Wednesday, June 30, 2021

Argentine inflation lessons for the U.S.

This is a rather long post, but it should prove of interest to all those worrying about the possibility of a non-transient and significant increase in U.S. inflation. I've drawn much of it from my previous posts on the subject of Argentina and inflation.

I first visited Argentina in 1970, when I spent my summer there visiting my soon-to-be wife. The country has intrigued, fascinated, and frustrated me ever since. In 1975 we decided to move there and I've been an avid student of monetary policy and inflation ever since. In 1976 we witnessed the military overthrow of the disastrous government of Isabel PerĂ³n. After a few years of "relative" stability under a military dictatorship, things began to deteriorate about a year or two after we returned to the States in 1979. Our timing couldn't have been better. By the late 1980s, Argentina was spinning out of control, as its annual inflation rate peaked at over 20,000%. During a visit to the country around that time I was fascinated to watch hyperinflation unfold: prices almost tripled within the span of three weeks. Miraculously—or so it seemed—inflation subsequently fell to zero by the mid-1990s, thanks to the government's decision in 1991 to peg the peso at 1-1 to the dollar.

During the four years we lived in Argentina, inflation averaged about 7% a month. That adds up to an annual inflation rate of 125%, and that's enough to seriously impact your everyday life. My first memory of when the reality of inflation hit me was the day I collected my first paycheck. I began thinking "what should I do with this money?" Keeping the money in my pocket or under the mattress made no sense, since the money was losing value constantly—because prices were rising constantly. The decision was easy: we had to spend the money, and spend it fast. So my wife and I set off for the nearest warehouse store to buy "stuff" that we could store in the closet. Canned foods and powdered milk for our 1-year old infant ranked high on our list. We scoured the store and found a bunch of storable stuff, but we couldn't find any milk. I thought that was curious, because it was very popular (Leche Nido, by Nestle). But then I opened a door to an adjacent storage room and saw boxes of powdered milk stacked to the rafters. So I asked the girl at the cash register if someone could fetch us a couple of boxes. "I'm sorry, sir," she replied. "The milk is not for sale."

That's when it dawned on me that everyone was thinking like I was: nobody wanted money, everyone wanted stuff instead. For the next several years I would juggle money balances between pesos and dollars and "stuff." With lots of inflation, money becomes like a hot potato. When I saw something for sale that I needed and the price looked reasonable, I would buy it immediately, because I learned that if you waited to look for it in another store, the price was likely to go up. During one episode of very high inflation, grocery stores would post prices on chalkboards, and change them throughout the day. It was a daily struggle to survive, because salaries and wages always went up after the prices for "stuff" went up (incomes lagged prices, and over time that impoverishes wage earners). 

In 1979 we sold our house, in preparation for returning to the U.S. There was no such thing as a mortgage at that time, and hardly anyone had a checking account. If you wanted to buy a house, the best terms you could find were "0-30-90," which meant that you had to pay one-third of the purchase price at the time of signing the purchase contract, followed by the second third a month later and the final third in three months. The man who bought our house (for the equivalent of about $30,000) graciously agreed to pay me the full amount in cash at the signing of escrow. Before going to the escrow office to finalize the deal, we went to his office. There he took out several grocery bags full of peso bills and started counting the bills; after counting each stack he passed it over to me, and I counted it, then he placed the stack back in one of the bags. I wish I could remember what the price of the house was in pesos, but all I remember is that the bills were of large denomination and they filled three grocery bags—it took us a half hour to count it all. After we had both counted the money and signed the escrow papers, he accompanied me to the bank to help me carry all the money and to serve as an informal body guard—can you imagine carrying cash equal to the price of a house in grocery bags while walking 6 blocks to the bank? I handed over the bags of money to the cashier and explained that I wanted to convert the pesos to dollars and wire the total amount to my account in the U.S. It took the cashier 20 minutes to count and verify the bills. I was fortunate that at the time it was legal to convert pesos to dollars and to wire dollars to an overseas bank account—it hasn't always been like that, and it isn't today.

When we visited Argentina in 1986, I remember my 6-year-old son was fascinated by all the banknotes that people carried around in order to conduct their daily transactions. They had denominations ranging from 3 to 8 digits. Prices were routinely quoted in "palos" with a palo being slang for a million, much as we would say "5 bucks." A friend gave my son a grocery bag full of old peso notes that he had collected, and he went almost crazy with delight. "Wow, Dad, how much can I buy with all this money?" he asked me. "Well, Ryan, with all that money you might be able to buy a pack of chewing gum," I replied, even though the nominal value of the notes must have been in the tens of millions. I then tried to explain to him how inflation worked, but I quickly realized he just couldn't understand it.

Years later I would study the situation in Argentina during the time we lived here and understand what was happening. In a nutshell, since the government was unable to finance its deficit by selling bonds, it simply ordered the central bank to print up new currency in order to pay its bills. New bills flooded the country like Monopoly money. Money became like a hot potato that nobody wanted to hold. Better to change my peso salary to dollars at the beginning of the month, and then convert back to pesos when I needed to buy something. Better to save money by buying stuff than to save money in the bank. Since very few people back then had bank accounts, newly-minted bills just kept accumulating in the economy and losing their value. A $1 million peso note issued in 1978 was initially worth several thousand dollars, but by the mid-1980s that same note was worth only 20 cents and was withdrawn from circulation.

Bottom line, the supply of pesos was growing rapidly at the same time that the demand for pesos was falling. This resulted in a huge increase in money velocity (which is equivalent to saying there was a huge decline in the demand for money), and the ratio of money to nominal GDP fell sharply for years and years. A 50% increase in the money supply could support a 70 or 80% rise in prices and nominal GDP. The government would periodically try to slow the rate of inflation by limiting money growth to a rate lower than the prevailing rate of inflation, but it never worked because the velocity of money just kept increasing. More and more people held their money balances in dollars instead of in pesos, and spent their pesos as fast as they could. The government was essentially financing its deficit via an inflation tax; as long as you were holding pesos in your hands, they were losing value and you were effectively paying money to the government. So everyone naturally tried to avoid holding pesos. It was a vicious circle, as rising inflation destroyed confidence and the demand for money, and that in turn fueled higher inflation.

