manipulating current consumption that responds to interest rates - like the housing market, which is mostly consumption.
A $100 in a drawer can't cause inflation. It's not a stock problem; it's a flow problem.
Inflation is always, everywhere, a lack of effective competition. In situations of excess supply you have very little to no inflation. Firms are too scared to push prices for fear of losing market share.
We don't need hair shirt people going around confiscating assets from people. What we need is more investment to create more capacity to supply, and anti-trust action in any areas where a monopoly has arisen.
We don't need an Office of Budget Responsibility, we need an Office of Price Competition.
The target should be to maintain leptokurtic turnover vs price curves in all markets. Then we'll have stable prices.
It's arguably both a stock problem and a flow problem (MV = PQ). If the stock is constant and the flow increases, you get inflation. If the flow is constant and the stock increases, you get inflation.
> Inflation is always, everywhere, a lack of effective competition. In situations of excess supply you have very little to no inflation.
Excess supply at a given price level almost by definition means prices should trend downwards (it is price that ultimately balances supply and demand, and therefore it is too high a price that causes the relative excess of supply/lack of demand).
The price of commodities around the world is going up, by definition this cannot be due to a lack of competition - there must be something else at play.
1) Humans aren't perfectly rational. A lot of people who don't understand exponential curves will end up going broke - like people who earned money and "saved" it by storing it in a bank account. To put it bluntly, a bunch of old people will be left destitute despite working hard and saving.
This also affects wage earners who aren't keen negotiators. They'll quickly end up with a below-market wage and might not realise what is going on.
2) Price signals take time to propagate because the economic hive mind doesn't move at the speed of light, it moves at the speed of takes-a-few-months. There will be wild mis-allocations as people work out how to measure goods in something reliable that isn't dollars.
3) The new money has to start somewhere, that group will get a massive advantage in allocating resources. They probably aren't good at it, because if they were they wouldn't need free money, so they'll cause massive waste.
4) Triggering high inflation is bad strategy for making things better, so if it is being used the people running the show are probably not the most competent of chaps. They'll be making a lot of mistakes. Eg, usually a high-inflation strategy will get coupled with other tricks to destroy savings - think gold confiscation or wealth taxes - as people try to respond sanely to money printing. If you run the numbers on how capital gains tax interacts with inflation you have a "hey! wait a minute..." moment if you like saving money.
In my view, the main problems with inflation are:
1. It introduces a transaction cost tax. Every time a business raises prices, they need to spend time re-printing menus, marketing materials, websites, etc. They need to spend time renegotiating contracts. They need to re-figure their cost structure, and see if it still makes sense to use the same suppliers.
2. It disincentivizes long-term investment or planning over short-term consumption. If money's going to be worth less later, spend it now, regardless of whether you need what you're spending it on. Any long-range plans or savings will likely be invalidated by changing cost structures anyway.
As a concrete example, in times of high inflation the rational thing for an employee to do is to completely ignore their actual work and spend all their time focusing on getting a new job. Existing employees usually fall behind inflation, because they aren't actively negotiating their labor contracts and usually have no negotiating leverage anyway. The folks who make it up are those who job-hop. There is some employer out there willing to pay more than your current one; go find them, ask for 20% more than your current salary, and reap the windfall.
But if everybody does this, no actual work gets done, exacerbating any supply shortages. People become so incentivized to chase higher dollar values that they don't pay any attention to what those dollars represent.
The first business receiving inflated prices does not really affect what their suppliers are charging them does it? When a business makes more money and if there is competition they can afford to sell at a lower price and still make profit. And they can invest in making production cheaper which will eventually decrease prices, one could think.
Good points about why inflation is bad. I was just wondering if it is self-correcting problem then it can not be very bad. It seems like a complicated problem. Except supply-side inflation is easy to understand.
It’s not as simple as that, and thinking about the second and third order follow-ons is important. History has taught us it goes something like this:
1. People have more money, so the majority spend it (instead of saving it).
2. Companies, seeing more demand, but can’t expand supply as quickly, raise prices.
3. People are feeling good cause their companies are doing well, but wait… we should get a raise and get some of that profit!
4. see #1.
For example, when companies can produce a good at a rate X, they can up prices at rate 1.05X. But suddenly, they run out of resources and can only produce at constant, instead of rate X, but continue to raise prices due to “projected” demand.
