The great inflation predicted by wise men: 3 reasons why it won’t happen

inflation in the Weimar Republic

Is inflation coming?

In the middle of the year 2021, prominent figures of the economic world, such as Ray Dalio, Warren Buffet, and many other investors, economists and specialists have been warning anyone who will listen: the great inflation is coming!

They may disagree as to whether inflation has already arrived or has a little way to go. Or whether it will be “worrying” inflation (say 6% per year) or “runaway” (the reincarnation of the Weimar Republic), whether it will have some “painful” consequences or whether it will be the end of our era. But it seems to be a certainty among many economists that inflation is coming.

Orthodox economics has good reason to think so. But this website is called Unorthodox Economics and, therefore, we will argue why, despite everything, inflation is not going to rise.

And let history be the judge!

Why should inflation soar?

Inflation is the loss of the value of money. If €100 next month can buy me fewer things than this month, there is inflation.

Now, we are coming out of confinement due to COVID, and not unlikely there will be a peak in consumption, and therefore in demand, due to needs that we repressed during last year. This peak will coincide with a low production capacity as economy is just coming out of a period of hibernation, so it is not unlikely that we will see a spike in prices. But it is not a one-off spike that is worrying, it is prices rising for months.

Why is this such a concern? In 2020, the world’s central banks injected some $6 trillion (1) into the economy battered by COVID. In the lead, the American Federal Reserve (Fed), followed by the European Central Bank.

According to World Bank data in 2018, money in circulation worldwide, counting banknotes, coins and checks, was around $36 trillion (about $106 trillion if other analogous forms, such as money in current accounts or bank deposits, are also taken into consideration). The world uses this money to buy and sell all the products and services it generates. Imagine, suddenly 6 trillion dollars ($6,000,000,000,000,000,000) appear, out of nothing and with no other backing than debt securities. According to traditional economic theory, immediately galloping inflation unleashes because there is much more money to buy the same amount of goods and services.

Now, even worse, in 2021, the Fed has another $ 4 trillion more injected into the US economy! 4 trillion in an economy of about $ 19 trillion annual GDP.

How can anyone pretend that inflation is not going to appear? Read on…

Why, despite all, there won’t be inflation

There are several reasons why that announced great inflation is not coming, at least not in the major economies, which are the ones that weigh globally. Two reasons are well known but, in my opinion, they are not the leading cause. The third one is responsible, although few speak about it.

Three reasons why inflation won’t soar

The stock market and real estate soak up the money

Much of the money injected into the economy in recent years, through quantitative easing, ends up in the laps of companies and large investors. They invest it in what earns them the most. Safe investments, such as government bonds, yield around zero or even negative interests and are of little interest. That leaves the stock market and real estate. And these, indeed, are having spectacular growth. In this sense, there is inflation, inflation of assets. But asset inflation is not included in calculating the CPI (consumer price index), which is the basis on which government agencies determine inflation. Asset inflation only has an indirect influence. For instance, an increase in the price of housing rents is recorded by the COI. In any case, investments in the stock market and in the real estate market absorb money. It slows down the circulation of money (technically: it reduces the velocity of money). Money changes hands much less and, finally, it is almost as if it is parked in a safe. Money that does not move is similar to money that does not exist.

The population in developed countries is aging

There are more and more retirees. Retirees consume less than the working population, so demand falls. With similar production, prices fall. In many countries, such as Spain, the population is decreasing. This is a powerful deflationary pressure. Japan, a strongly aging country, has struggled for thirty years to achieve some inflation.

Now let’s talk about the main reason why I believe that superinflation will not come:

It’s not the money supply. It’s production capacity

Increasing the money supply devalues prices, yes. But only at equal production.

What if there is more production capacity than demand? What if demand is reduced due to a lack of money in circulation?

Technology has improved production systems far more than indicators such as GDP or productivity would suggest.

More and cheaper manufacturing is taking place. The need for labor is reduced. Fewer people work, they are paid less and the unemployed are not reabsorbed by the labor market. The unemployed do not produce and do not consume. An excess supply is created. As there is more supply than demand, prices fall: there is deflation.

When central banks inject money into the economy, albeit inefficiently, it ends up reaching people who live on the bare minimum and gives them the opportunity to become normal consumers again, creating demand.

It may seem counter-intuitive because we are used to seeing the economy from the perspective of a shopkeeper rather than a country that can create money. But when there is a large production capacity, giving money benefits both those who receive it and the producers of goods and services.

Increased demand benefits producers: they sell more and earn more.

Central banks are doing what they have to do: increasing the money supply, thus money in circulation, in the hope it reaches the citizens, increasing their consumption capacity. The economy grows.

If anyone thinks that this must necessarily go wrong, they should know that the ECB and the FED have been doing it since the 2008 recession. During this time, inflation has not shot up. On the contrary, central banks have remained well behind their inflation target of 2% per year. The reason is this underlying deflation due to technology.

What is the price of this central bank-induced growth? An accounting note, a debt. Of course, you might argue on the importance of this debt. Proponents of Modern Monetary Theory claim that debt can grow quietly as long as there are idle resources because the central bank owns the currency and does not go bankrupt. The classics believe that this debt will be an unbearable burden for new generations.

Who is right? It makes for a long discussion, but I suppose that if someone came from outer space without a clue about all this, they would ask us: what is worth more economically? Not to have debt, that many people are unemployed and that companies produce below their capacity. Or having debt (a convention with no physical manifestation), lots of people working and companies producing more.