Inflation, failed policy and unfulfilled dreams


Let’s mix and paraphrase Goya and Shakespeare and ask, “When reason sleeps, what dreams can come?” I’m mixing and paraphrasing because the sources (Francisco Goya’s “Los caprichos” aquatint series and Hamlet’s “to be or not to be” soliloquy) aren’t quite accurate. Goya’s man dreams and Hamlet consciously contemplates suicide.

I say that policy makers around the world have put their reason to sleep but stay awake to do much harm. It is better to say that the evil is a murder of national interest rather than a suicide, since certain leaders remain present and continue their madness.

Policy in the United States and only slightly less in China allows for inflationary increases in money supply and spendable paper demands, combined with a conscious effort to suppress production via lockdowns. The result is the essence of inflation/recession: increased purchasing power and empty shelves.

In a sense, it is already the recession or the depression, since so many citizens are dissatisfied, even depressed, with their personal economic and social situation.

Everyone who uses social media has seen and heard the frustrated citizens of Shanghai at night, barking at the moon. In Anytown USA, citizens can be seen cursing the price on their gas pumps and also cursing politicians who are seen as responsible.

Everywhere, there is a sharp reduction in the satisfaction that citizen-consumers derive from their economic life, and everywhere there is a sharp drop in the benefits that citizens earn in their productive and professional lives. Even when people “make money” from housing bubbles or stock market fluctuations, citizens understand that this speculative wealth can disappear as quickly as it appears.

Politicians who put their sanity to sleep as they spread fake good times with checks in the mail and corporate bailouts have good reason to fear a loss of public support and/or electoral setbacks. These concerns are now provoking double-down type political actions, in anticipation of classic recession signs in the statistical wind.

OK, there’s a lot of economic dissatisfaction around. And it’s linked to inflation. But what is the process by which inflation turns into obvious, standard, daily recession (or worse)?

Price reports

During inflation, the prices of different commodities rise at different rates, and therefore the price relationships change. Some ratios are critical. For example, the price of gasoline may double, while the price of steak in the supermarket may increase by 50% and the household wage may increase by only 5%. The head of household finds that traditional shopping habits need to be changed, which reduces the overall level of economic satisfaction of the buyer.

In an economy like China’s, with significant elements of centralized planning and control, many critical prices and price ratios are set externally in uncontrollable international markets. Producer input prices faced by Chinese planners and companies are now rising 9-10% a year, spoiling old plans and forcing companies to make uncomfortable changes to the prices they control, especially wages and prices paid for locally produced inputs.

(Money wages cannot be reduced, but the decline in purchasing power caused by inflation does the job.)

Without such adjustments, the prices China has to charge for the goods it exports must rise, leading to lost sales, endangering the inflow of international money, and jeopardizing the domestic growth factor. produced by these export earnings.

Likewise, production costs throughout the U.S. economy have risen and cost ratios have changed, reducing profits and dislocating production efforts (sometimes due to misguided regulatory shutdowns like the one that caused an artificial shortage of preparations for infants across the country).

Bubbles and crashes

A classic process by which bubble inflation in the stock market leads to recessions is the margin call crash. Stock brokers, who actually hold the shares “owned” by customers who bought the shares with money borrowed (on “margin”) from the broker, where the shares were pledged against the debt, will sell the shares and then cash in the collateral during times of panic.

This process can happen in any market, anywhere, China or America. It consists of the forced sale of assets, once rising in value, now falling in price, which were purchased in the first place with borrowed money; particularly where the lender was an intermediary in the transaction and the underlying asset was put in place as collateral for the loan: this collateral has now disappeared as far as the lender is concerned, because even if the lender takes over the asset while the borrower cannot pay, the value of the asset is now insufficient to pay the debt.

The cash-strapped lender itself is selling the asset, even at less than “true value”, because no one knows when the drop in value from the bursting of the bubble, seen everywhere, will will stop. It is the downward panic that too often characterizes the exit from a bubble.

