Inflation IV

 

Subterranean Homesick Blues

Look out kid, don't matter what you did
Walk on your tiptoes, don’t tie no bows
Better stay away from those that carry around a fire hose
Keep a clean nose, watch the plainclothes
You don't need a weatherman to know which way the wind blows

But you do need to know that there IS a difference between
short term weather
and
long term climate.

If there is a fixed amount of money, and money is the medium of exchange in trade, then all trading must stop if one group of players has all of the money.  On the other hand, if society wishes trade to continue, then it must increase the supply of money to allow trade. 

The first situation describes when the supply of money is based on a fixed asset, e.g. gold or crypto currency ( e.g. Bitcoins will be eventually limited to 21 million).  When money is based on a fixed asset, it is said to be a commodity currency, such as the gold standard.  The second situation describes a fiat currency, where society creates money to accommodate trade. The first is the Chicago School, the second is  Keynesian. 

The United States Dollar was on the gold standard until 1933, when private ownership of gold was made illegal.  However gold still was the international trading currency.  After Bretton Woods, the United States Dollar became the international trading currency backed by gold.  Predictably, international players accumulated more and more dollars, and potentially gold, until the Nixon Shock of 1971.  This was followed by an economic readjustment, as the supply and demand curves had to readjust to this new reality.  Since that time, while long term inflation has been persistent, short term corrections between the supply and demand curves have been minimal.

Calls to go to a commodity currency, where that is backed by gold, or by crypto currency, appears to risk subjecting the economy to major corrections in the supply and demand curves.  Overall, the markets have been generally stable after they recovered from the Nixon Shock. But long term inflation has increased because the  international trading currency was a domestic fiat currency which was not growing to account for international trade ( the Triffin Dilemma) .

The year to year increase in the 2022 CPI was 4.4%.  The December 2020 to December 2021 increase was 7%, but 4.4% is based on the average of monthly CPI weighted by the days in each month.  The 7% increase is only relative to the lower demand in December 2020.  Given that the long term inflation has been suggested to be 4%, this change in short term inflation might not be cause for alarm. The increase in CPI seemed to begin in March of 2020, which is also the start of the COVID shutdown. Making policy decisions based on a comparison of today with COVID conditions would appear to be unwise.  It is like declaring that a drought is over based on a comparison of today’s rainfall with that during of the worst of the  drought.  The short term change is nice to know, but it is the change over the long term that is important.