Insights, The Bridge
Jason Hsu, PhDScroll down
While perusing LinkedIn over the past few weeks, I’ve seen many references to Milton Friedman’s famous proclamation that “inflation is always and everywhere a monetary phenomenon.” Unfortunately, I suspect many using the quote—and even more who read it—seriously misunderstand its context.
In my experience, people rarely understand the way in which macroeconomists like Friedman are concerned with inflation. Similarly, most macroeconomists don’t concern themselves with aspects of inflation that so agonize Main Street and its political leaders. There is a disconnect between what I call “academic inflation” and “Main Street inflation.”
Of course, there usually isn’t any harm when Main Street and academia speak different languages. One might even say it’s the norm in most disciplines. The risk only arises when Main Street and its politicians begin building policy based on their misunderstanding of academic literature. Presently, I think there is a real risk that economic technocrats are being pressured into gross misapplication of Nobel Prize-winning monetary models.
To a monetary economist, inflation is about the average worker facing average price increases. This inflation is a benign non-event—a nuisance at most. It only matures into a major risk if it becomes hyper-inflation, which leads to currency failure and devolves the economy into an inefficient bartering system.
For economists, 8% inflation means wages for workers go up 8%, wealth for households goes up 8%, rent goes up 8%, gasoline goes up 8%, groceries go up 8% and so on. Net-net, it is a giant wash. You are not worst off from the scary 8% inflation, because your income and wealth have also gone up 8%. In real terms, it is as if nothing has happened!
Of course, inflation is inconvenient for business owners. For example, a restaurant owner will have to re-print menus every quarter when facing 8% inflation instead of just once a year when inflation is at 2%. But other than this annoying “menu cost” problem, the Fed’s only real requirement is to restrain 8% inflation from escalating to 80% inflation before we become Zimbabwe.
Friedman’s helicopter money experiment makes this crystal clear (see my prior article, This is Not the Matrix, for a detailed explanation of helicopter money). If you rain free money from the sky, everyone becomes nominally wealthier. But nominal prices also go up. This means that at the end of the day, no one is better or worse off. You received free money and were happy for 30 minutes about the windfall. Then you went to the mall only to find prices have risen enough to make you poor again. You could be angry; but, frankly, you’re just as well off as you were before money rained from the sky.
While raining money doesn’t cause any affordability problems (because wealth and prices have gone up in unison), things can still get psychologically uncomfortable. But there’s a simple fix: the Fed can stop raining money or even take some back. Inflation problem solved.
It is truly that simple if you only need to worry about the credibility of the nation’s fiat currency. Indeed, a monetary economist can rightly conclude that inflation is always and everywhere a monetary phenomenon. Leave it to the central bankers. Politics have no role here.
However, we don’t live in that world. I would never use the derogatory epithet “ivory tower economist,” nor do I view economics as a dismal science. It’s just that Friedman was concerned with a narrow problem: how to avoid a Zimbabwe redux. But let’s make no mistakes here. Friedman’s inflation is not the same inflation that Main Street is worried about right now.
Above, I explained how macroeconomists view inflation through the soft lens of averages. But that is not how Main Street experiences inflation on-the-ground.
For Main Street, inflation is what happens to them specifically; not what happens to a hypothetical average person estimated by a regression. Workers must wonder, “My wage has only increased by 4%, but gasoline has shot up 50% and I drive 40 miles to work; and prices for everything else seem to be increasing faster than my employer is giving raises; how long will this last and how will I pay next month’s rent?”
To Friedman, on average, inflation leaves us neither better off nor worse off. But the convenient averages he and other macroeconomists use to build their models are cold comfort on Main Street.
In practice, an overwhelming number of American households deal with the bad end of the distribution—because of the extremely skewed wealth and income distribution in the United States, most households are actually “below average.” To add insult to injury, these families benefitted very little from the 0.5% interest rate that is now in our rear-view mirror.
The primary beneficiaries of the growth and prosperity created by our recent history of cheap money were investors with meaningful stock or real estate portfolios and technology professionals. That cheap money has pushed wealth inequality to a breaking point. To use Friedman’s analogy, the helicopter money has been raining down for years—but only in the wealthy neighborhoods. And now, inflation has broken the back of the affordability camel.
