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A Reader Asks "What Would it Take for Me to Change my Mind on Inflation?"

Is inflation transitory? That's the question on everyone's mind.
Author:
Powell Says Factors Driving Inflation Should Be Temporary

Reader Question

Hi Mish,

I’ve been a big fan of yours for some time. I stumbled upon you when you were writing Mish’s Global Economic Trend Analysis on blogspot. You had written several articles on Ron Paul, which caught my attention circa 2011.

I appreciate you insights and your blog. I really enjoyed your recent interview with Daniel Lacalle. It made me question my own views on the transitory versus perpetual inflation debate.

I understand your argument in how the US is following Japan and Europe in the debt and demographics categories. Like you, I believe that these demographic shifts are putting upward pressure on wages. To me, this will put more money in the pockets of consumers, who are likely to spend it, putting upward pressure on the PCE and CPI. I think part of the debate will be if this spending will counteract the lack of spending coming from retiring baby boomers.

Another thought I’ve had on inflation is, Murray Rothbard had stated that changes in prices in general are determined by changes in the supply of and demand for money. During Japan’s deflation and during Europe’s, there have been great strides in the globalization of the economy. This has increased the supply of goods and increased the demand for money, causing deflationary forces. If globalization has hit its limit and begins to contract, consumers will see a decreased supply of goods causing the demand for money to decrease. If the supply of money stays the same or increases during this period, inflation could become more perpetual.

Another aspect of this debate is that Mises (and reiterated by Rothbard in his book America’s Great Depression) stated that the “boom-bust cycle is generated by monetary intervention in the market, specifically bank credit expansion to business.”

In your article, “Exploring the Idea “There’s Never Been a Better Time to Borrow”, you made a great case that businesses are not excited about borrowing from banks. The shutdowns have created great uncertainty in the economy. Businesses are unable to forecast future demand like they could prior to the shutdowns. Once this uncertainty has cleared, I believe, businesses will borrow again. However, if this demand doesn’t pick up, deflation will become prevalent and the inflation we are seeing now would have truly been transitory.

I’m curious what changes would need to take place for you to change your views on the transitory side of the inflation debate.

Finally, I want you to know that you are part of the inspiration for my own blog and investment newsletter (baerlocherbearing.blogspot.com).

Thanks,

Alan

What? No Inflation?

Case Shiller Home Price Index National and Top 10 by City 2021-04

Right now the Fed and BLS massively undercount inflation and a look at housing proves it.

On Monday, I noted Home Price Growth Hits a New 30-Year Record, What? No Inflation?

Transitory or Not?

I agree with the Fed that inflation is transitory. But my key reasons strongly differ as to why.

I suggest it's transitory because the Fed has sown the seeds of another economic collapse in its foolish struggle to force routine prices up while ignoring clear asset bubbles that will pop.

On top of that, demographic forces are in play. Sure, wages are rising, but we have to balance that with demand destruction from retiring boomers as well as pending supply of homes.

Might I Change My Mind?

For starters, no one has a clear crystal ball. We are all speculating, but there are a couple of things that could get me to change my mind on the transitory nature of things. 

  1. Monetary Madness From Congress Signed Into Law
  2. The Fed Moves to Make Its Liabilities Legal Tender

Congressional Madness

I see little scope now for the Senate to go completely insane this year or next as Democrats do not have even their own 50 votes let alone 10 votes of Republicans to do what they want. 

However, it's possible they change filibuster rules, and get control of the Executive and Legislative branches, then pass some $90 trillion AOC and Progressive free money madness including guaranteed living wage indexed to inflation. 

Should that happen, we are talking huge inflation for years.

Fed Actions

If the Fed were to make its liabilities legal tender, then look out.

Contrary to widespread myth, the Fed cannot give money away. The Fed makes loans to banks giving them money for assets, typically US treasuries. These swaps, have to be paid back and thus cannot be directly and permanently spent.

Sometimes these swaps have been dubious if not outright illegal as was the case with the Fed buying of junk bond ETFs. But given the Fed is beholden to banks, the Fed does not want to quickly destroy the dollar. They are content to do it slowly at a rate of about 2% a year, blowing bubbles in their wake that will pop. 

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One hint they would be marching down a more lenient path would be if the Fed suddenly supported cryptos for reasons that sound like something out of the mouth of Elizabeth Warren.

Digital Currencies and Parachute Pants 

On June 20, I asked Elizabeth Warren Supports Central Bank Cryptos. Should You Be Worried?

On June 28, the Fed's Vice Chair for Supervision, Randal K. Quarles, commented on Central Bank Digital currencies. 

For details, please see A Fed Governor Compares Digital Currencies to Parachute Pants and Bitcoin to Gold

Quarles' statements were shockingly refreshing. He openly blasted all the stated reasons for central bank digital currencies out of the water. Indeed, his speech seemed aimed directly at Elizabeth Warren. 

But as with Congress, that can change. Powell may not be reappointed and no one can say for sure who the next Fed Chair will be or what craziness may ensue.

Those are the two things that could get me to change my mind in a hurry. 

Meanwhile, the Fed has blown another bubble, the third in just over 20 years and it will pop.

Bubbles Pop, When? Why?

I cannot answer either question but I can say the widespread belief that it will take rate hikes by the Fed is simply wrong.

Bubbles pop when there is a sudden sufficient attitude change. I assure you that one final rate hike by the Greenspan Fed did not cause an attitude adjustment.

Yet, one week there were lines in Florida wrapped around the corner for the right to enter a lottery to buy a condo. That's how nuts it got. But literally one week later the lines vanished. 

Similar things have happened in Japan. 

I am amazed actually how big these bubbles got, but it was only recently that "measured" inflation took off. 

I also recall the prevailing attitude when oil hit $130. It was next stop $200, then $500. We hear similar comments today but will only know in hindsight.

Right now, speculation and housing are all the Fed has, and they are surely trying to keep them going. But to bet on the Fed is to bet that bubbles never pop. 

The dotcom crash, the housing crash, and 30 years of Japanese deflation fighting prove otherwise.

Addendum on Assumptions 

What About Gen X?

Fantasyland Projections

Mish