Recent news cycles have been peppered with reports of looming inflation from economists and business leaders, along with the expected denials and excuses from politicians and their propaganda outlets in the news media. Chief among the distortions being advanced is the notion that inflation cannot persist in a down economy.
The basis for this fallacious claim is a relic of Keynsian economics known as the “Phillips Curve.” This diagram represents a perceived trade-off between inflation and unemployment within a market economy, which was based on experiential observation during the mid-twentieth century. The narrative that is used to sell this line of reasoning is that inflation results from increased economic activity increasing demand and pushing up prices. Conversely, the theory holds that when inflation is not present, the economy must be slowing and that unemployment will result.
The Phillips Curve theorizes an inverse relationship between inflation and unemployment.
Since the current political regime in charge of the United States contains legions of avowed Keynsian supporters, it is not surprising that this mantra is
being used to describe the current economic situation. The fundamental fallacy of this argument lies in the fact that it ignores the impact of monetary expansion on prices and output.
The impact of monetary expansion is articulated quite succinctly in the quantity theory of money. Fundamentally, this theory states that the nominal price level is a product of the amount of money in circulation times the velocity with which that money circulates through the economy. When the money supply increases sharply, prices will do the same. When the velocity of circulation decreases sharply, prices will move similarly. The hitch comes in the current situation where the velocity of circulation has gone down significantly, but the money supply has gone up very significantly. The net result of this situation has been for asset values to deflate from the reduced circulation since much of the monetary expansion is being held by banks to satisfy reserve requirements and to hedge against future uncertainty.
M x V = P x Q
- M represents the nominal money supply
- V represents the velocity of currency circulation through the economy
- P represents the nominal price level
- Q represents the real value of final transactions
The problem that is implicit within the propaganda that is being peddled by the political establishment and their unquestioning followers in the media is that there will be a ‘whipsaw’ effect when credit markets normalize and monetary circulations return to historic levels. This whipsaw will be for the massive amount of new money printed by the Federal Reserve to cause rampant, runaway inflation that most of the population is not prepared for.
Likely responses to this inevitable inflation run in one of two directions. The first is to tighten the money supply, which will result in sharply increasing interest rates. This will have the net effect of increasing the cost of capital for business ventures at the exact time when the economy is on the cusp of a recovery. It is quite likely that this type of a disruption will push the economy back into recession. The second option is for the government to simply allow the inflation to rampage through the economy, and attempt to blame the rising prices on corporate greed or some other equally vacuous scapegoat. This second option is far more likely, given the current political leadership’s propensity to avoid difficult decisions, castigate blame, and sacrifice the wellbeing of the economy for the sake of perpetuating government power.
As prudent investors, it is incumbent on each of us to understand the events that are likely to transpire and arrange our affairs accordingly. In this case, the power hungry regime in charge of the country will use the crisis to extract power from the pockets of Middle America by foisting massive inflation on the populace. Those of us who have prepared ourselves by acquiring multiple income-producing assets financed with fixed-rate debt will be inadvertently enriched by the reckless irresponsibility of government. Unfortunately, the rest of the country will sold down the river by a power-obsessed administration that is only interested in expanding the scope and reach of government.
- The mainstream media perpetuates a distorted view of inflation
- This is based on a Keynsian economic fallacy
- This fallacy is rooted in a perceived tradeoff between inflation and unemployment in the “Phillips Curve”
- This narrative ignores the impact of monetary expansion on prices
- Market prices are established based on the level of currency outstanding and the velocity of its circulation relative to the amount of goods and services produced
- Increasing the supply of money when output stays flat or contracts must push market prices
- The current direction of government policy is highly inflationary
- What will you do to prevent your wealth from being destroyed by inflation?
“This unchecked spending is growing faster than our economy, faster than inflation, and far beyond our means to sustain it.” – Jim Nussle
The Solomon Success Team
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