More on the current inflation

 

More on the current inflation

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

 

The world community experienced a shock to the economy when the pandemic hit in March/April of 2020 – a major contraction of economic activity.  Had central banks, around the world along with our Fed, not intervened, there would have been a large deflation across the international economy, to include the United States.  That would have affected asset prices, probably on a broad category – physical and financial assets.  One can only speculate what that impact would have been, remembering that asset prices underlie the foundation for credit, as collateral, and the importance of credit to keep liquidity flowing to support economic activity/behavior.  Not to mention that a prolonged deflation could result in cuts to income – derived from wages and salaries – something Americans have not experienced in many generations.

 

Instead of dealing with a deflation, and the possibility of a deflationary spiral, central banks did intervene; and, in the case of the United States, where we also had a very large fiscal intervention, we were able to stabilize the price level to some extent where we are dealing with some degree of inflation at present without knowing its severity.  The broad category of asset prices has held firm or have even risen substantially.  Credit markets were disrupted, but the Fed has intervened to support specific sectors of the credit market.

 

Only to that extent can this inflation be considered a monetary phenomenon.  When the international economy shutdown, that caused physical harm to the economy – unemployment, a substantial reduction in the output of goods and services, and business closures.  In other words, greatly reduced economic activity of actual physical/real people and structures (businesses, equipment), and the flow of goods through the vast distribution system.

 

The injection of monetary and fiscal stimulus bolstered segments of the economy.  But it has been uneven.  This has resulted in imbalances among the sectors of the economy and especially between the demand for goods and services and the ability of the broad economy to respond, to fulfill that demand.  The supply is lagging the demand.

 

That gap between supply and demand is affecting prices.  You see this gap in the uneven recovery by comparing Personal Consumption Expenditures (PCE) with the broad Industrial Output. 

https://fred.stlouisfed.org/graph/?g=JACK

Industrial Production and PCE

https://fred.stlouisfed.org/graph/?g=Jm29

Capacity Utilization

And you see the effect on price when you compare the Consumer Price Index (CPI) to the Producer Price Index (PPI) – it is the PPI with the wild swings that tells the story.  In the post-2008 Financial Crisis years, the PPI took wild swings while the CPI remained steady; the price increases in the wholesale system were absorbed within the economy and not passed on to consumer, as reflected in the gradual increases in the CPI.  This time the price increases in the PPI are not being absorbed within the economy, they are being passed on to consumers, as reflected in the CPI.  The PPI leads the CPI and is driving the CPI.

https://fred.stlouisfed.org/graph/?g=JvxR

PPI and CPI

The inflation behavior now is due to the PPI swings and the behavior in the productive sectors and the supply chain/distribution system that services the productive sectors.

 

That we are in an inflationary time period, and not a deflationary time period, is a monetary phenomenon.  But that is a one-time event.  The inflation we are now experiencing is due to imbalances within the physical economy – namely the recovery of the production and distribution sectors lagging, failing to satisfy, the demand for goods and services.

 

In this current inflation Aggregate Demand is leading Aggregate Supply, and the lag in production and distribution results in the PPI leading the CPI.  This inflationary cycle is not due to monetary factors, but due to the real, physical economic structure and process – the flow of goods and services have been disrupted.  There is little the Fed can do about that; and probably little Central Planning by the government can do.

 

Take care of the Big Picture – dealing with the pandemic and restoring an operational framework – and let the individual agents (big businesses and small businesses, and the folks who make up the labor force) figure things out for themselves.  Sooner or later order shall be restored, and we will probably be operating at a higher price level, but without the inflationary pressures and back to some sense of stability.

 

Inflation in the future?

Economics Without The B.S.**: 

[**  Double entendre intended.]

An economy is not just goods and services, but also people.  We seem to have lost all proportion in what a shock to our economy we experienced this past year.  Without delving into details, let me be descriptive.

 

Just in April 2020 alone, near the beginning of the pandemic when we had a national lockdown, we lost [net] over 20 million jobs, and over 6 million people dropped out of the labor force of near 165 million (about 8 million total dropped out of the labor force and we have recovered around 5 million of that), and the unemployment rate rose, just in that month, over 10% (from 4.4% to 14.7%), for the worst month in U.S. history, even nothing during the Great Depression came close to that.

The month before, March 2020, when the international economy shut down, there was a sell-off of U.S. treasuries to raise cash.  The Fed stepped in to the tune of over $1 trillion per day; described by the NY Fed’s John Williams “a staggering amount” to provide liquidity to support the market activity.

 

Now if that alone does not impress you for what a shock we experienced, let me relate this: during that lockdown of about three weeks, the complete Los Angeles freeway system was wide open without any hitch, and I have lived in Southern California for over forty years.

 

May I digress into a little detail now?  Our logistics system, the supply chain, is not just national in scope but international.  While we were experiencing the lockdown, so was the rest of the world.  Container ships were taken out of service and temporarily put in mothball status at a variety of secondary ports around the world.