You have to break the cycle somewhere, and it’s painful no matter where you start, from unemployment or raise taxes or add regulations.
The US Fed only has 1 tool out of the 3, as congress is the ones with power to raise taxes or add regulation.
> You have to break the cycle somewhere, and it’s painful no matter where you start, from unemployment or raise taxes or add regulations.
I know your explanation is simplified, but as you describe it, it seems like the obvious solution is to just stop raising the prices? I feel like there must be something more complicated at play, because "we need more unemployment so that the companies don't have to stop raising their prices due to incorrect predictions" is ridiculous.
For me, current inflation is caused by the fact that people have too much money the do not need and they invest it instead of buying goods.
This leads too more speculation on everything, stocks, cryptos, energy, real estate and even staple foods.
In the last 10 years every of those indexes has gone massively up. This has resulted in companies having share prices increasing faster than their performance would have suggested. If there's more demand for company X stocks then the price will go up even if company's performance is not so great.
And here starts the loop for me, company X employees want a slice of this cake. Their are recompensed for the higher stock price (bonuses, wage increases) and not for their "real life" performance. And now those employees have even much more money they didn't need, so what they do? They invest and speculate => loop.
While the upper middle class (and above) has became richer thanks to this (more salary, stellar investment performance, low interest rates to invest even more etc) the bottom class has lost everything, they have pretty much the same salary than 10 years ago but everything is more expensive.
Nevertheless, almost everywhere in the world, we have also seen wealth tax cuts. So those who had money to invest have now even more and those who need to be helped are helped even less because less taxes means a state less able to help them.
All of this have brought us to where we are today. Unfortunately.
The problem is a situation of run-away inflation can arise. This happens because the vast majority of the money supply is created by commercial banks lending activities (not central bank reserves as many seem to believe) - i.e. whenever any commercial bank lends, it creates new money.
When inflation goes up sharply, real interest rates can become sharply negative (as they are presently), and this provides an incentive to borrow money at negative real rates, where you profit by not having to repay as much in the future as you borrowed in real terms. This borrowing/lending activity itself then serves to further increase the money supply, until such time as interest rates are raised sufficiently so as to bring the (expected) real interest rate back into positive territory, thereby removing the profit incentive that drives marginal money creation.
[1] https://www.investopedia.com/terms/b/bank-reserve.asp#citati...
e.g. imagine you negotiate a 13% raise because inflation was 13% last year (btw so did everyone else). congrats - everyone just guaranteed that they will have enough money to create 13% inflation next year, when the cycle will repeat
unemployment solves this because it's a "-100% raise" and takes spending power out of the economy
and inflation is generally considered bad because among other things it distorts markets for savings and loans
Only until expectations catch up with the reality of the money supply. If there isn’t enough money in the business’s account to pay that 13% raise people get fired or the contract gets renegotiated, or the business goes under.
The Federal Reserve Chairman actually said this in a speech several months ago.
Maybe if we sacrifice a lamb, things will get better.
For this unemployment "solution" to work, more people have to be out of work. Sacrificial lambs in 2022.
As things improve, "the rising tide will lift all boats". Except for the sacrificial lambs who will sink like stones.
Yes, that's part of it. Inflation is a race. It's not a problem for whoever gets access to the newly created money first. It's a tax on people who have fixed income (or cash reserves) of some kind, because they will be the last group the new money flows to. It's not about the increase in money supply, which doesn't really matter because the market will adjust prices, it's about how the newly created money flows through the economy.
Precisely. The less money people have the lower prices have to go for sales to be possible so increased unemployment is a downward force on prices but isn’t all that successful right now when there’s also a massive skilled labor shortage in the vicinity of record expansions of the money supply.
But imagine a country that imports 25% of GDP and exports 25% of GDP, so that trade makes up 50% of the GDP. Now it can have an increase in inflation without a change in its monetary policy. For instance, if it buys a critical supply from a country, and that other country has an appreciating currency, then suddenly the imports will be more expensive. This is with no change to domestic monetary policy.
Inflation is anything but self-correcting, as countless episodes of hyperinflation have demonstrated: a thousand percent a year, ten thousand, ten billion percent - we've seen it all [0]. And that is the real problem with inflation: it truly has no upper bound. And above certain levels, it's very hard to bear.