The key feature of the U.S. monetary system—as distinct from Argentina's—is that the Fed cannot create money directly—only banks can do that. The Fed can, however, make it easier for banks to create money by increasing the supply of bank reserves. Banks need reserves in order to collateralize their deposits. The Fed creates reserves by buying securities (e.g., Treasury bills, notes and bonds, and more recently, mortgage-backed securities and some corporate bonds). In effect, the Fed buys securities and pays for them with bank reserves. But crucially, reserves are not money that can be spent anywhere.

In times of great uncertainty and surging money demand, like today, the Fed fills the market's need for short-term safe securities by buying riskier securities from the banking system and paying for them with risk-free reserves which pay a floating rate of interest; reserves thus have become T-bill equivalents. If banks don't find the reserves attractive they can use them to support increased lending, which indeed does result in a monetary expansion. But if that expansion exceeds the market's demand for money, then higher inflation will be the result. Throughout most of last year, the fact that inflation did not rise strongly suggests that the Fed's actions were not inflationary. Bank reserves—which swelled by about $4 trillion last year—served to satisfy the banking system's demand for risk-free, short-term assets, and the public's demand for a massive increase in bank savings deposits and checking accounts. Demand for money and money equivalents was turbo-charged last year by all the uncertainties and disruptions caused by the Covid-19 panic.

But now things are changing. Uncertainty is declining, and confidence is increasing. People don't want or need to hold so much money in the form of bank savings deposits. Prices for many things are rising, and measured inflation has accelerated significantly. The Fed argues that the rise in inflation is only transient, the result of lockdown-induced supply shortages coupled with exuberant demand from newly "liberated" consumers who no longer worry about Covid. The Fed also argues that "easy money" is necessary to help the economy back on its feet. I disagree. 

I think the Fed is making a big mistake by pegging short-term interest rates at a level that is far below the current rate of inflation. Holding cash or cash equivalents (e.g., bank savings deposits, checking accounts, T-bills, money market funds) pays virtually zero interest, just as holding actual cash does. But holding cash in your pocket or at the bank means you are losing money—you are effectively paying an inflation tax which amounts to as much as 8% per year (the CPI rose at an 8.45% annualized rate in the three months ending in May). 

Let that sink in. Your money balances are costing you 8% per year. Cash is not a safe asset these days. It's a very expensive asset, in fact. Better to get rid of cash by spending it on almost anything else, right? Buy land, buy powdered milk, buy stocks, buy commodities, fix up your home, buy a car, invest in new plant and equipment ... the list goes on, and not surprisingly, the prices of all those things are rising. It's Argentina deja vu all over again. Oh, and in addition to shedding unwanted cash, you might also consider borrowing money in order to buy things, since the cost of borrowing is less than the rate of increase in the prices of those things.

Current Fed policy amounts to a concerted effort to undermine the demand for money, at a time when the supply of money continues to surge. The M2 money supply has risen at a 15.4% annualized rate in the six months ending in May, and it's up at a 15.1% annualized rate in the three months ending in May. That's a classic prescription for rising inflation. For the two-decade period leading up to the Covid period, M2 growth averaged a little over 6% per year—and for that same period inflation was relatively low and stable.

It gets worse. The Fed is not just targeting a near-zero rate for short-term securities that is far below the current level of inflation, it is all but ensuring that the rate on short-term securities will continue to be far below the rate of inflation for at least the next two years—and possibly for as far as the eye can see. The market is in full agreement: the implied yield on 3-mo. LIBOR two years from now is 0.8%, which implies about 2 Fed tightenings in the interim. In fact, the entire Treasury yield curve, from 1 day out to 30 years, falls well below the current rate of inflation. The TIPS market provides further proof that interest rates are expected to be below the level of inflation for as far as the eye can see: 5-yr real TIPS yields are -1.6%, 10-yr real yields are -0.9%, and 30-yr real yields are -0.2%.

Who wants to hold Treasuries that will produce negative real returns for a lifetime? Who wants to hold cash that will lose up to 8% of its value in the next year? The longer real yields remain negative, the more the incentive to reduce one's holdings of cash and other "risk-free" securities, and the more the incentive to increase one's holdings of "stuff" that will on average appreciate by the rate of inflation. 

Economics is all about scarcity and incentives. Today the incentives are powerfully lined up to fuel a cycle of rising inflation. People respond to incentives, and they are voting with their feet. That's why the prices of things are rising, and that's why rising inflation is very unlikely to be a transient problem. Unless, of course, the Fed reverses course and begins jacking up short-term interest rates in a BIG way. Which in today's political environment seems unlikely. 


Andrew said...

Thank-you Scott;

I can't help to think that on a fundamental level, the problem in Argentina
must have some how involved the amount of work that people did.

My own belief is that if a society is working efficiently, then they will prosper.
If they are not working efficiently, then chaos.
The "system" needs to ensure work is accomplished efficiently.

I can understand the hoarding in response to hyper inflation.
However, wasn't there some how a dis-incentive to work too?

Scott Grannis said...

Argentina’s economy is notoriously inefficient. GDP per capital is an order of magnitude less than that of the US. There are numerous reasons: endemic public sector corruption and a chronic lack of investment arguably top the list. But high and volatile inflation over the years and decades is a factor as well, since inflation is corrosive of stability and trust and investment. After years of disruptive policies (mostly of the very left-wing variety) it is no wonder that people’s incentive to work has been dulled. But as I see it, the causation flows from bad policies to a subsequent lack of productivity, not the other way around.

And in any event, it is a proven fact that the central bank engages in massive money printing. For most of the past decade the money supply in Argentina has increased by more than 30% per year on average. No amount of efficiency and work ethic can alter that fact, nor can it overcome the sheer volume of money printing.