 

You can think of our international/national logistics system as queuing theory -- waiting/processing lines, or queues.  One line is for processing (moving goods -- from Asia to Europe and the USA; and for moving goods across the USA) -- and also for moving empty containers once they are off-loaded back to Asia; and one line is a waiting line for reserve capacity (extra containers, trucks, storage space, etc.) that is needed to fill gaps in the processing line or take capacity out of the processing line when it is not needed and thereby make the processing line flow more efficiently.  The whole system operates on flow -- keep the processing line flowing. In normal operation the processing line capacity (the movement of goods) far exceeds the waiting/reserve line capacity.

 

When the pandemic hit in February 2020, economic activity was halted, greatly reduced.  So the processing line had to be shrunk -- back in Asia, and in Europe, and in the USA.  Container ships were taken out of service and put in temporary "mothball storage". When they are put in storage (idled at smaller ports), they require a certain amount of processing to avoid the marine corrosion that can deteriorate them in a short matter of time (90 days).  Rail cars and trucks are taken out of service and put in storage on lots. Empty containers and chasses are taken out of service and put in storage on any lots they can find.

 

All of the companies that are part of this network -- big companies, international companies, but also a lot of small operators who operate on a small margin -- in various forms of transportation (rail, truck), storage (warehouses, lots, small dirt lots [and we have them in Greater LA in low-income neighborhoods]), brokers and freight forwarders and packing & crating companies, etc. -- had to reduce their operations or in some cases close down. Employees were laid off.

 

The waiting/reserve queue does not have the capacity to hold all the trucks, trailers, containers, chasses, and especially the container ships that were taken out of service.

 

In the case of the empty trailers/containers/chasses -- these items are probably stored anywhere in the country where the owners (shipping companies in most cases; but could also be freight brokers) could find cheap storage rates. 

 

So, as economic activity picks up, it will take a little time to put all the pieces back together in order to get good flow moving again.

 

It takes time to deprocess the container ships that were "mothballed" for several months.  And who knows where some folks put all those empty trailers/containers/chasses?

 

Two things need to happen to rid the economy of inflation.

(1) The shock to the economy was due to the pandemic. We have to either conquer the pandemic, or learn to live with it. Then we will return to some sense of normalcy.

(2) And then, the economy will normalize along with prices, and we will probably be at a new and higher price level for our large economy and without the inflationary pressures.

 

The analogy you could make to understand a shock to the economy would be when we came out of war time periods into post-war, more normal, periods – like after World War I when we experienced a short (18-month) depression or the short, but sharp, recession we had in 1946/1947 right after World War II.  1946 was the second worse calendar year in our entire history, right after 1932 during the Great Depression.

 

Normally when we have a big shock to our economy after coming out of a big war we can have a deflation (1921 and 1922) or inflation (1946 and 1947).  When we shutdown the economies world-wide from February to April 2020, our Federal Reserve along with the fiscal stimulus of the federal government, pumped enormous amounts of money (well into the trillions of dollars) into various aspects of the economy to keep it somewhat afloat, putting a bottom on the recession, in order to avoid a deflation.  We perceive a deflation to be worse than an inflation, because of the negative consequences on investing for the future.  One moral hazard of that is that asset prices have not corrected and have spiraled upward.

 

Whether all that funding that went into the economy to keep it afloat will result in long-lasting inflation will depend on raising our productivity levels as we go forward.  We have had very poor rates of productivity, as measured by the Real GDP, since 2001, skipping the pandemic year of 2020 – yearly averaging 1.98%; and only 2.41% if you leave out the recession years, well below our historic yearly averages of well over 3% per year (3.77% since 1790 and 3.03% since 1947; and 4.53% during the ten years of the 1960s).  This is also true for labor productivity (output per hour), in which the rate of labor productivity has been in a downward trend since 2005.  So what it will take to turn things around, we will just have to see; but, there is plenty of room for corrective action.  There is no need for us to return to the inflation of the 1970s – this is not a similar situation.

 

Algorithms of Oppression?

Economics Without The B.S.**: 

[**  Double entendre intended.]

You live long enough and this stuff gets recycled to come back at you in new fangled ways.

Bezosism, an off-shoot/American adaptation of the Toyota Kanban System that became popular in America in the 1980s, making rate in mind-numbing work according to algorithms [of oppression].

Wall Street Journal article -- 

https://www.wsj.com/articles/the-way-amazon-uses-tech-to-squeeze-performance-out-of-workers-deserves-its-own-name-bezosism-11631332821?st=64p34g630brmxni&reflink=desktopwebshare_facebook&fbclid=IwAR0L3mEBUL4uO9PHTa5uUpfkjg5p9VEFjpcy8Xuf3ibVChRwrkFS_skDeP8

TOYOTA Kanban Production System

From the 1980s, in America. This was Japanese adaptations of the influence of Edwards Demming and Joseph Juran on Japanese manufacturing and management after the destruction from WWII.