Higher prices reflect a new equilibrium between the quantity of money and the quantity of goods and services being produced. Until that revised equilibrium is reached, you generally suffer from shortages of goods and rising prices.
> It's still very much in the system, the money supply hasn't changed at all.
The money supply doesn't need to decrease for inflation to stop, it just needs to stop increasing on an output-adjusted basis (and even then you need to wait for the equilibrium to be roughly reached before price levels stabilise).
https://en.wikipedia.org/wiki/1973_oil_crisis
> "By the end of the embargo in March 1974, the price of oil had risen nearly 300%, from US$3 per barrel to nearly $12 per barrel globally; US prices were significantly higher. The embargo caused an oil crisis, or "shock", with many short- and long-term effects on global politics and the global economy. It was later called the "first oil shock", followed by the 1979 oil crisis, termed the "second oil shock"."
The 1979 oil shock was caused by the steep drop in oil production in Iran, and was only partially mitigated by the petrodollar recycling system that US and Britain had set up with the Gulf Arab states in the latter half of the 1970s (initiated under President Ford's administration). It was later offset by the deepwater oil boom, in the North Sea and Gulf of Mexico, as well as by falling demand to the rise of more energy-efficint vehicles and energy-saving initiatives:
https://en.wikipedia.org/wiki/1980s_oil_glut
By 1983, the inflation rate was back to 3.2%, which seems to match the notion that energy prices were the dominant inflationary factor over the 1972-1985 period.
It's curious that the author of this piece entirely neglects this fundamental dynamic, instead claiming that it was due to a push for full employment (which is something of a neoliberal trope, i.e. it's an argument in favor of decreasing domestic US employment by shifting manufacturing overseas to sweatshop zones).
Just look at the US unemployment rate - it dropped from 10.8% in 1982 (3.8% inflation) to 6.6% in 1986 (1.1% inflation).. i.e. Inflation plunged while employment boomed... doesn't that completely upset that argument?
https://www.thebalancemoney.com/unemployment-rate-by-year-33...
Before 1965, 10, 25 and 50 cent coins made in the US was 90% silver. In 1965 all coins changed to a base metal. So that alone caused prices to rise in the 1960s to early 70s, and all silver coins disappeared from circulation.
As others mention, 1973 and the again 1978(?) the oil shock happened, which put inflation on steroids.
And, not long after, the dollar was convertible to a fixed amount of gold, either. I forget the year for that change.
The USA (especially) and UK (just a bit) have just spent trillions on a war in Iraq and Afghanistan, everyone (I can't think of an exception) has spent trillions on a war against Covid-19. It's not surprising that there is now an inflationary surge. The solution is not to have more wars or pandemics.
Unfortunately this is (to some degree) not a matter of choice for all parties. I don't think for a second that the timing of Putin's war suited the west, which is why Putin went in when he did. The timing of any war in Taiwan will not be chosen to suit all parties either. The war on terror was a matter of choice. History is revealing it to have been a very bad choice indeed. The next pandemic will not be a matter of choice either, whether it's man made or natural no one is going to wake up in the morning and say "wouldn't it be great if we had covid-3?" but if we get covid-3 we will have to react to it.
For me this is the real lesson - one that Putin is learning as well. If a state is presented with the possibility of embarking on a war of choice there is no real choice. The only rational thing is to refuse to embark on that course because the risk of catastrophe is very high and the opportunity costs are higher.
It looks like there were three peaks in overall inflation mountain range, and only one of them was from the oil price shock.
I believe the author might have been using the article she linked as a major source:
https://www.federalreservehistory.org/essays/great-inflation
Keeping inflation low keeps long rates low which keeps money cheap which blows up asset bubbles.
We probably need closer to a 5% inflation target than a 2% inflation target.
But very likely what will happen next is a massive recession and the Fed will once again cut rates to zero.
It is interesting because back then the method used to fight the inflation was a list of interest rate hikes, followed by privatisation of a lot of state property that was sold for peanuts then liquidated(snapped very quickly by various people "with connections"). However, the tax burden was quite low (no VAT at the beginning, and the huge majority of businesses activity was in the "grey market" anyway). It took years and years for the situation to improve. Of course as with everything in economy there were many factors that led to the crash, not just interest rates.