Christian S. Herzeca, Esq. said...


I want to follow up generally on Andrew's point ("The "system" needs to ensure work is accomplished efficiently.").

I have faith that the American economy will continue to prosper notwithstanding excessive government deficit spending and entitlement growth largely because of the efficiency and competitiveness of American enterprise. This seems to me to be largely a cultural issue that has held intact during most of American history since its founding. Generations enjoyed higher standards of living that their preceding generation, and social mobility existed together with the prospect that an improved standard of living was obtainable. what seems to me to be the biggest risk to this American success story is not so much a money suppy and demand issue as it is a cultural issue, with the emergence of CRT and democratic socialist policies. Merit is not as highly regarded as it was when I was young. it is now queried as a manifestation of privilege. achievement is no longer viewed as enviable since it leaves in its wake victims, for whom achievers are at fault. our schools and universities have espoused wokism, for lack of a better word, to an extent that I find unfathomable, but this trend has the potential to not only diminish educational achievement in our schools, but impair the efficiency and excellence of the American economy in a way that will overshadow an inflationary growth rate of M2. I have seen George Will dismiss wokism as a cultural trend that will play itself out. I can only hope that he will be right.

Johnny Bee Dawg said...

Lets see what happens when Joe stops paying people to sit on the couch instead of drive gasoline and meat trucks.
Supply chain issues will smooth after this Fall. Truck drivers will return to work, and start delivering again one day.

Every single new policy and policy threat of the past 8 months, on the margin, has the real effect of hobbling growth, and creating artificial shortages, inefficiencies and price spikes. All these bad effects are currently being masked completely by the Fed accommodating like mad in "crisis mode", and the economy re-opening from the artificial imposed unconstitutional shut downs. The US looks like Alred E. Neumann's moron face: "What, me worry?" Happy as a clam as "confidence" is back, bay-bee!

After the Fed calms down, and the massive GDP rebound has played out, we will go back to fighting the long term deflationary effects of Marxist policy, and the general lawlessness of our government. We have been fighting this for many years. All this "confidence" will disappear once the Fed stops propping up Uncle Joe.

Right now we are standing strong by swigging gallons of good strong Fed liquor and the virus fraud fading out. CASES down!!! Swinging away, kissing all the girls, and shouting with bravado like a good dumb drunk. Im happy to drink it up and own my beer-goggle beautiful stocks while the drinks are free. Im up 46% YTD, thanks to Value, Small Caps, Re-Open and Meme stocks. Why not? Even tech has come alive this month. But at least I know its a rebound. I do not think its "confidence". I dont feel one bit confident. Im climbing the Wall of Worry. Farmers say to make hay while the sun is shining.

Let the 10 year yield get back up to the 1994 downtrend line after the Fed tightens, and DE-flation returns. Just my opinion. Mid-terms will give the Fed cover to tighten away. The Fed is very good at fighting IN-flation. Their battle will continue to be DE-flation brought on by The Great Reset mindset that's gained momentum over my career. And we will be swimming upstream vs a flood of massive new debt.

Gold is down 9% this year. 10 year yield has slipped below 1.45%, while the entire curve yields below inflation.
Inflation is in every headline, and constant talk on TV. But does this look like a market that is running from inflation?

Rick Jones said...

My wife and I bought an apartment in Buenos Aires in 2005. Fortunately, we bought it from the outgoing Spanish ambassador, and he had a U.S. bank account, so most of the money was just a simple transfer between U.S. banks. But he had a need for about $100,000 in cash in Argentina, so we had to do that in Buenos Aires.

The scene was insane. We were in a small, secure room in a bank. He——the ambassador——had hired an armed guard. This guy was there, standing behind the ambassador and his wife with a bullet proof vest and sub-machine gun. The rest of us were sitting around a table.

One of the bank people walked in with large silver platter stacked with $100 USD bills . . . $100,000 worth. He put it in front of my wife, and we counted it. We passed it to a notary, who counted it. She passed it to the ambassador and his wife, and they counted it. It was like a drug deal. When all was said and done, they took it outside to an armored car the ambassador had hired, and then transported it to another bank.

At one point in the process the ambassador took me aside and apologized. He said something like, "You and I know how to do things in a civilized manner, but this is how they do things here, and we have to go with it."

Argentina was a weird place to live, and after three years we got tired of the constant uncertainty in everything. We were fortunate to find a U.S. buyer——completely by accident——who paid the entire price in the U.S.

One of the interesting things I found was that a lot of the home burglaries took place in poorer neighborhoods. It seems that the Argentine government had seized money from bank accounts in the early-00s, and no one wanted to keep their money in Argentine banks. The wealthy had the means to move it offshore, but the poor people converted whatever they had into U.S. dollars (typically $100 bills) and stashed them around their apartments. We saw that sort of counter-intuitive behavior everywhere.

Benjamin Cole said...

The Eurozone just reported June core inflation year-over-year at 0.8%.

Japan is in minor inflation.

China is running consumer inflation at about 1.3%.

I am not sure why the US should have higher inflation than the rest of the developed world.

If true, perhaps you want to short the dollar or short Treasuries.

Side note: the Federal Reserve is now conducting an aggressive reverse repo program---to prop up overnight and short-term rates.

True, the US should institute a constitutional ban on property zoning, which would cool off inflation scene in shelter (but would take several years of building before it gains traction).

I think the labor markets will cool off as soon as the unwise extended unemployment benefits cease, which is in September.

Interesting times.

New all-time record on the S&P 500 yesterday. The market is said to be forward-looking.

Benjamin Cole said...

A report from the Dlla Fed and their "trimmed mean" outlook for inflation. They sound very, very worried...and then say:

"Based on our expectation of labor market conditions continuing to tighten, trimmed mean PCE inflation should increase to 2.4 percent by year-end 2022 and remain at that level through mid-2023. This also implies a headline PCE inflation rate of 2.4 percent by year-end 2022. Given the unusual nature of this business cycle, there is significant uncertainty around this forecast."

