US inflation is playing with fire- but we do need to stay warm
A short note on why inflation is used to keep economies afloat in rough times
Inflation is when the price of something goes up and we’re mad about it.
I get into this more in Blockchain Thoughts & DeFi Economics - but things are always changing in price. When something goes up in price and we’re happy about it that’s investment. If we’re mad about it, it’s inflation.
It really is that simple. We use complex seasonally adjusted models of made up consumer baskets of goods because measurement is hard even when ideas are simple. When oil goes up and gas goes up, I’m mad, but oil companies and their shareholders are happy.
The who matters when it comes to inflation.
Now, over the next 6-18 months we’re going to hear a lot about inflation including accusations of manipulation. There are objective benefits to the government in misleading us about inflation- although I don’t actually believe they’re doing so.
Most directly, certain programs are pegged to the government’s estimates of inflation (changes in the consumer price index) such that inflation requires the programs grow (e.g. Social Security).
More indirectly, it keeps people from panicking, like they did in what is my opinion the most analogous recession to today’s time- the Panic of 1837.
The economy is driven by consumption. What is not consumed is saved and in theory savings are what drives investment so that we can consume more/better in the future.
Inflation, combined with low interest rates, incentivizes consumption and disincentivizes savings.
If everything fun is going up in price and your savings account pays < 1% (or really any amount below inflation) you might as well go have fun now, because it’s going to get more expensive later.
At the most basic level, that is what is happening in the economy. The US has weathered COVID-19 into a widespread vaccine availability era, people were saving like crazy compared to pre-COVID, and inflation + low interest rates will get them out of the house and spending.
But who is going to be hurt by this? It again, depends.
Inflation hurts workers whose wages (which are sticky in that wages don’t change often, most companies do reviews once a year after all) buy less stuff.
But inflation also inflates share prices (extremely not sticky) and corporate assets making it easier for companies to borrow against their assets to try and grow the business and make investments (which works as long as those investments pay off above the inflation rate!).
This can lead to either protection of jobs (people aren’t fired because the company looks good on paper) or creation of new ones (if good investments are made).
Corporations can also thrive in this environment through squeezing profit off wage stickiness. If your share prices and revenue are going up, but your biggest cost (employees) is staying the same, then even if your other costs (i.e. paper, wood, manufacturing materials, steel, etc.) are going up you can still net profit.
To summarize:
Inflation + low interest rates pushes people to buy buy buy
Inflation of corporate assets funds investment
Corporations can profit in a high inflation environment because even if their non-labor costs go up, labor wages are sticky, allowing them to essentially pull value from employees.
The average worker is the biggest loser in all of this, but to some extent, it is better a bad job than no job.
In the long term, what you hope to see is that when the economy flips into a high interest rate environment with low inflation workers become savers (which means investors) and having retained some employment through bad times, will have the skills and leverage to drive labor costs (their hard earned wages!) up when other costs are down.
This seesaw between capital and labor is the foundation of a modern state-capitalist economy. Now there are plenty of arguments to be made that economies should not be state-capitalist (hyper free markets, disproportionate labor taxes but low capital taxes) but instead be democratic socialist (regulated markets but disproportionate taxes on capital and low labor taxes).
But I’m not hear to argue that (although I have plenty of opinions on it).
I just wanted to clarify on how this inflation game is supposed to turn out so we can judge it appropriately in the future.
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