I have lately seen some very muddled thinking about supply chains and inflation, and I would like to remind confused readers of some very basic economics that will hopefully not only put your minds at ease, but possibly even lift up your spirits.
Inflation is always and everywhere a monetary phenomenon
Consider the citizens of a benevolent dictatorship with a curious feature: the only thing available to purchase, and the only thing required to sustain life, is blueberries (because I happen to be eating blueberries). Optimally, each household needs to consume a pint of blueberries per day, so in most years the country produces a pint of blueberries per household, per day, and each day, each household is paid with a voucher worth one pint of blueberries.
This year, a dangerous fungus infected many of the country’s blueberry bushes, leaving the country with only half a pint of edible blueberries per household per day. This leaves the country in an unfortunate position, obviously, and some hard choices have to be made. The price of a pint of blueberries might be raised to two vouchers, or perhaps households will only be issued half a voucher per day. In either case, some or all of the population will be left malnourished. Alternately, half the households might be expelled from the country, or left to fend for themselves, although this leads to further hard choices: shall the exiled be selected by lot, by age, by health, by blueberry cultivation skill, or by some other method?
But none of these outcomes describes inflation, because inflation is a monetary phenomenon. The decrease in the purchasing power of a blueberry voucher in this case is not monetary: it’s driven by an actual shortage.
This is largely the situation the citizens of rich countries find ourselves in today. Certain goods are impossible to find at their old prices (replacement parts for household appliances is the one I seem to hear people gripe about most frequently, but before that it was Playstations and graphics cards), not because of a devaluation of the currency, but because of an actual shortage (so-called “supply chain disruptions”). This is an example of prices doing their job under capitalism, as a mechanism to ration goods. In the case of the container ship bottlenecks, imported goods will over time begin to skew towards more profitable luxury goods, while the poor are left buying domestic goods or second-hand imports.
This will hurt, and it will hurt the poor disproportionately, but it is not necessarily inflationary. Inflation, properly understood, refers to a relationship between the money supply and the total quantity of goods and services available (either newly produced or stored in inventories). It can occur when the money supply is fixed and the quantity of goods and services shrinks, or when the money supply grows faster than the quantity of goods and services. But shortages of individual goods alone cannot produce inflation without knowing what is happening to the money supply.
Shortages are painful, but betrayal leaves scars
I’ve been trying to understand the experience of Americans who lived through the 1970’s for a long time and I’ve come to think of the psychic trauma of that generation in two distinct ways. First was the pain of actual shortages: the OPEC oil embargo and Islamic Revolution reduced the availability of crude oil to the West, with correspondingly higher prices for gasoline, plastics, and other oil derivatives. But this has never seemed quite adequate to me. If gas is expensive, you can drive less, move closer to your job, carpool, ride a bike, etc. And indeed many iconic images in our culture date to that era, whether it’s lines at the gas station or Jimmy Carter turning the thermostat down in the White House (and the resulting sweaters).
But it’s not just that people didn’t want to adjust their behavior in response to reality. Rather, they didn’t think they should have to. After all, they were doing what they were supposed to. They moved to the suburbs because they were told to move to the suburbs. They bought two cars because they were told to buy two cars. And then they were suddenly expected to change their behavior just because the facts on the ground changed? It’s fashionable to dismissively call this a sense of entitlement, but I have great sympathy for entitlement. When your fridge breaks you’re entitled to have your landlord fix it. When a restaurant gives you food poisoning you’re entitled to sue. When you lose your job you’re entitled to unemployment insurance. The problem with the generation formed in the 70’s is not their sense of entitlement, it’s that they were told they were entitled to something beyond the power of the US government to provide: cheap, plentiful petrochemicals.
Inflation benefits virtually everyone
All of the above is my way of saying that the chance of inflation becoming persistent in the United States is relatively low. While individual goods are in short supply, driving up their prices, the US economy will grow much more swiftly than the money supply this year. If the goods you personally buy are going up in price, you’ll need to make choices you would prefer not to make, whether that’s replacing your phone less frequently, hand-washing your dishes, or even joining a car-sharing club. You were promised overnight replacement parts for your household appliances and cheap used cars and you’re not getting them, that sucks, and nothing I tell you will make it suck any less.
The good news is that if persistent inflation does come to the United States, it’s going to be a fantastic development, for two related reasons.
First, inflation is an economy-wide phenomenon. A 10% inflation rate represents a 10% rise in the cost of all goods and services, including the ones you provide (i.e., your labor). It’s true that certain prices are “sticky:” if you don’t belong to a union or your contract doesn’t have a cost-of-living adjustment, your income might not automatically increase alongside economy-wide price increases. But wages aren’t the only sticky prices: your rent won’t immediately increase either, so if your salary happens to go up before your rent, you might even end up better off on a pure cash-flow basis!
But second, the main thing inflation does is devalue the existing stock of debt. I think this concept confuses people because when inflation is high, newly-issued debt is priced to accommodate inflation (or automatically includes an inflation adjustment in the interest charged). But for debtors, repaying the principal on a mortgage, car loan, or student debt with much less valuable future dollars is a godsend.
This used to be well-understood: the original populist movement in the United States, the one you learned about in the context of William Jennings Bryan’s “Cross of Gold” speech, was organized around a demand to debase the dollar by resuming bimetallism, the issuing of currency at the “old ratio” of 16 ounces of silver to one ounce of gold. Why? Because farmers understood that reducing the value of the dollar would reduce the value of their outstanding agricultural debt. And they were right to do it!
It is true that there is a narrow sliver of people in the United States who are creditors to this day, primarily wealthy people who for one reason or another choose to invest some portion of their assets in long-term, fixed-rate dollar-denominated bonds. But perhaps ironically, thanks to progressive income and capital gains taxes, they’re also the people we rely on to provide the taxes that finance our debt, so reducing the value of the existing stock of debt through inflation is a boon to them as well. Not, of course, so great as that afforded to debtors, but in a debtor country, no one is completely left out from the windfall of inflation.
Leave a Reply