Well, I guess you have to be a central banker to be worried about inflation in the 2% to 3% range during and after an economy-wrecking pandemic.

(BTW I agree with Scott Granni the economy was largely wrecked not by the virus but government restrictions).

Well, we will see.

Carl said...

@Benjamin Cole
The virus had a direct impact before collectively induced modifications and the collective actions compounded the negative impact but developed countries' (with the US leading the way) legislative actions (based on collective debt incurred) more than compensated the negative economic impact overall as shown by higher deposits, higher retail sales, higher disposable incomes and higher household debt worth.

Consistent with a 'new era' secular trend, deleveraging no longer occurs during downturns (exogenous or endogenous). This is now supported by a bipartisan disconnect between gradually increasing debt levels and gradually decreasing interest rate levels giving rise to the idea that money has reached the permanent new plateau of being perceived as free.

Data and data interpretation underlined by this site (and consensus view apart mainly from the risk-free bond markets) suggest that inflation from lost of confidence in the currency will happen. From a humble perspective, i offer the opinion that, given what is now unsustainable debt levels, a deflationary restructuring episode will be necessary before inflation is for real.

When you think about it, despite the huge human impact in some areas, the Covid-19 episode will only be a small blip in the long term macro scheme of things. It is as if people were, in the aggregate, put to sleep for a few months and people woke up with excess deposits etc as a result of borrowed money by the central Fed-Treasury complex. And now people expect the aggregated and newly stimmie-stimulated debt drug addict to become productive (inflation potential) overnight?

@C. Herzeca Esquire
i think we met on a different discussion Board where i tended to disagree a lot with you. So much so that you had equated me with a eunuch while discussing a successful investment into a restructuring utility and had established my morality level at the level of a pre-schooler. When peripherally talking about government-supported enterprises, i had suggested the difficulty in compounding a series of low probability events but that's another story.
FWIW, i agree with your optimism and the enduring American Dream but the polarized climate should contribute to a very interesting interim period which may deflate some short term great expectations.

Carl said...

The above should read higher household net worth not debt worth (Freudian slip i guess).

Benjamin Cole said...


I am concerned about a welfare culture. People expect free money and fat government pensions (not PC to say so, the VA is the worst offender).

So we tax productive people to pay for it.

I have long advocated lower taxes on wages and reduction of social welfare programs.

Alack and alas, I have discovered that comments on a blog have very little impact on national policies.

wkevinw said...

There is a large fraction ~30-60%, of the US population that now has a life of debt serfdom- work and survive only. There is no thought of owning something or starting a business based on savings/ownership and one's own skills, persistence, etc.

Note that there are something like half as many small businesses as there used to be about 50 years ago.

As such, lack of hope for such "ownership/economic freedom", shows up as a willingness to stay at home and collect the checks if the amounts are about the same for work vs unemployment.

People need productive jobs that allow for hope. (People are not made to respond to endless welfare/unemployment insurance- no matter how generous.)

Note: the opportunity to get some skills in a trade, for example, hasn't been this high in a long time. For somebody who wants that competitive advantage when the labor market "normalizes", now would be a great time to go get that kind of job. I believe that's what I would do when I was a lot younger. I hope we have enough people still left who would do this. We still need a better job market for most people.

The jobs have been lost and de-waged to globalized labor markets.

Carl said...

-On the usefulness of those discussions
1) When de Tocqueviile visited America and when its democracy was felt to be immature, he submitted that an unusual feature was the ability and willingness (of varying quality) of public participation into the political process. Just see this 'forum' as a modern town hall meeting, with Mr. Grannis as the moderator.
2) With a more ambitious goal in mind and a more dedicated self-interest, it appears that a financial crisis will be a necessary trigger to reach the next phase and i'm trying to define ways to benefit throughout.
The underlying problem is the faster growth of entitlement programs compared to real growth in private incomes and the fact that entitlements have become the norm, in a context of free debt without material constraints.
One of your senators once said: " It cannot too often be stated that the issue of welfare is not what it costs those who provide it, but what it costs those who receive it." and i think that we, the people will eventually figure it out. The US is the best place to enter, go through and leave, a bankruptcy-related restructuring process.
In the 30s, Alvin Hansen described a stagnation hypothesis that makes a lot of parallels to today's predicament (it makes a lot of sense when you read it) but he was eventually proved wrong. He underestimated America's resilience and did not include the possibility that the world was about to enter a second global conflict. There are many reasons to be bullish; it's just not that obvious now if you pay attention to fundamentals.
Back to the topic at hand which is inflation, the path that has been defined so far will eventually be an inflationary one. What is fascinating now is that the present period is characterized by a very unusual and relative balance between inflationary and deflationary forces. It has become an unstable stability. My bet is that there will be a debt deflation component. The sooner the better. Of course, you can't always get what you want but the US appears to be (IMO) the best place to get what you need.

Benjamin Cole said...

From the Friday jobs report, hourly wages in June at $30.40, compared against $29.35 a year earlier.

That's about 3.6% up, in one year. If you get 1% to 2% increase in productivity, then you are close to 2% increase in unit labor costs, which seems to be what most Western central banks want.

The Reserve Bank of Australia has a great track record with an inflation target band of 2% to 3%. But they may have just been lucky, as Australia has a lot to export.

It may be the 2% inflation target is too tight, given large structural impediments in the US economy. House prices and rent being the big one.

My guess is presently productivity is rising nicely and will more offset wage increases.

The inflation will come from oil, housing and certain production snags, such as in semiconductors.

Yes, inflation always and everywhere as Milton said...but even if a central bank does a good job, and you continually tighten supplies....

randy said...

