A Tale of Two Inflations
Posted July 26, 2022
“All the headlines are about inflation,” James said during a recent conversation with Jim Rickards, “but there’s really two kinds of inflation.”
James and Jim got together recently.
If you’ve followed both James and Jim in the past, you’ll know they’re often at odds. Which made the conversation all the more lively.
They talked about everything from the market, economics, climate change, innovation, vaccines, COVID-19, and the flavor of the quarter: inflation.
Let’s focus on the latter.
The Two Types of Inflation
First thing you should know about inflation: There are two types.
Cost-push inflation is when demand remains the same or grows when prices go up.
An example of cost-push inflation is when, in 1973, OPEC decided to restrict production, causing prices to rise 400%.
Even with price increases, the demand for oil can’t be clawed back drastically. It’s hard to scale back on consumption in any modern economy.
And there’s another one:
Demand-pull inflation is when higher demand meets insufficient supply, driving prices up.
This is also known as a “supply shock.”
We’re currently being hit by both.
Everyone’s got an idea of why this is happening.
But, contrary to popular thought, says Rickards, monetary policy doesn’t contribute to inflation.
He said it again for the people in the back: “monetary policy has nothing to do with it.”
Milton Friedman popularized this idea, he says, but it’s wrong:
“In 2008, the Federal Reserve balance sheet was $800 billion. And in 2014, at the end of the taper, it was $4.5 trillion. The money supply went out by 400% and there was no appreciable inflation that entire time. There is no correlation between money supply, base money, and inflation.”
What contributes to inflation, then? Psychology.
“You wake up in the morning,” says Jim, “you see inflation around you and you say, well I was thinking of buying a refrigerator, I better go buy it now before the price goes up or a new car or suit or whatever.”
What Friedman missed, said Jim, was velocity: “In other words, the quantity theory of money.”
Velocity is King
What is velocity, you ask?
“If I buy a newspaper from the newspaper guy for a dollar, he takes the dollar and buys a flower, the flower guy takes it and buys a coffee, $1 caused $3 to be spent. That’s velocity.”
So Friedman believed that velocity is a constant. And, indeed, it was during most of his career -- from 1950 to 1980.
But he was wrong.
Hence our current economic predicament.
And it’s why the Fed is far more interested in manipulating the psyches of the masses than the actual money.
Destroyers of Demand.
Though they differ on some points, both James and Jim agree on one thing:
The Fed is pretty powerless in the face of runaway inflation. All they can really do is destroy demand.
“Last time I checked,” said Jim, “they don’t drill for oil. They don’t drive
tractors. They don’t drive trucks. They don’t unload cargo in Long Beach and they don’t pilot container cargo vessels across the Pacific. So the Fed can’t do anything about the supply side. What’s called cost-push inflation. They can fight inflation one way, which is to utterly destroy demand. And this is what Paul Volcker did in 1981.”
By raising interest rates, mortgage rates go up. Unemployment goes up. People are laid off. Financial uncertainty sets in.
And it gets worse.
The Devil and the Deep Blue
As you read this, the Fed is trapped between Scylla and Charybdis…
It is on the horns of a dilemma…
Between the devil and the deep blue sea…
A rock and a hard place.
No matter what they do, Jim says, a reckoning is coming.
In fact, Jim predicts a “Financial Fourth Horseman” is set to show up — and with near mathematical certainty — on July 27th at exactly 2 p.m.
But, before you think, “Oh, I’ve heard this story before”...
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