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The Mysteries of Inflation

By April 4, 2021Commentary

A couple of random observations, since there isn’t a lot of CV-19 research to report on today.  First, we are the only developed, supposedly democratic country that does not require IDs to vote and allows other voting nonsense.  Other countries are concerned about citizens having faith in the outcomes of elections.  Ours has one party that wants to be able to engage in fraud and chicanery and apparently is fine with most citizens distrusting the outcome of elections, and polls show, the majority of people do think there are significant problems with our elections.

A second connected observation is that we don’t have a free-market economy; we have an economy dominated by a few large corporations that overcharge consumers for lousy products and services.  They get away with that because most of our industries are oligopolies.  The government has failed to use the antitrust laws to maintain true competition in markets.  So now we get a pathetic cycle of corporations with enormous power which buy off politicians to keep their market power in place, and which in turn spew whatever ideological garbage the party in power wants them to promote to keep their market power.  Let’s take two examples.

Delta Airlines has done everything it can to suppress competition.  It prevents rivals from getting gates in its hubs.  It then charges the highest prices in the industry for service that is often abysmal.  It doesn’t have to worry, though, because it buys off politicians to keep them from investigating their abuses.  So why would we be surprised when they go “woke” to curry favor with politicians?  Somehow, of course, Delta has no problem doing business in China, and going along with the party line there as well, including humans rights abuses.  And Delta doesn’t seem to have a problem with the much stricter voting laws in all the other countries it flies to.  Ed Bastien is a cowardly weasel.  What should happen is that no airline should be permitted to have more than 30% of the landing slots and gates at an airport.  Period.  Airlines who have more than that should be forced to give, not sell, them to other airlines.  That way we might have some actual competition.

Kenneth Frazier, the former CEO at Merck?  Another hypocritical moron.  Also willing to tolerate any level of human rights abuses and lack of democracy in a country as long as he can sell drugs, and conduct shady clinical trials, anywhere he wants to.  He prices drugs at an outrageous level that deprives many Americans of the ability to afford needed care.  He abuses patent-granted monopoly positions in drugs by suppressing competition and constantly raising prices with no justification.  In my book, he is a scumbag, regardless of the color of his skin.  But he also gets away with it because the drug companies have always been among the top campaign contributors, so we never get effective regulation of their abusive practices either.  The solution here is to strip drug makers of their patent protection if their initial price generates a return over a certain level and if they raise prices.

It all starts with money in politics, and despite the fact that there are concerns with it as well, this is why I strongly support government financing of elections, with no contributions allowed by anyone other than individuals and then only at a very low level, to equalize the playing field.  Once the mutual cycle of bribery and extortion between politicians and corporations and unions is broken, we might get reasonable policy, and politicians could focus on doing something instead of raising money.

On to inflation and why you should be very worried about the flood of spending washing over the country.  Everything has a price.  Real goods, services, hard assets like land and buildings and equipment, financial assets like stocks and bonds.  And money itself has a price.  Those prices theoretically in a free-market economy are set by the agreement of buyers and sellers, but we don’t really live in a free-market.  Aggregate demand and supply does play a role in intermediating prices between buyers and sellers.  In some areas the government attempts to influence prices.  Sellers, or less frequently, buyers, with large market shares can override normal supply and demand price-setting.  Inflation is merely the increase in price for something, and deflation is a decrease in price.  The government “measures” inflation in several categories.  You can read the somewhat unbelievable formulas used for measuring inflation at the US Department of Labor website or by googling.  These inflation indices, of which CPI or the consumer price index is the most commonly referenced, are manipulated by the government because they are used for things like Social Security payment increases.  True inflation in the total basket of things the average consumer buys is a very different thing and likely is much higher.

While in the last decade the price of many common products has been pretty stable, service prices have risen more rapidly.  Real property inflation has been substantial.  But what has really soared has been the price of financial assets–stocks in particular.  If you want to invest, the price you pay for what you are investing in is a key determinant of the returns or value you get from that financial asset you invested in.  The more you pay for a stock for example, the lower the dividend yield and the less you can expect in the way of price growth.  (Absent the kind of manipulation that occurs regularly in our financial markets by large fund companies, which have every incentive to juice prices to make their supposed returns look better.)  If everything costs more, you need more and more income just to be able to buy the same amount of a good or service.  (I am not going to go into the effect of productivity or supposed quality effects which can affect the value received, but they are important concepts.)  This can itself lead to people raising prices for goods or services or other items they sell, so that they can generate more income to offset the additional sums they must lay out for what they want to buy.  You can see the feedback effects if people perceive that prices are rising.