Wkevinw - "Note: the opportunity to get some skills in a trade, for example, hasn't been this high in a long time. For somebody who wants that competitive advantage when the labor market "normalizes", now would be a great time to go get that kind of job. "

I couldn't agree more. One of the best things that could come out of the Covid experience is a material rethinking about the value of a 4 year college education. The costs are way out of line (because of loan subsidies) and the gain is highly questionable - especially in the soft non-stem degrees. I have a nephew struggling in a 2nd rate public university - for which I'm paying for. In business school but with little direction. I'm trying to steer him to a technical trade - maybe something in dev/ops. In fact Google is now supporting VERY inexpensive certification programs, and having a policy that these programs are equivalent to a 4 year degree when hiring. Unfortunately I'm not having immediate success in that effort so far.

Carl said...

@Benjamin Cole
You seem to suggest that the Fed has managed to achieve a sweet spot for inflation and your outlook for productivity is positive. i disagree. :)

Time is spent here because it feels like one of those rare times when one has to pay attention.

One of the defining features of the 2010-9 decade has a been a modest wage increase (rising slowly from 2 to 4 % per year; NOT really a new Covid trend and, apologies to the politically oriented here, not a trend influenced by the 2016-2020 term) above a very disappointing productivity growth (1.1% annual over the period). This would normally be a recipe for inflation but it hasn't been, quite the contrary. Why and what's in store?

People and consensus thinking have marveled at the recent productivity numbers as unproductive people (not meant in a pejorative way) stopped working and received government transfers funded by debt. In the last jobs report, as people have started to go back to unproductive work (leisure, hospitality, retail, government 'services'), wage inflation has started to moderate. From this perspective, going forward, it is reasonable to expect very poor productivity numbers as a result of things getting back to 'normal'. Wage inflation above declining productivity growth, in theory, should be inflationary but, even if there is no difference between theory and practice, in practice, there is (there has been and IMO there will be).

All the fundamental ingredients for productivity growth look unfavorable at this point (this will eventually change for the better) and compensating with debt has the potential to reach non-linear changes in the foreseeable future.

i know they say don't fight the Fed but i think the Fed has become its greatest enemy. Can you imagine what they will do when markets fall 20%+ and when housing prices decline. It's really a great time to be alive.

@those who discuss skills-job markets mismatch
Three offsprings of ours are making their way through higher education and the compromise for support (mental and financial) was the inclusion of a productivity component into the equation. It's not clear if that is a widespread concern.

Unknown said...

Scott I very much appreciate your work and your perspective that helps your readers prepare for the future.

John said...

Regarding the decline in small businesses. I had my own consulting business for about a year and a half. It was insurance that really sounded the death knell. Professional E/O, commercial building (in case a client came over to my house and slipped on the sidewalk), commercial auto, and family Obamacare were way too much. I was so hopeful when Trump promised "great care for less money." All he did was eliminate the personal mandate, which drove the cost up even more.

wkevinw said...

"Obamacare were way too much. I was so hopeful when Trump promised "great care for less money." All he did was eliminate the personal mandate, which drove the cost up even more. "

The health care business(es) are a big problem, and basically comprised of crony capitalists. The Republicans do their usual lazy thing: the "free market" will solve it all while the Dems just want everything socialized. Once socialized, I don't see many ways back to a private market.

I know a bit about state management of Medicaid and a Republican governor (past) limited competition to help his cronies and hope that his career would continue to rise in politics. The only thing that happened was even less competition- this is crony capitalism.

There are several MDs (and insurance execs) in congress. Do you notice any particular hard work in trying to improve the competition and market efficiencies in health care? Nope. That's all you need to know. The Republicans like it the way it is.

Very unethical.

Carl said...

Medical inflation has been a large contributor to baseline CPI-type inflation measures for a long time.
It's possible that this tapeworm is a poster child within an overall picture which remains, at least so far, deflationary.
Money spent on medical care does not go into consumption of other products and into investments and has been increasingly reliant on higher publicly-funded debt levels compared to core earning power.

HDX said...
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randy said...

Instead of adding Puerto Rico and D.C as states, it would make far more sense to break California into 5+ states. That would remedy the perceived problem of underrepresentation in the Senate. And the more real problem of California having too much weight in all kinds of corporate policy that must bow to the behemoth and it's lowest common denominator demands.

HDX said...
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randy said...
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randy said...

"how would 5+ stupid states be better than one stupid state?"

My guess is it would sort out to 2 very progressive states, and 3 moderate purple states, maybe even a red one. But the progressive states would have much less weight, money, and influence than the combined state now. It would be far easier for families and companies to move just across the border to a slightly better run, lower taxed state.

HDX said...
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randy said...

I'm reminded of the wisdom of Buck Owens.

"You don't know me but you don't like me.
You say you care less how I feel.
But how many of you that sit and judge me.
Ever walked the streets of Bakersfield."

HDX said...
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randy said...

Actually I'm from Texas. I just admire Buck Owens. And a subtle way of pointing out that not all of California is like LA and SF.

HDX said...
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Johnny Bee Dawg said...

Market participants have bid up the 10 year below a 1.40% yield.
I saw 1.35 this morning. Negative yielding world looking for a home?
Moving average support at 1.30% ish.
Steady-earning tech stocks are starting to catch a bid again as the re-open trade tires under the weight of constant Marxist assault.
Market doesn’t seem scared of Inflation today.

We will just have to see how it goes.

Carl said...

"Market participants have bid up the 10 year below a 1.40% yield."
And 30-yr 'risk free' opened at 1.95% this AM. This 1.95% includes expected inflation and a time premium, leaving expected real rates deep in negative territory.
How does that sound? Inflationary?

-The economic output has 'recovered' but 7 million American workers have not.
How does that sound? Inflationary?

-Since the Covid episode, the upward slope in the % of Americans retired has accelerated.
How does that sound? Inflationary?

Japan continues to lead the way and is preparing a stimulus package (their stimulus packages look more and more like helicopter money) just in time for the to-be-announced elections. It looks like they may reach the inflationary wall first but they are showing the potential depths of deflationary possibilities.

