Inflation Theory.
The idea of inflation is pretty straightforward: prices of stuff rises so you need more currency to buy the same thing. The basic notion is that over time, prices tend to go up.
Over the last while, this notion has become a pretty big and important one as it has driven the decision making and actions of global central banks, which have in turn driven global markets and economies. Simply put: because “inflation” has been below what the economists think it should be, Central Bankers have kept interest rates extremely low (zero and even below zero now). The theory is these low interest rates will stimulate economic activity, leading to “inflation”.
The other thing that these Central Banks have done is buy securities. Buy buying things like mortgage securities, government bonds, in Europe even corporate bonds and in Japan even equities, the Central Banks cause the prices of capital markets to rise. This too is supposed to stimulate economic activity and lead to “inflation”.
While I was driving around today looking at cars and houses and stuff, I couldn’t help but notice that the prices of these things are higher than they used to be. Especially houses.
But the same is true for other stuff. Stocks are up. Bonds are up. Asset prices everywhere are way higher than they used to be.
So that means the interest policy is working right? “Inflation” is happening?
Well, not really according to the way the theory works. For these academics the thing that matters aren’t assets but instead the other stuff of everyday life; goods and services and the things we consume. However, this seems like a mistake.
The thing is, by ignoring assets in the “inflation” math what the economists are doing is benefitting those who own the assets and hurting those who do not. If someone owns assets and the prices go up, they can always sell them and buy more stuff like goods and services. On the other hand, if someone is say, young and self-determining and working their way up in society without wealth inheritance and wants to buy assets…well that is kind of a hard thing if the prices of the assets keep going up.
What is particularly pernicious about this issue is that what seems to be happening is that in many cases, lowering interest rates could potentially even hurt working people. I’m an uber optimist about technology but at the margin making it cheaper for companies to borrow might make it easier to displace workers with equipment. Low interest rates might also hurt “inflation” itself by creating excess supply through binge borrowing of say, oil & gas drilling companies, which, while potentially beneficial at the pump, ultimately doesn’t help accomplish the end goal the economists are aiming for.
What is potentially even worse than all of this is that there are other side effects to this theory. Lowering interest rates means you can’t make money by saving. Literally, it has now become almost an accepted fact that banks don’t pay interest on savings and checking accounts. The same is true for simple stuff like buying government or corporate bonds. In the old days you could safely buy these and save for retirement. Pension funds could do the same: allocate to safe investments and generate enough income to pay for their future obligations. Not anymore.
What is even worse is that from a simple arithmetic point of view if you want to retire in the future but your assets don’t earn any interest, you need to save a lot more to actually retire. If you could previously earn 8% on a base of $1MM, that would give you $80k of income. But at 2% interest rates you need $4MM for the same income to pay the bills. What this means is you have to work more. Longer. Like years longer. This same issue clearly impacts basic stuff like home ownership as well.
The final issue I’d like to highlight is that this theory treats the securities governments are buying (and those that all other investors are forced to buy at higher prices and lower return and yield levels) as if they are part of the same economic theoretical world driving these decisions. They seem to assume that the prices of these securities only go in one direction, but we know that is false.
The fact is that historically sometimes the prices of securities fall, and that is because risk exists and sometimes companies or even countries face challenges or even fail. This basic reality has led to deep collapses in asset prices of all kinds throughout history and as recently as last decade in a global fashion.
The deepest problem with what appears to be a pretty pernicious academic theory being implemented is that the assets that everyone is increasingly hard-pressed to reach for may in fact not end up being worth what people are paying for them. They might decline.
If these prices decline dramatically this could be bad for so many reasons to articulate in one short post, but one idea is this: if asset prices fall and interest rate policy doesn’t adjust to provide enough income to offset these declines, then an entire generation of retirees and pension funds could be in deep trouble. Given that recent “policy” has been to lower interest rates during time of stress, it is hard to imagine rate policy would intentionally be set to help if asset prices fall.
However, if (when) risk arises again — perhaps say Political Risk — and if (when) asset prices fall as a result, we might be in completely uncharted territory. The upside of this would be that it might help to correct some of the economic schisms that have happened between asset owners and workers as a result of recent policy. But sadly the workers might be hurt with lost jobs if the market collapse leads to an economic downturn.
Unfortunately, there do not appear to be any easy solutions to these issues. Sadly when you play economic theoretical games with the global economy as your petri-dish the experiment only gets to run one time. There are no do-overs. Hopefully, we won’t here a global “oops” from our not-quite philosopher king economic politicians pulling these strings. But it is hard to imagine that not being the case as these ills run their course.
