I’ve never been so hesitant to poke a bear in the eye. But the deservedly famous economist David Rosenberg has it badly wrong on inflation. And that is despite, until now, being right about deflation for longer than I’ve even known what deflation is…
I hope you’ve detected the deference that Rosenberg deserves. He’s a bit of a hero for sticking to his deflationary guns in the face of spectacular amounts of quantitative easing (QE – central banks creating money out of thin air in order to buy stupendous quantities of bonds). But I still think that he’s missing something when it comes to our latest bouts of inflationary policy. Something has changed.
In a recent interview Rosenberg argued that inflation was indeed transitory, as argued by central bankers. His reasoning is the same too. The spike in prices is being caused by pandemic-related problems. And, because the pandemic is temporary… hopefully… the inflation is too.
The argument is simple, and there is plenty of data to support it too. In fact, you’d probably be in a bit of trouble if you try to challenge Rosenberg on any sort of economic data.
But what data is he referring to? Well, for example, as pointed out in the interview, inflation isn’t happening evenly across prices. In fact, it’s very concentrated in just a few prices.
This suggests that the problem is supply chains, not the value of money – an important distinction we’ll get back to below. The logic of this is simple. If the value of money were what’s changing, then prices should be rising more or less together across the economy. The divergence between prices tells you that supply chains are the problem.
To be fair to him, Rosenberg does admit that the inflation has been worse and gone on for longer than he expected.
First of all, the definitions of transitory and persistent represent gray areas. So if you believed that transitory meant weeks, months or even quarters, this is obviously not proving to be transitory. But transitory truly defined just means an event that is expected to be short-term or brief in nature. What we’re seeing right now is a very sharp inflationary experience, and its magnitude has altered people’s perception on the duration of this inflationary period. Certainly, inflation rates are higher today than I would have thought several months ago. It also has proven to be a little stickier.
Stickier meaning that it has stuck around longer than expected. Believe it or not, this is an academic economic term…
The stickiness of supply chain disruptions is probably because the pandemic has made a few surprise comebacks. Surprising to some, anyway. Or, if you prefer, the lockdowns have made a few surprise comebacks.
But here’s the fascinating part of Rosenberg’s interview, the bit that got me disagreeing:
[..] supply will come back on stream. We know that because that is what history tells us. So to bet on inflation is to bet against human ingenuity – and I’m not willing to do that.
That is a very deep point worth a lot of thought and explanation. Although, that is before we get to why it’s wrong.
Despite what central bankers will tell you, deflation is actually the healthy norm of a functioning economy. This is for a simple reason. Over time, because of technology and many other factors, we get better at making things. Which means they become cheaper, adjusted for quality improvements at the very least.
Put differently, as productivity improves, you’d expect prices to fall. This happened during the Industrial Revolution, for example. Mass production made things cheaper.
Only those obsessed with debt fear such deflation, because debt becomes harder to pay off in a deflationary world. This can comfortably be adjusted for with lower interest rates, but economists and central bankers nevertheless fear deflation.
That’s why central bank inflation targets sit around 2% and not the more obvious 0%. The 2% inflation rate is designed to give a margin of error before entering into the supposedly dreaded deflation.
The most obvious criticism of Rosenberg’s point is that inflationary bursts have happened in the past, despite human ingenuity. Thus, betting that human ingenuity will deliver low inflation or deflation is sort of missing the point. It must be something else that is at hand when high inflation strikes.
He’d probably respond that, when it comes to the inflation we are seeing now, it’s only a question of solving supply chain problems. Which is a matter of human ingenuity. In fact, some economists argue that the shipping container is the most important invention, ever. But that’s another story.
Let’s turn Rosenberg’s comment around. To bet on inflation is to bet on human fallibility – and I certainly am willing to do that. Especially given the last two years.
Humans, especially central bankers, make mistakes. And big ones too. That’s why inflation can happen, despite all our attempts to compete with each other on the free market, as well as solve supply chain problems with our ingenuity.
I believe Rosenberg’s focus on the “stuff” side of the equation is the key error. As Nigel Farage keeps repeating in our weekly videos, “inflation is a disease of money caused by government”. Inflation, in other words, is about money, not stuff.
Sure, prices can go up and down because of supply chain problems. But is that inflation? Is it the devaluation of money? Or is it just prices moving because of supply chain disruption?
Because we measure inflation by tracking prices, we can’t tell the difference. Are prices rising because money is becoming worth less, or are prices rising because of supply chain problems?
The correct answer is both, and neither.
Of course supply chain disruption is causing prices to rise, which economists refer to as “inflation”. That’s Rosenberg’s point.
But this does not mean you can rule out other factors, like the velocity of money and the money supply, which drive true inflation.
Rosenberg’s excellent career, as I understand it, was built on betting that huge increases in the money supply would not trigger price spikes. This was partly because the velocity of money was falling, which offsets the money supply rising.
He was right about this.
And the velocity of money absolutely plunged during the pandemic.
But here’s the thing. As the supply chain disruption eases, so too will the velocity of money recover. Even if it is to lower levels than before the pandemic, this could still amount to a significant increase.
Thus, baked into a “human ingenuity” recovery is also a vast policy mistake which will trigger inflation. All that money supply will begin to circulate as spending returns to normal.
As ever, it’s worth remembering that inflation is at least partly a momentum phenomenon. Once it kicks off, it is notoriously hard to rein in.
You might say that inflation is what happens when human ingenuity catches on to the devaluation of money and begins to try and avoid it. People do this by spending their money as fast as possible. Which, of course, causes even more inflation.
Supply chain chaos may be just a spark. But we’re sitting in a powder magazine – and that’s what really has changed.
Editor, Fortune & Freedom