Tell me where i'm going to die so i don't go there.

DJD said...

The concern about the money supply seems overblown. The Fed can REDUCE the money supply by simply selling bonds to the banks.....and also increasing equity requirements.
Dave Doyal

Benjamin Cole said...

More record highs on Wall Street, yields slipping on Treasuries.

If there is bad news out there somewhere...Wall Street doesn't know about it.

randy said...

Speaking of California -

A few takeaways - even Ezra Klein recognizes that good intentions rule making is usually badly fails it's intended goals and is always corrupted by money interests. (Probably the most significant problem with Democrats in practice.). But it seems his position is that the elite (like him) should have more influence, and the riff raff less.

I'm surprised at the top reader comments. Calling out that activist groups destroy any chance of effective governance. Benjamin will relate to the utter hypocrisy of opposition to building, and how that affects housing prices.

Scott Grannis said...

DJD, re "The Fed can reduce the money supply..."
Yes, of course they can. But today that would mean selling upwards of $4 trillion of bonds. That would translate into a gigantic reduction in market liquidity. So big, that I seriously doubt that anyone at the Fed would even entertain the notion. One other thing they can is to raise the interest rate the Fed pays on reserves, since that would have the effect of increasing the demand to hold all those excess reserves (again, around $4 trillion worth). They can either reduce the supply of reserves or increase the demand to hold those reserves, or both, and the net effect would be to reduce the risk of inflation.

What I've tried to make clear here is that in the meantime they have created powerful incentives for people to NOT hold the existing supply of M2. That has the effect of increasing the velocity of money (money becomes a hot potato because it is losing value daily due to inflation). So they have set in motion forces that are working in the opposite direction of what you propose. For them to change course dramatically would be highly problematic and potentially very disruptive to the market, and today's Fed would be loathe to undertake such action.

So yes, there are solutions to the threat of higher inflation, but how likely are they to be implemented in time to avoid a very significant rise in inflation and inflation expectations?

Scott Grannis said...

I'm tempted to view the rather significant recent decline in Treasury yields as indicative of the market reacting negatively to 1) the likelihood that Biden won't be able to "stimulate" the economy very much, and 2) the news that the Delta variant of Covid is spreading like wildfire and thus it could negate the beneficial effects of mass vaccinations.

Both fears, if realized, would be bad for the economy, which is why real yields have fallen and continue to trade at very low levels. To put this another way, the market has become much less sanguine about the future.

When everyone starts worrying about a collapsing economy (due to lack of fiscal stimulus) I get rather excited since I think the proposed stimulus would actually be very damaging to the economy. Thus, I'm getting more optimistic because I think the market is failing to adequately assess the risks (i.e., the market is overestimating the risks). And as far as I can see, the Delta variant is not causing more than a very mild increase in cases and virtually no increases in deaths. Virus wisdom has always held that the more contagious a virus, the less lethal it is. So I'm not worried about the Delta variant.

Roy said...

"And as far as I can see, the Delta variant is not causing more than a very mild increase in cases and virtually no increases in deaths."

So, basically, you write a couple thousand words article and comments as an "economist" but your actual conclusion is based on you being a tourist-virologist?

1. There's already data that even pfizer/moderna vaccines are far less effective against Delta transmission. See recent Israeli data. Still, the vaccines are highly effective in preventing death/serious conditions.

2. This of course only applies to the vaccinated. There are many adults who are still unvaccinated, mostly in Trump Land. They will suffer. Their kids will suffer. There is no herd immunity.

3. As long as so many are unvaccinated, including in other countries, it is a certainty there will be newer variants and those will be even worse.

4. The ONLY way for a resilient economy is through vaccines. We will certainly see a booster shot before winter.

5. You have been complicit on this blog from day one declaring that it's not a pandemic and how there's nothing to worry about, belittling the importance of vaccines. Wake up.

Carl said...

"What I've tried to make clear here is that in the meantime they have created powerful incentives for people to NOT hold the existing supply of M2. That has the effect of increasing the velocity of money (money becomes a hot potato because it is losing value daily due to inflation). So they have set in motion forces that are working in the opposite direction of what you propose."

The hot potato effect that you describe has been a concern since the introduction of unconventional monetary tools (more than 10 years ago!).

Central authorities (like Japan) were expecting consumer-type inflationary pressures but these pressures have not really manifested (apart from recent and temporary related to the transition phase we're going through IMO). Take a look at long term trends in M2 money velocity.
The Fed were expecting/hoping for their easing to stimulate private loan growth but this has not occurred, quite an opposite effect actually when you look at trends in loan growth at commercial banks. The Fed hasn't been able to apply a constructive transmission mechanism to the real economy.

The hot potato effect however has had a huge effect for asset-type inflation. Low interest rates, debt and easy cash has circulated within the market and has driven the yields on all asset classes close to zero (that remains to be discovered for some asset classes). People have been driven to an apparent and superficial wealth effect by reaching ++ for yield and driving the price of securities upwards. This is not only in stocks but also in junk bonds, government debt securities and even short term government bonds where the demand (in exchange for excess cash in correlation to excess reserves) was high starting in early 2021 and with money market funds being attracted through reverse repo operations to get a 0% yield, a demand that jumped recently when the yield offered by the Fed 'jumped' to 0.05%! Today's levels of the RRP program is at 793.4B.

People are not inclined to hold money but the excess money will tend to go where it circulates better and, so far, this has been through the asset inflation channel and this obviously creates an unusual set of risks. In 2021, a record amount of brokerage accounts have been opened after the reception of stimmie checks (federal borrowed money) and some of the money has been used to a large extent to push prices to absurd levels in specific situations (AMC, Gamestop etc).

Carl said...

