Fire brigade or arsonist?
Federal Reserve official says inflation persistence led her to support interest rate hike
“Both spoke about inflation pressures arising from supply shocks, such as the war in Iran, as well as from solid business and consumer spending.”
The direction of cause and effect isn’t so simple. As it turns out, governments fund war with inflation. And commodity prices started to rise before the war started. We’ll get into the source of business and consumer spending next.
Fed’s Goolsbee: Strong demand may be adding to US inflation, ‘no ambiguity’ how Fed would react
“If demand overheats, there is no ambiguity about how the Fed needs to respond,”
You could look at it that way, and alas too many establishment economists do. But here’s another way:
Demand is infinite. There is no limit to human desires. But it can only drive up prices when that demand is backed up with cash. I can hold my breath until I turn blue “demand”ing stuff, but unless I open my wallet, it has no effect on prices.
This may seem trivial, but it makes a crucial point. Inflation comes from money. As Nobel Prize winning economist Milton Friedman once put it, “inflation is always and everywhere a monetary phenomenon”.
Supergiant corporations don’t just “demand” massive amounts of energy and materials to build data centers without having massive amounts of cash to do their demanding with. Governments don’t prosecute wars without having access to massive amounts of currency to demand weapons with. Neither of these can cause inflation … they are but way stations on the road from money production to final prices.
I categorically reject this imagery that inflation comes from anywhere other than the banking system, and that it’s central bank’s job to fight it.
Central banks aren’t the fire brigades, they’re the arsonists.
Inflation is not things going up due to excess demand, it’s money going down due to excess supply.
The Spartans of ancient Greece would agree. They famously didn’t mint gold and silver coinage to prevent demand for material and luxury goods.
Another example but in reverse, when the French colonised Madagascar they installed a tax that had to be paid in Francs. This forced the locals to abandon their subsistence lifestyle and work in French factories, farms etc. However, they were deliberately paid enough that they had enough left over for “small luxuries” such as lipstick, parasols, thus CREATING DEMAND for French products.
You would think if ancient Spartans and French colonials could understand it, PhD Fed economists could too!
“It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
– Upton Sinclair
Here’s a single interesting data point. Mrs. Thrifty has a hobby business and she buys custom-made plain brown corrugated cardboard shipping boxes. Her supplier just announced an 8 percent price increase while bragging that industry-wide the price of cardboard boxes is going up 10 percent right now.
Back in the stone age those of us interested in economics and finance used to watch the cardboard carton industry closely because, like copper, cardboard boxes are involved in most all products spanning across most all industries. This single anecdotal data point says double digit inflation rates might be barreling at the US economy right now, with producers paying the new higher box prices the first time this quarter on their next order. We shall see.
Thanks, Thrifty. That strongly jibes with the macro data. The September PPI released Thursday (2026 1015) was up 6.3% versus the same month a year ago. And that’s lagging data because it spans a whole year. CPI was up 3.7% over the same time frame, and that’s even more lagging data because it’s downstream of producer prices. This on top of having been given a soothing statistical massage.
This at least partially explains the bond rout. Besides extraordinary borrowing demand from the US Treasury, capped by hundreds of billions more from US tech giants that historically borrowed little, the bond market knows inflation better than any government statistic.
It will be interesting to see how the Fed handles this. Wall Street has been pleading for it to take a powder next week, but it’s sworn it would not be complacent about inflation. Given that real time inflation is much higher than Fed funds, and even the bond market has hiked more, its current policy position is easy.
The implications for investors are fairly simple. Even producer prices are downstream of where inflation registers first … in asset prices. So the only path to lower consumer price inflation cuts through asset prices. If consumer price inflation is to meaningfully come down, asset price inflation has to go first.
“ If consumer price inflation is to meaningfully come down, asset price inflation has to go first”. What corner to be in for normal people. The only way to have affordable food and housing is to set fire to your retirement accounts. I hope we find another third choice, neither of those is appealing.
Fortunately (or unfortunately) it’s not something up to us. But it’s the main reason we have inflation in the first place. Powerful people and institutions benefit from it.
The connection between asset prices and consumer prices is not well publicized. We’d like to imagine asset prices can go up 10%-20% a year without interruption and we all get rich. But in the long run, they can’t, at least not without consumer prices following. We did a deep dive into why in The Claw Machine. From 35,000 feet, imagine if the real global economy grew at 3% indefinitely. And imagine if the global stock market cap grew at 6% indefinitely. The growth of the latter exceeds the real global economy by 3% … and if this goes on indefinitely, the value of the stock market grows without bound … to many times the value of everything on earth and then some. That’s not possible. So boom inevitably leads to bust.
But what can and does happen is that the total purchasing power of all assets … currencies, bonds, stocks … stays in line with the total global economy. This means that an increase in the purchasing power of any one must be offset by losses in the purchasing power of the others. Usually it’s currency that takes the brunt of it. And depreciating currency is, of course, inflation, and it shows up in rising prices for everything we buy.
Because people don’t immediately run out and buy things with their stock market gains, asset price inflation can go on for a long time before it spills over into consumer price inflation and starts to trigger public anger and a policy response. Sometimes it it only takes a year or so, like it did back in 2020-2022; other times it takes longer. But it always does eventually. Either consumer prices rise to meet asset prices or asset prices come back down. Or some messy combination of both.