The Real Inflation Debate

The Real Inflation Debate
Jeffrey Snider
Ever since the U.S. Consumer Price Index (CPI) first accelerated in March of last year, it has been confused as a good proxy for the underlying economy. It sounds like it should be this way—that if prices are accelerating so wildly, as they soon would, wouldn’t that be a product of the red-hot economy so often quoted all across the news media?

That was only ever one potential explanation, and never the most likely. Prices are multifaceted, and economics as a discipline has done an exceedingly poor job of educating the public about the nuances of price.

Start with the word inflation. The term itself has been conflated with another, overheating. There is this neo-Keynesian idea drawn from the Phillips Curve, whereby scarce workers, it is believed, mean competition among businesses for them, driving up wage costs which companies then have to pass along to consumers as inflation.

Taken to its logical conclusion, we’re supposed to want officials to do what they can to avoid the situation where most of the population is working and making good earnings doing so. Huh?

Actual inflation is something else entirely—an oversupply of currency—the old adage of too much money chasing too few goods, or something like that. History has shown, conclusively, there is no other type or explanation. Legitimate inflation is, as the economist Milton Friedman once said, always and everywhere a monetary phenomenon.

If money is well-supplied, neither too much nor too little, there is no reason to fear, let alone try to avoid, going to full employment.

The problem for the public is the subject of economics. This field of social science and its major “schools” hasn’t, for many decades, made any serious attempt to study money and the monetary system. Yes, decades. And the reason why is fairly simple and straightforward: Economists wouldn’t even know where to begin.

While this may sound like an incredibly controversial claim, that’s only because economists and central bankers (same thing) have done everything in their power to avoid the topic. And if you aren’t willing to take my word for it (you shouldn’t), how about none other than the word of former Federal Reserve Chair Alan Greenspan, speaking 20 years ago (below is taken from a June 2000 transcript of a meeting of the policy-making Federal Open Market Committee):

“CHAIRMAN GREENSPAN: The problem is that we cannot extract from our statistical database what is true money conceptually, either in the transactions mode or the store-of-value mode. One of the reasons, obviously, is that the proliferation of products has been so extraordinary that the true underlying mix of money in our money and near money data is continuously changing. As a consequence, while of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition.”

The banking system had indeed proliferated products that had become untraceable, yet usable money many decades before Mr. Greenspan’s "confession" in 2000 (it’s one the “Maestro” had made repeatedly throughout the 1990s, too, except no one was listening to what he was saying on account of how infrequent the man said anything of note). This is where eurodollar money comes in, and right where economics was left out.

But, you’ll note, the Federal Reserve is mandated by law to engineer some kind of price stability, a task made insanely challenging—as Greenspan was saying in 2000—by virtue of having no way to “locate money.” Yet, inflation is money.
So, what do you do instead to work around this massive knowledge gap?

Monetary Policy, a Sleight of Hand

Conjure another explanation for inflation, and do so using what’s called "monetary policy," which actually contains no money in it. The Fed came to target interest rates—an interest rate, the federal funds rate—rather than money supply. The idea was simple enough, hoping merely to influence bank behavior (primarily) since banks were and are where the money really is.
It is an indirect and convoluted theoretical method, yet policymakers were left with no other option. By raising or lowering the fed funds target, the Fed only ever hoped that the banking system would make the “right” changes in money supply in response, which might then produce the desired real economy results: both price stability, defined as low inflation, along with maximum employment.
Appealing to the Phillips Curve view, tying together max employment with inflation, this was a way to evade every kind of monetary discussion, no matter what circumstances. Not once has Fed Chairman Jay Powell been asked in the myriad of press conferences or other official situations in the past year or so the only inflation question which matters: is there or is there not too much money, Mr. Powell?
The monetary system, however, has offered us the details anyway (via curves and spreads). Its verdict about the last few years has consistently been, no, not inflation, regardless of how high CPI levels had gone. Furthermore, the system also told us there had never been a recovery, either, and that turning consumer prices into a red-hot economy was a huge mistake that would eventually come back to haunt us all.

These views have essentially collided over the past five months, with inversions becoming severe, and more economic data aligning with the position of the inverted curves rather than the Fed’s dart-throwing regime.

Now even consumer price indexes, such as the CPI, are behaving as inversion has predicted for them. The latest estimates for the month of July 2022 were not the first to go this way, either, even if much political attention focused on the slight decline in overall average prices for the month. That data show the situation has been changing since March, a general process of rolling over, which is only now gaining a wider appreciation, spotlighted by that tiny monthly negative.

Labor market data, too, have turned. Though the headline payroll figure in the Bureau of Labor Statistics’ Establishment Survey for the same month of July surprised on the upside, for the Fed’s view suggesting more price pressures still ahead, the Household Survey indicates the exact opposite: an already-weak economy now heading toward another round of possibly serious contraction.

The latter would easily explain all of it: money, inversions, downside CPIs, and everything in between (including the lagging Establishment Survey). Understanding money has meant, and will mean, understanding what aren’t really subtle differences.

Markets have been confidently pricing the Federal Reserve’s upcoming embarrassment from even before the first rate hike. More and more the path to get there is becoming clear, with less ambiguity by the month. Why? Because policymakers wouldn’t know the first thing about inflation.

Rate hikes aren’t really the problem, and never were. It’s all much more basic than that. The whole thing is how little "economics" resembles actual economics.

Jeff Snider is Chief Strategist for Atlas Financial and co-host of the popular Eurodollar University podcast. Jeff is one of the foremost experts on the global monetary system, specifically the Eurodollar reserve currency system and its grossly misunderstood intricacies and inner workings, in particular repo/securities lending markets.