" And as far as I can see, the Delta variant is not causing more than a very mild increase in cases and virtually no increases in deaths. Virus wisdom has always held that the more contagious a virus, the less lethal it is. So I'm not worried about the Delta variant."

i would say you are directionally correct but some nuances are necessary. The new variants, especially the delta one, are closing the space that humans have been able to create between immunity related mostly to vaccines (also because of natural immunity to some extent) and the virus evolutionary potential. Yes, a decoupling has occurred between 1-rising cases and 2-hospitalizations and deaths but the decoupling is imperfect ie you should expect Covid-19 burden to rise, not to previous extents and not enough to mandate significant restrictions but it is what it is. If you look at Israel who has been a leader in vaccinations and the related real-world studies of vaccines, they have achieved a rapid and extensive vaccine coverage but the variants are causing a higher proportion of new cases now in vaccinated vs unvaccinated and they are starting to see some increase in more severe cases.
See the following (use Google translate if necessary):
Unfortunately, the US still has pockets not characterized by sufficient levels of natural and vaccine-induced immunity (in correlation to political allegiance for the vaccine coverage) and numbers are starting to show relatively (compared to Israel) poor numbers in new cases and also for more severe disease.
The virus impact is likely to be relatively limited (compared to before) but it's only a virus and the virus itself has no political connection. i doubt that the residual impact of the virus will have any durable impact on yields (real and nominal).

Yields are moving down for a reason,
because of debt brought to oblivion.

Johnny Bee Dawg said...

Couldn't care less about any "variant".
Mutating viruses are less virulent. Every time.
The scam continues. Ignore data, and then laugh at my words.

My church has been meeting in person for well over a year....spreading natural immunity upon the globe.
Singing. Hugging. Close contact. Masks non-existent. Zero Covid deaths
Everybody of our massive group that got "Covid" got over it like a flu case. Everybody.
No experimental, emergency-use-only gene therapy for me.
I'm in a control group that has a 99.99% survival rate, anyway, so no thanks.

CASES!!!! Dr. Scott Gotlieb knows!!

Radio said that Missouri has the most per capita CASES from variants in the USA.
However, Missouri's 7 day average virus death count is ZERO.
I dont live in Missouri, FWIW.
So enjoy your pandemic!

Mask up! Stay inside! Listen to tiny Dr. Science!!! He knows.
We live in absurd world right now.

10 year yield fell some more today.
Almost back down to the S&P 500 Dividend Yield.
Almost makes you want to buy some stocks after a little more pullback.

Joe's got this. Just wake him up. Let the Man WORK! Let him BREATHE!
God Bless Joe! Save us, Joe!

Carl said...

"The scam continues. Ignore data, and then laugh at my words."
Your post is not all wrong and one has to wonder which thought process prism you use in order to formulate conclusions.
Your Missouri assessment does not appear to fit with official numbers.
Covid deaths have been occurring in Missouri and are expected to rise with a typical lag given their rising Covid-related hospitalization. Per capita, Missouri now reports rising covid-related hospitalization rates which is about three times the national rate. See their offical site which reports the test positivity rates, their hospitalization and death rates as well as their hospital capacity occupied by covid-related cases.
Missouri now is a relative coronavirus hot spot and the Missouri people these days need to be hugged but they also need to figure out the basic biology related to viral spread and its potential consequences.

But i do agree that rates are and will tend to go down and this quasi-belief is related to the way you (and many others) analyze issues.

HDX said...
This comment has been removed by the author.
Fred said...

I recommend Dr. Monica Gandhi, MD, MPH for well reasoned analysis of the effectiveness of the vaccines against the variants. She has the credentials, experience with viruses and wisdom that most of the talking heads lack. According to Dr. Gandhi, the production of T cells and Memory B cells provides effective protection against serious illness and death, possibly for life. I also believe natural immunity provides similar protection based on the studies I've read although it's still best to get at least one shot of the vaccine. So, if you've had the virus or the vaccine, go and hug someone and sing to your heart's content. The panic porn is designed to promote more clicks and, in the case of the drug companies, sell booster shots.

Johnny Bee Dawg said...

New Daily Deaths 7 day average for Missouri thru July 7....ZERO
ZERO DAILY DEATHS is not much of a "hot spot", despite what the media says.

Carl said...

"New Daily Deaths 7 day average for Missouri thru July 7....ZERO"
Your interpretation of the recent worldmeter data is incorrect.
Also see the Missouri public health website referred to above.
Also look at the their recent hospitalization pattern (Missouri, by age group etc):
Because of vaccinations mostly as an effective at-risk group protection, this coming wave will be much less significant but 'we' are letting the natural experiment going to an extent that is difficult to reconcile with rational analysis.
It's sad in a way that this issue has become so childishly political because the heterogeneous response has cause a recurrent pattern (waves) with, first, cases spreading in younger age groups, in groups where basic behaviors vary, and then with people getting sick, hospitalized and dying and eventually reaching at-risk groups. Without vaccines (Missouri is not a positive outlier here), this wave would have been associated with much worse outcomes.
Just stay tuned to the increasing covid-death pattern in Missouri in the next few weeks.

A fascinating aspect is that this heterogeneous approach with much irrational input is likely to be the vehicle of choice as we enter a phase when 'macro' topics such as inflation (or the desperate lack thereof) will take center stage at the policy level, for better or for worse. This too shall pass.

Ataraxia said...


On inflation and the gold standard. Gold standard solves relative currency price fluctuations by providing an immutable peg. But how does a fixed supply of gold keep up with expanding aggregate supply? Isn't it deflationary?

HDX said...

Another comment of mine was mysteriously deleted... not deleted by author (which gets marked as such)... the comment was just completely deleted.

I'm sure Scott is going to claim "technical difficulties" to explain why some comments stay posted and others are marked deleted by author and some are just wiped from existence.

If you believe that, perhaps you might be interested in buying the Brooklyn Bridge from me, at a very reasonable price

Carl said...