To summarize, QE did little to improve Main Street’s nominal wealth, but the eventual reckoning has brought about price increases that hit them disproportionally. Meanwhile, to a Python coder working from home, their wage has increased meaningfully, as have their stock options. $6 gasoline may be something for them to complain about over a $10-dollar cold brew Barista coffee, but it doesn’t materially impact their life. But to someone who must drive 40 miles to work for minimum wage, $7 gas is lifestyle altering.
These are all the reasons why inflation to Main Street is not just a “monetary question.” The inflation on Main Street is and always has been a (social) class struggle; it is a fundamentally political problem.
At the heart of the inflation problem are two questions 1) who has the power to give free money to their “tribe,” and 2) who has to pay the bill in the form of inflation? This is, of course, just another way of asking, “Who has the power to redistribute wealth?”
When the government prints money, that money can be given to different people through different channels.
I am being blunt and without nuance here for the ease of exposition. However, it shouldn’t be hard to speculate which political party prefers which method for raining down helicopter money. Unsurprisingly, the Dems generally prefer 1 and 2 (as does Beijing, with its common prosperity policy). The GOP and those clinging to the ghost of trickle-down economics generally support 3.
It is critical to understand that giving people fiat currency doesn’t create real wealth; it just redistributes it. This is not a capitalist struggle, where owners and labor argue over who contributed more and thus deserve a larger share of a jointly created pie. This is a zero-sum class struggle for redistribution, where the pie gets no bigger and we fight to maximize our share.
My message for Main Street’s political leaders is this: you cannot look to Milton Friedman to solve your problem. You don’t have the “menu cost problem” caused by an 8% wage rise bundled with an offsetting 8% CPI increase. And there is no risk of the US going the way of Turkey or Zimbabwe. This is not a macroeconomics 101 exam.
For a Main Street politician, one of two things have happened. Either 1) your voters are holding the bill for free money that went to other people; or 2) the little free money you secured for your voters has now been eroded by rising prices. Meanwhile, Wall Street and Silicon Valley have spent the last several years enjoying the cheap money that contributed to our current inflation.
The truth is that, at the end of the day, there will be winners and losers in how our government goes about tackling inflation. But choosing those winners and losers is fundamentally a political problem, not an economic one. We cannot let our politicians shirk their responsibility by pretending Main Street inflation is always and everywhere a monetary problem.
Again, Friedman will not solve this. And we certainly shouldn’t look to Jerome Powell and the economists on the Fed; unelected macroeconomists should not have the power to decide winners and losers. Our politicians must guide the national conversation on inflation with much greater understanding and honesty. The real problem isn’t the helicopter money; it’s that the helicopter money rained down unevenly.
Worsening wealth inequality has been masked by the story of a rising tide of cheap money that lifts all boats. But poorer families weren’t on those boats; they were already under the water drowning. The real problem isn’t that “nominal prices” have increased. The real problem is that “real income and wealth” for low net worth families has fallen dangerously low. This is why we should not naively seek to contain nominal price increases at all costs. There is real risk that we will harm poorer households disproportionally in our fight against inflation… immediately after we just disadvantaged them in the process of creating that inflation in the first place.
So, what will happen if our politicians pursue an economic “hard landing” that weakens employment for below-median households? What if Fed rate hikes crater consumption by further reducing their real income and wealth? If these things happen, we will achieve a Milton Friedman victory against inflation but an ultimately empty victory for Main Street.
Subscribe to receive the latest Rayliant research, product updates, media and events.
Issued by Rayliant Investment Research d/b/a Rayliant Asset Management (“Rayliant”). Unless stated otherwise, all names, trademarks and logos used in this material are the intellectual property of Rayliant.
This document is for information purposes only. It is not a recommendation to buy or sell any financial instrument and should not be construed as an investment advice. Any securities, sectors or countries mentioned herein are for illustration purposes only. Investments involves risk. The value of your investments may fall as well as rise and you may not get back your initial investment. Performance data quoted represents past performance and is not indicative of future results. While reasonable care has been taken to ensure the accuracy of the information, Rayliant does not give any warranty or representation, expressed or implied, and expressly disclaims liability for any errors and omissions. Information and opinions may be subject to change without notice. Rayliant accepts no liability for any loss, indirect or consequential damages, arising from the use of or reliance on this document.
Hypothetical, back-tested performance results have many inherent limitations. Unlike the results shown in an actual performance record, hypothetical results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over- compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical results in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any investment manager.