Taguchi Methods --

https://en.wikipedia.org/wiki/Taguchi_methods

Edwards Demming --

https://en.wikipedia.org/wiki/W._Edwards_Deming?fbclid=IwAR0Z1v0Pzw-rqRfDVprTO2vj20O095V6fes-TrcVqAFN-mqjMRR_iscV1MU

Joseph Juran --

https://en.wikipedia.org/wiki/Joseph_M._Juran?fbclid=IwAR1WwWY2ItLrwFTxbFxmTCkBqzSv6NDC1nqmBUV_UBkAgmsXQRtgSDJcEk8

Peter Drucker, management guru, was another who advised Japanese on management style. I wonder what he would think of "Bezosism"?

https://en.wikipedia.org/wiki/Peter_Drucker

The Thrust For Power

 

The Thrust For Power

Economics Without The B.S.**: 

[**  Double entendre intended.]

Jacob Bronowski -- The Ascent of Man --The Thrust For Power

When the United States emerged out of World War II as the preeminent hegemon there was a recognition that world affairs are conducted through the use of the military (force) and commerce, along with diplomacy. The United States originated from the evolution of 18th Century Western Enlightenment, and the American Enlightenment version of that was to understand that a rules-based system provided a democratic society more stability than one based on power relationships – a society of laws, not men. The American Enlightenment, however, is not idealistic but practical, understanding that people, while possessing “goodness”, still tend to act in their own self-interest – so it is a combination of power relationships and a rules-based system. The manner in which the United States attempted to conduct international commerce was through a rules-based system, not a power arrangement – the Bretton Woods Agreement, the General Agreement on Tariffs and Trade (GATT), which later become the World Trade Organization (WTO), the International Monetary Fund (IMF) and World Bank. It has functioned, but not without mistakes, and still needs much improvement. So what we have for world affairs is a rules-based system for commerce, the use of the military force still, and a diplomatic system that is a combination of the two. The expansion caused by globalization, along with the expansion of the international financial system backed by the dollar has not been smooth. Imperfect human beings existing in such a system have created imbalances in those relationships which have resulted in inequalities, growing inequality gaps. If there is a recognition to spread democratic governance for promoting a broad-based general welfare, then it is imperative that a rules-based system prevail that is perceived to be fair to all so that it fosters engagement by all the participants.

 

Flood of New Debt Tests Bond Market and our National Security and Leadership 

Economics Without The B.S.**: 

[**  Double entendre intended.]

Wall Street Journal article -- 

https://www.wsj.com/articles/flood-of-new-debt-tests-bond-market-11615372201?reflink=desktopwebshare_facebook&fbclid=IwAR2UK7sJw3AMwRMgdLIpGyZ9iTv92CWcNmc0w9lMmfFmzWIMrhqtSgE8jJc

The increasing debt load of the U.S. is changing the composition of our debt -- and will likely result in its being of longer duration than the average of five or six years as it has been for about twenty years now.

We used to have longer duration on our debt prior to Bill Clinton's Administration -- more of our debt was held in 30-year bonds. Back then as we had budgets that were more in balance, we converted some of that long-term debt (30-year bonds) for shorter-term debt (2-year, 5-year, 10-year notes) when we turned over our debt for refinancing. The shorter term of our debt composition makes it less subject to risk for investors -- and that has made it attractive to investors to take on that debt.

With an average duration of five to six years for our debt composition/portfolio -- we turn over about half of our debt every two or three years. If we lengthen that duration past six years, it will add more risk for investors -- and we could wind up financing our debt at higher rates of interest, and become more of an expense in our annual budget.

The way to avoid this additional cost is for the U.S. to raise its level of productivity -- which has been at historically low levels for about twenty years now. Something to watch in the news over the next several years. Our ability to sell our debt to investors (domestic and foreign) depends on how competitive we are with other investment opportunities in the international marketplace.

Also note the chart with the Fed taking more our debt onto their balance sheet. This is what is giving the Fed leverage in the international markets during times when it intervenes at times when the international markets are not functioning well. The Fed uses these treasuries to swap with foreign central banks (the Fed gives them our treasuries, highly valued, for their currency, less valued) and the foreign central banks make loans to their businesses, during times when credit/funding/liquidity is tight. [It is illegal for our Fed to loan to foreign businesses; but this is how our Fed gets around this. This is an indication of how screwed up our international market system has become, and what the U.S. has to do to stabilize the system we created and take responsibility for since WWII.]

So our Fed bails out the rest of the world during periods of instability -- in order to avoid downward deflationary spirals, which are bad for investment, growth, and lead to long periods of panic/depressions like we had in the 19th Century.  We had frequent deflationary periods during our history through the 19th Century right on up to the Great Depression. We have only had three deflationary years since WWII -- 1949, 1955, 2009.

These continued bailouts are an indication our reliance on markets to self-correct are not working. Some think (me included) this instability causes imbalances in our globalized economic system and contributes to inequality.

And the consequences for the United States, since this is a system we created and take responsibility for maintaining, is that this inequality, both globally as well as domestically, hinders our ability to spread our democratic values, highlighting the contradictions in our stated objectives of trade/commerce and pursuing our foreign policy, and therefore is a major obstacle in our national security strategy.

Human progress depends on economic development, which is furthered by broad-based growth and a democratic system of governance.