Tuesday, August 03, 2021

What's Behind the Inflation Hall of Mirrors?

The global economy may have finally run up against hard limits of "infinite substitution" and "infinite expansion" funded by central-bank free money.

We are in an interesting Hall of Mirrors moment: prices are rising, yet we're assured by the Federal Reserve that this inflation is "transitory," and other voices are insisting the primary forces of the economy (globalization, debt and automation) are all profoundly deflationary, meaning prices of everything will eventually plummet as supply will outstrip demand. At this same moment, others are declaring the start of a new secular inflation that cannot be controlled with Federal Reserve interest-rate manipulation / bond-buying.

What do you see in the kaleidoscope of reflected images? Here's a few things I've seen in the Inflation Hall of Mirrors:

-- A package of three rib-eye steaks in Costco for $65

-- a Ford dealership with no new Fords on the lot and a scattering of used cars

-- A Nissan dealership with no Versas, Ultimas, Leafs, etc.

-- used cars with 140,000 miles carrying nosebleed asking prices

-- a basic breakfast in a restaurant for over $20

-- resorts charging $450/day, with surcharges and taxes on top

-- utility fees rising 10% to 20% annually

One can argue all of these are examples of temporary inflation generated by an imbalance of limited supply and high demand. Perhaps. But it may also be the case that the costs of production have increased in ways that are not temporary.

Consider wages. Once wages go up and benefit costs go up, they do not come down. Very few people will accept a pay cut as prices soar.

Consider coffee. Demand for coffee is typically stable. If prices rise 30%, most coffee drinkers will not switch to tea. They will pay the higher price. The three-pound tin at Costco for $10.99 may well go to $15.99, but the $5 extra will not induce most coffee drinkers to switch to some other beverage.

As frost and drought reduce the global coffee supply, what exactly is "transitory" about lost harvests and damaged trees? It takes many years to get a substantial yield off a coffee tree, and the harvesting process is labor-intensive. If labor isn't available, the crop rots.

Scarcity hasn't been a factor in decades. Globalization has institutionalized the idea that there is always "more" of everything available somewhere: more lithium, more cheap labor, more oil, more coffee, more wild fisheries, more fresh-water aquifers to tap, and so on. The possibility that "more" has morphed to "less" simply doesn't compute in an economy based on the secular divinity of infinite substitution: there is always a cheaper substitute somewhere in the world that can be tapped and funneled into the global supply chain.

So what happens when there are no cheaper sources, and no substitutes? In the secular religion of infinite substitution, this is "impossible," hence non-transitory inflation is "impossible." But perhaps this secular faith is no longer aligned with the real world.

Intensive Care Units (ICU) offer an insightful analogy. ICUs are a concentration of specially trained talent which can only be acquired through long years of experience. In the In the secular religion of infinite substitution, it's an article of faith that there is a pool of specialists that can be tapped if we just print enough money to buy them.

But printing money can't create a pool of specialized talent. This process is experiential and cannot be purchased off the shelf or ramped up with Fed stimulus. There is no pool of ICU experience in Lower Slobovia waiting to be tapped with Fed free money.

Fed free money might fund the construction of a new ICU ward and fill it with expensive equipment--itself a lengthy, multi-year process--but if there's no staff with the requisite experience, the new ward will fail to fill the scarcity as intended.

It's also possible that the existing pool of specialized talent might actually shrink as the imbalance of supply and demand burns out overworked staff.

In other words, the global economy may have finally run up against hard limits of infinite substitution and infinite expansion funded by central-bank free money. In the temples of this secular faith, accelerating, permanent inflation is "impossible."

All sorts of things that are viewed as "impossible" happen with remarkable regularity. What's behind the Inflation Hall of Mirrors may surprise true believers in "transitory inflation" and global deflationary forces.




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