"Gold standard solves relative currency price fluctuations by providing an immutable peg. But how does a fixed supply of gold keep up with expanding aggregate supply? Isn't it deflationary?"
Even during periods of a strong gold standard, price stability was not a feature.
You are playing with two variables in an equation that contains many. In theory, if gold production does not hold to growth in monetary supply, this would lead to deflation but we no longer live under a gold standard; there is only an indirect and weak link to gold based on social convention. And gold production has been going up. i agree though that gold is not the right vehicle in a deflationary environment.
The mention of the gold standard is interesting because the principles behind such as system runs absolutely contrary to modern politics. The gold standard was to 1- put a limit on growing negative international trade balances and 2- to limit government debt. Using a gold standard necessarily meant limitations on domestic flexibility to deal with national issues and relied on episodic periods of austerity. At times, the induced austerity was so large that the standard had to be abandoned. At this point, there is absolutely no political will to put constraints on the growing negative trade balance (as a % of GDP) and on the growing fiscal deficits (as a % of GDP).
The Bretton-Woods Agreements contained the seeds of its own destruction even if there was a remote link to gold because the system (as Triffin correctly described contemporaneously) relied on an unsustainable trajectory linked to rising trade deficits as a result of the USD being adopted as an international reserve currency. The ultimate convertibility was unsustainable and that aspect was suspended in 1971. Then the modified floating regime became based on a sustainable path of discipline and constraints on public debt in developed countries...
What's coming are the necessary discussions to define a new (and more sustainable) monetary order and it's possible that commodity-based reserve currencies will be discussed. Mr. Benjamin Graham had floated the idea in the 30s.
Austerity was possible in pre-Keynesian and pre-monetarist (managed currency) eras but it appears no longer possible now. i think though that the US will eventually decouple from Japan.
Benjamin Cole would say that there is nothing but blue skies and he could be right but President Hoover had also promised that prosperity was just around the corner and had submitted that the early cracks were simply passing aberrations instead of some fundamental fault.

Ataraxia said...


Thank you for the excellent reply. I'm trying to understand why some people and economists believe the gold standard to be a sort of panacea as a monetary system. I'm still hung up on how a fixed supply of anything backing currency can accommodate ever increasing aggregate supply.

Carl said...

^The idea behind the gold standard was to prevent governments from entering a deflationary debt trap (...) and/or from considering MMT as a viable monetary policy.
The growing debt remains tied to the future taxation capacity (which is the effective equivalent of the gold standard) which is great but not unlimited and it's not a free lunch.
We've entered uncharted waters and there are no obvious restraints as nobody wants to take the punchbowl away and it's become a bipartisan problem.

Scott Grannis said...

@Ataraxia: In theory, a gold standard can work despite there being a fixed and/or limited supply of gold backing it up. It can work because it requires the government to expand or contract the supply of money whenever the price of gold falls below or rises above the pegged price.

For example, let's say the US decides to implement a gold standard by pegging the price of gold at $1500/oz. It then observes that the price of gold starts rising above $1500. This would be a signal that there are "too many" dollars in circulation. The Fed would then need to shrink the US money supply by selling bonds, and it would need to do that until the price of gold fell to $1500.

Scott Grannis said...

@HDX: Every now and then I purge comments which are obviously either spam or free-riding ads for some company or product. (About one fourth to one third of the comments I receive on my posts fit this category, and so I purge then to keep the comments section free of clutter.) It's likely that one or more of your comments were inadvertently selected by me for deletion. If so, I apologize for that. I very rarely delete comments from legitimate readers. Very rarely.

Carl said...

The inflation numbers released today support the thesis of developing inflation.
But what if this is peaking inflation from the recent binge in collective debt?

"The prevailing view in the late 1970s was that U.S. and world inflation
rates would accelerate. Some analysts predicted that the gold price would
increase to $2,500 an ounce; the forecasters in the oil industry and in
the banks that were large lenders to firms in the oil industry predicted
that the oil price would reach $80 to $90 a barrel by 1990. One of the
cliches at the time was that the price of an ounce of gold was more or ´
less the same as the price of twenty barrels of oil."
This was recently read from a book written by Mr. Kindleberger.

People have short memories and, even in 2006-7, with oil prices rising and some inflation numbers picking up, there was a similar "narrative" for significant inflation coming... that was right before it became mainstream to accept that the Fed would do whatever it took to prevent deflation.

Before the fundamental economic laws were suspended in 2020 (virus, individual human responses, monetary, fiscal etc), the global economy was losing steam and the yioeld curve was inverted. Now, the main two differences are 1- higher collective debt levels and 2- a deeply entrenched (and bipartisan) notion that declines will be prevented and losses, 'socialized'. What could go wrong?

HDX said...

Scott, I wrote a comment that was very critical of the lockdowns and Fauci's non stop lying spree.

There were no products mentioned, no advertising, no companies.

Just that lying turd bureaucrat Fauci who wrecked so many mom and pop businesses, destroyed trillions off the US GDP, and led to thousands of deaths -- I'm talking about all the medical treatments and early detection tests that were delayed or skipped so that pompous turd could throw out the first pitch at a MLB game.

Scott Grannis said...

Carl: you left out some key facts.

The 70s were dominated by the devaluation of the dollar (vs gold), a surge in oil, real estate, and commodity prices and quite a few years of high and rising inflation (which peaked in 1981/82 at double-digit levels). There was every reason to think that inflation would continue. I went to work for the Claremont Economics Institute in 1981 and we spent the next several years trying to persuade our clients that inflation was set to decline dramatically. It was a tough sell, but we turned out to be right. I know what it is to buck the prevailing opinion.

In 2005 and 2006 inflation was climbing and real estate was soaring and the Fed was belatedly trying to raise rates to stop it. Inflation was very real back then. The Fed had to tighten so much in an effort to stop it that they triggered the Great Recession in 2008. I was worried about rising inflation in 2004/2005, and I even challenged Art Laffer on the issue at one of his conferences. I also worried about collapsing home prices, and I predicted they would decline by 35%. I turned out to be right.

Today the almost universal consensus among the “experts” is that today’s inflation will almost certainly be temporary. I have no problem bucking the consensus again.