Sent August 2022
The majority of the economic news in the past month has been on inflation. What caused it, how big it might be, the ravages of it, how to stop it, can we land the economy “softly” by attacking it, etc., etc.. Even more discussion and speculation is on whether we can tame inflation without having the economy crash – or more specifically, fall into recession (which was, technically speaking, triggered yesterday by the announcement of 2nd Quarter GDP being negative).
Thus we hear the use of such imprecise words such as “hard landing” or “soft landing.”
The Bigger Economic Point
Nonetheless, much of this public folderol misses the bigger economic point, which is simply this: Can high inflation continue to exist without causing serious harm to the average USA household as well as to the broader economy? On this point, the unequivocal answer is “No.” There exist no general economic phenomena more hurtful than the constant and uncontrolled rise in price levels.
Is a “Soft Landing” Possible?
If the above is true, though we need to be careful on what must be done in response, we certainly need to run the risk of a hard landing. That’s the reason the Federal Reserve increased interest rates by 0.75%, to tamp it down. The odds are not in favor of accomplishing a soft landing, but for reasons far beyond this letter, let me just say it’s hard to tell if we can do it because never in the annals of mankind have we ever had a situation that looks like today. There’s just a lot of uncertainty and off-setting global forces at play. But, if inflation is the beast, it must be defeated. The stock market has gone down in 2022, and might go down further or it might only head upward from here. We don’t know the exact direction of the market on any given day, but long-term, it’s upward moving.
What Caused (and Causes) Inflation
However, the point I want to raise in this monthly communication is what was the SEMINAL cause of the inflation bout we are experiencing. I want to give you some insight as to what I think is the biggest cause and you’ll find it enlightening. Further, if we understand what caused inflation we should be a little smarter about not lighting the next inflation fuse.
Money Supply
It has to do with things called “money supply.” More particularly, categories that the Federal Reserve measures that are call M-0, M-1, M-2. These categories haven’t gotten a lot of attention but they are simply various definitions of money. Category M-0 is simply the currency in circulation (the coins in your pocket and the dollar bills in your wallet) plus Federal Reserves, but M-2 includes Checking accounts, Savings accounts and Money Market funds. If Milton Friedman was right, as I quoted to you 3 months ago, that…
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”
…then we probably should look at money supply, if out of curiosity for no other reason.
If I skip all the hype about inflation being caused by the “special operation” in Ukraine (it has a small impact), or supply chain shortages (they have an additional impact small to medium), or the jargon about quantitative easing, etc. and etc., maybe we should just square our shoulders up and honestly say: “If you put a 5-year old in a candy store and give him twenty bucks, he’s going to buy a lot of candy.”
The tremendous and unprecedented helicoptering of money into the cash accounts of individuals (stimulus checks, extended unemployment benefits, money for childcare), and companies (PPP bailouts) – fiscal flagrancy supported by both parties – massively increased money supply. We have never seen anything like it in the history of mankind… which is why (certainly at least in part) we have experienced the rise of inflation like it’s never occurred in the history of economics.
The Fed was asleep at the switch and should have increased interest rates quicker, but the essential problem stemmed from our drunken-sailors Federal legislature passing one bill after another. I would speculate your neighborhood recently got paved or the highway you travel has road construction on it… all further representations of free money being poured on the inflation fire.
Facing and Moving Through Inflation
Let me close with another old quip often applicable to economics: The Law of Unintended Consequences. It refers to the frequently-observed phenomenon in which any action has results that are not part of the original actor’s purpose. We wanted to preclude an economic crash and had a booming stock market in 2020 and 2021. It was a terrific party. Now we are having the hangover. The good news: if we don’t drink a lot more today, we should sober up.
It remains my deep and distinct honor to serve you.
Patrick Zumbusch
Founder and CEO
Wellspring Financial Partners