And a most important price is the price of money.  If you want to borrow money, you have to pay a price, typically referred to as interest, to borrow or “buy” that money.   If you want to lend or sell money to someone, you want something more than just getting your money back.  You have to be compensated for the risk that you don’t get the money back and you make some assumption about inflation in the prices of everything else over the course of the time you are lending the money, because you don’t want to end up with less purchasing power than you started with.  Interest rates or the price to buy money have an enormous effect on the economy because today borrowed money is the source of funds for so much of what businesses and individuals buy.  When interest rates start to rise, that is itself a form of inflation, it is an increased cost to those who are borrowing the money.  That increase gets factored into the prices for whatever goods or services are being sold by the borrower.  So when interest rates are rising, like they are now, there will be an inflationary effect from that alone.  Eventually the rates get high enough that they dampen demand, since I don’t believe the basic laws of economics have been or can be repealed.  And that dampening will lessen growth.  And then we end up in the nirvana known as stagflation, where prices are rising but growth is limited.  Individual expectations play a role, but the sheer supply of debt being dumped on the market by the federal government and businesses is overwhelming demand, and to get the debt sold, the price has to be raised, i.e., the borrower has to pay more interest.  And that is where we are now.  Unless it is immediately reined in, even reversed, we are in for a world of hurt no matter what the Federal Reserve or the Treasury Department says.  And we are giving enormous power to foreign buyers, like China, who we increasingly will need to sop up all that debt.

Join the discussion 6 Comments

  • Andrew S says:

    Great, thought-provoking stuff, Kevin!

    On corporate power, I believe the root cause issue is not money in politics, rather, power of government. Strip the power from the government, you strip the power of the corporations influencing policy. There is no perfect answer to this conundrum, but I believe an ideal society limits coercion.

    Inflation! My favorite topic as of late. I believe we are past the point of no return. There is no option to “immediately reined in” as you put it. Monetary policy is out of control and in lock step with fiscal policy and there is no backing out – without very, very painful consequences, something our current (and past and future, mind you) establishment will not allow. Yield curve control of long term debt could be the other shoe to drop and would be a game changer.

    What does this do to assets? Well, I guess it depends. If we simply have the sort of inflation we’ve had in the last 20 years, expect to see all assets increase, aside from debt and fiat. The stock market will continue to rise, along with real, hard assets, e.g., real estate, commodities, and other.

    On the other hand, if we see inflation creep into long term yields (and even the fake CPI) that would be a game-changer. To the extent this becomes significant, we will see all fiat-denominated assets get decimated. That means, equities, debt, cash. The implication is to get your money in hard assets. I love real estate. But, while I simply love real estate, I have an absolute man-crush on Bitcoin. I believe this will emerge as a new asset class of true saving, something we haven’t had for decades.

    My crystal ball (and I’m saying this tongue in cheek, as this is so impossible to predict and time) says that we’ll only see inflation in the typical areas for the next couple of years, e.g., stocks, real estate, education, health care, etc, will continue to increase. And that, after a couple of years, the inflation will be too hard for the Fed to “control” and that’s when fiat denominated instruments will get crushed and, subsequently, all SHTF.

    I hope I’m wrong on fiat-based getting decimated, but it seems inevitable and simply a matter of time. And, back to my man-crush, Bitcoin, it is one primary asset that will accelerate this progression.

    All IMHO and not financial advice. 🙂

    Cheers, Andrew

    • Rob says:

      I own Bitcoin too. Actually not Bitcoin but the Grayscale Bitcoin Trust. I have zero confidence in it but it’s been my best investment. I can’t decide if Chamath Palihapitiya is a scam artist or an upstanding citizen. I’m leaning toward the former. Maybe he’s a little of each.

  • Rob says:

    I’ve been predicting inflation for about 2 decades now, but this time I think it’s even more likely than all the other times I predicted it and was wrong. And coincidentally, Merck is one of the few stocks I own because it’s actually quite cheap and pays a good dividend.

  • Matt says:

    I’ve always struggled on the topic of limits on campaign financing, due to the ‘first amendment’ argument, but to me some type of geographic criteria seems like a reasonable rule. Why should people or corporations be able to spend on / donate to or against a candidate in a district where they don’t live or own a business in? We don’t (officially) allow foreign nationals or corporations to spend on campaigns, do we?

    • Kevin Roche says:

      I completely agree with the geographic limitation. No one should be able to contribute in regard to an election they can’t vote in.

  • J. Thomas says:

    All of the political funding and policy decisions are driven by one goal, to maximize share owner wealth (profit) for too few. In my unicorn world, these products need to be reclassified as ‘essential’. If you think of the PUC and how they regulate the profits of ‘essential’ utilities (used to be 7%), this prevents greed and keeps the costs stable. If you want to fix health care system, get all of it out from within companies (employee benefits), put everyone on the street where competitive markets can develop within the insurance companies. Then make the medical system, insurers and drug companies ‘essential’ with profit caps. Treat 401K monies like HSA monies that can be spent on anything to do with healthcare tax free. This opens up a huge pool of money available to cover a person’s future medical costs. By law, all medical policies would have a catastrophic 10% max based on your income and savings, so no one can bet wiped out by an illness. Personal taxes can be adjusted accordingly to motivate behaviors that support a healthy life style.

    Game over for the greed machine and political pandering. Now their goals are not to deliver 30+% returns to their shareholders. The goals are to be in business with reasonable, stable and predictable profits, reinvest profits above 7% back into their systems to drive out inefficiency and lower costs … just like the electric and gas companies ! The CEO salaries of ‘essential’ heath care companies/divisions can be limited to 50X their lowest paid employee, and the taxation of them can be sorted out to encourage behaviors that result in process and product development for the benefit of the customers.

    Health care and unlimited profits by all of the companies that make up the system are a bad mix …

    And one more … each time you get a shot of NARCAN, you get a tattoo. Once you have 3 tattoos, no more NARCAN !! …. I told you it was a unicorn world, HA !

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