A QUICK RUSTY COMMENTARY ON INFLATION IN 2022

Money is just a medium of exchange, like a website that matches swaps between three or more parties. Money is supposed to be worth nothing. Labor and products and land have actual value, money is just a tool to match and exchange them. Money works best when it has the least role, and is not the goal. When money itself starts to have value, it distorts the economy. When money is predictable garbage, the relative power of those with actual assets such as labor and land is maximized.

The problem with too low inflation is money stops functioning as a medium of exchange. You cannot lend or borrow money to invest, because the money will be worth more than whatever goods you produce. This has been thoroughly documented for decades in Japan. And also in the US in the 1930’s when they burned good crops instead of selling them, and banks rather than farmers owned farmland.

After 2007, even Europe and the United States were suffering partial economic paralysis associated with too low inflation. And the theoretical remedy, quantitative easing, was highly flawed and just made bankers and hedge funds rich. I theorized better ways to create necessary inflation which I won’t mention here. But long story short, central banks in US Europe and Japan had been dreaming of creating a healthier self-perpetuating inflation paradigm for years.

Any shock to the economy, where demand does not meet production plans, causes defaults in the web of purchasing and liabilities. This causes goods and investments to suddenly lose value relative to money, until a new pattern of production and consumption emerges. But this sudden deflation becomes self perpetuating, to the extent it paralyzes parties left holding the bag, and hinders lending and investment.

People who have not studied money and history, should at least notice the Fed’s inflation target is not zero. Older experience suggested 2%, more recent decades suggest that is too low. Money functions best not as a store of value or goal of industry, but as a medium of exchange and also a unit for use in contracts. But contracts which are too dependent on the units introduce fragility and exacerbate boom and bust cycles. Banks want coupon payments, not to own farms.

Unpredictable large inflation also has several problems, including the difficulty of structuring contracts, and patterns of investment and liability. Unpredictable changes in the value of money randomly penalize one side or the other of bond or lease contracts. This randomly reallocates wealth. But inflation is not the only cause of problems in countries that had inflation problems, like Germany in the 1930’s or South America. Stagflation in the US in the 1970’s was the result of a lot of policy problems other than the Federal Reserve. And I am surprised people complain about devaluing our government debt to China.

The problem with commodity-based money, is the more more oil Saudi Arabia pumps, the more everyone else gets pinched. Suppose hamburgers are $1 and oil is $1, and the $200 economy consists of 100 hamburgers and 100 barrels of oil. Saudi Arabia pumps more oil, until oil is 50 cents, and they sell 200 barrels. That is deflationary, and the Fed will ease until hamburgers cost $1.25 and oil costs 75 cents, and they sell 125 barrels of oil and 75 hamburgers (25 of them to Saudi Arabia).

Or suppose Saudi cuts production to 50 barrels, and the price of oil doubles to $2. Now the Fed has to tighten to where burgers cost 50 cents, and McDonalds and Burger King default on their debt and lay off their workers. Or suppose there is no Fed, and inflation goes up and down optimized to the whims and fortunes of Saudi Arabia. Either way, Saudi Arabia gets rich, and everyone else is at their whim and rides the roller coaster. The Fed does not like deflation, Saudi would not mind as much for us to suffer under high oil prices.

At least the Fed sends their profits into the Treasury, and has some voter oversight. Imagine when Saudi Arabia or some cartel of mining countries acts as the Federal Reserve, raising and lowering production in response to changes in the value of the commodity relative to other assets. They will not optimize for US employment or even stock market stability. It is at least better that US banks and hedge funds get rich investing in flimsy California tech companies, than Middle East sultans buy gold-plated yachts.

Commodity-backed currency creates a case not just where the economy is distorted by money having value like a commodity, and prices being unstable. Cultural and political values are also rearranged and distorted to worship geographical ownership of mineral resources and commodity production. A Spanish culture of military conquest and mining for gold, rather than trade and production – and actually disdaining labor – can still be seen in Latin American values today, and in fact in cryptocurrency as a proud and honorable pastime of latins in Miami.

There is not some natural state of perfect money in nature, which the government screwed up. Commodity backed money makes tinhorn dictators rich in mining countries, instead of making hedge funds rich. Today’s inflation tilts power to workers and away from bondholders. Inflation is the best Fed policy which we have had in perhaps 20 years. Today’s inflation is like democracy, the worst system except all the others. The Fed let this inflation happen because they know what a paralyzing disaster deflation is, and that it can result from economic shocks like the pandemic.