However, it is interesting to see how the current government is taking an opposite path to "fighting inflation". There are some interest rate hikes, but no where near what they should be to quash 20% inflation which we have now. Instead there are various attempts to "buy time". "One time" extra benefits for the pensioners have been quite generous. Laws to help borrowers by forcing 3 months of repayment holidays on mortgages were brought up. VAT for food was taken to 0%, taxes on fuel were lowered. A subsidy for house heating fuel was created, freeze of electricity prices for people and businesses that keep within certain usage limits, direct subsidies to high energy consuming industries. Of course all those things are available as tools, because the country went into this period of time with pretty good finances, but still it is very interesting to see if this "alternative" approach allows the relatively small peripheral economy survive this recession and keep its one of best in EU unemployment rates for long. Especially in light of having to double its military expenses and various expenses connected to the War.
The Great Inflation of 1965 to 1982 came in the second half of the era when the great European empires were coming to an end (1947-1986). The most obvious event of the Great Inflation is the OPEC crisis, which obviously would not have been possible if the MidEast had still been owned by Britain. The independence of the Third World was a necessary pre-condition for the Great Inflation. One possible angle to explore is the extent to which independence allowed the nations of the Third World to demand better prices for their goods -- obviously in the case of oil, but possibly in the case of many other commodities -- and then possibly the way to break the power of the Third World nations wanting better prices for their commodities was for the developed nations to inflict a brutal period of austerity on themselves, cheating themselves so as to cheat the commodity-supplying nations.
This was an era in which the number of nations increased, dramatically, as the world transformed from a few big empires to 212 independent nations. Therefore, there was also a dramatic increase in the number of currencies that existed in the world. And so, there is another avenue of research that needs more exploration: whether the increase in the number of currencies that existed in the world lead to a kind of chaotic interference in the markets for currencies -- a world with just 11 currencies is a world where one can almost model the interactions in one's head, whereas a world with 212 currencies is far too complex for anyone to model it in their head. Did the sudden increase in the total number of independent currencies make it difficult, even temporarily, for the markets to send a rational signal about the value of those currencies?
Given such a complex situation, it is almost impossible to develop a properly multi-variate model, unless one is willing to devote one's life to the study of the subject, but as a method of getting traction on such complex subjects, it can be instructive, and even fun, to go through a single-variable account of the history, to see what impact a single variable might have had, for instance, in this case, the currency valuations of the various nations:
https://demodexio.substack.com/p/why-did-the-west-deindustri...
Such single-variable explanations always need to be taken with a grain of salt, but they do provide a way into a subject, without demanding 10 years of study.
- I wouldn't characterize Volcker as a 'lone hero', Carter appointed Volcker and Reagan reappointed him. there was political support for tight policies and fighting inflation. Volcker did a fantastic job maintaining that support and credibility with money supply targeting, and relaxing money supply targeting when it was leading to excessive tightness and overshooting.
- The Phillips curve may not be wrong in that strong demand leads to acceleration in inflation, however it is hard to measure, and there is a distinction between the short-run tradeoff and a much steeper or vertical long-run tradeoff. You can temporarily get higher GDP by tolerating higher inflation, but then expectations adjust and you need more and more inflation for the same GDP boost.
- there was a lot of weird stuff going on in the 70s with oil, farm prices, petrodollar recycling and emerging markets, loss of confidence in US leadership after Vietnam, extended dollar weakness. sometimes when it rains it pours, inflation expectations become self-fulfilling.
- high and variable inflation is really bad for asset prices. it makes investing more risky. growth stocks like tech are bets about a farther away future, as opposed to present earnings, so it's worst of all for them. beta for stocks is kind of like duration for bonds, anything with a high multiple is a long-term bet on continued growth.
- the Fed really wants to see slightly positive real rates, reasonable wage growth adjusted for productivity. otherwise they think they are behind the curve. with inflation this high, real wages are declining so that's bad for consumers and demand. and yet a Taylor rule means rates still need to go a lot higher, so that's why people think there's a risk Fed will overshoot and tip US into a recession.
see also
- https://www.federalreservehistory.org/essays/great-inflation
- https://www.nber.org/books-and-chapters/great-inflation-rebi...
- https://www.nber.org/books-and-chapters/inflation-causes-and...