An example will help. The investor buys an asset at 100 yuan. (Let’s say the asset is made up of 100 parts, each part initially worth one yuan.) To pay, he puts in 10 yuan and he borrows 90 yuan from his friend. A friend said, “OK, but if you don’t pay me when I ask for my money, and I will ask for my money if the asset is not worth at least 90 yuan, I will seize the asset, or another of your assets. it’s worth at least 90 yuan, so I’m sure I’ll get my money back.

The investor does not worry in an ascending bubble, because he reasonably predicts that the asset will soon be worth 200 yuan, and he can always sell part of the asset to settle the debt of 90, and dispose of all equity in a new position. (Since each of the 100 parts of the asset is now worth 2 yuan, the investor only needs to sell 45 parts of the asset to get enough money to settle the 90 yuan debt, keeping 55 parts for itself.) The remaining investment is debt-free, worth 110 yuan.

The price ratio that goes out of line in a particularly ruinous and dangerous descending bubble is the ratio between good and bad investments. All investments look bad and all are sold.

During a descending bubble, the total value of the asset in 100 parts falls below 90 yuan, the friend cannot get all his money back when he grabs the asset and sells it; although he does, then will come back to the investor and demand more money. The investor has been sold off of the original asset and needs to find other assets to sell to close the original debt.

The investor may be forced to panic sell very good assets at ridiculous prices, just to settle the debt against the bubble asset. It is the process by which a descending bubble creates a universal sell-off of all kinds of assets, destroying all kinds of value, leading in the worst case to market collapse and even general depression.

Some price changes and ratios are internal to companies. A family restaurant operator discovers that input prices are rising faster than he can pass it on to customers and stay competitive.

Suppose the price the family has to pay for incoming ground beef increases by 15%, but the family can only increase the price of hamburgers it sells at the counter by 5% if it wants to retain its customers. This either means that profits are falling or that they are compressing other costs: they may have let some of the hired staff go. This unemployment is another element of the recession caused by the change in price relations.

Policy Failures

Policymakers see these problems ripple through the economy: investors sell off good assets while lenders don’t get their money back. Small businesses fail. Ordinary workers are losing their jobs. None of this is “deserved”. Good investments are undervalued for pennies. Reliable workers cannot find jobs. Restaurants that serve great burgers are going bankrupt.

Policy makers are distraught. They make matters worse with commercial bailouts that fail to distinguish between good and bad burger sellers. Unemployment checks go to crooks as well as hard workers. Bubble asset prices are supported and decent assets are not finding buyers.

Everywhere, political errors are evident and cause unrest among voters/citizens due to perceived injustice. If and when politics gets it right, there is a general feeling of chance and failure. Policy makers are only seen to be right by chance and therefore get no credit. A general feeling of failure and incompetence prevails, both in private markets and in policy discussions.

Neither the Chinese way of doing things nor the Western tradition has succeeded in correcting the many imbalances that make up an economic order beset by the intertwined processes of inflation and recession.

When a “remedy” has occurred, there is a return to normal price and value ratios. Then, young couples getting their first job can earn enough money and have enough job security to buy their first home or condo without having to ask their parents to pay the unbalanced price demanded in a bubble real estate market. . Small businesses again pay for the necessary inputs while charging enough to make the profits necessary for long-term survival.

But how quickly or easily to bring about this normal state of affairs by political means, by planning or by indirect policy-making, is not known. Historically, this has certainly not been done in the short term.

Historically, all that can be said is that policy makers need to wake up their slumbering reason and stop making things worse. Otherwise, their nightmarish dreams will continue to stalk us all.

Tom Velk is a libertarian-leaning American economist who writes and lives in Montreal, Quebec. He has been a visiting professor at the Board of Governors of the US Federal Reserve, the US Congress and Chair of the North American Studies Program at McGill University and Professor in the Department of Economics at that university.


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