Keeping up with Inflation

With something like a third, or maybe even 40%, of all current money having come into existence in the last two years, naturally we have price inflation. Production of goods and services has not kept up. How could it? Even if there were not lockdowns and even if baby boomers were not retiring and thus withdrawing their top-drawer skills from the market, production could not come close to increasing as fast as money.

When money increases, there is a higher likelihood of consumptive demand increasing. People are willing to pay more for the same thing. Suppose 50 people are at an auction and that each came with $1000 to spend. The basket of goods on sale will not fetch any more than $50,000 in aggregate. Now suppose that someone flits through the room, handing $500 cash to each of the 50 bidders. What do you think will happen to bids and prices?

We have not seen prices rise as quickly as the money supply. It takes time for the effects of the increased money to be seen. At an auction, the goods are not all sold in an instant. An increase in the cash have effects through the duration of the auction. In a similar way, unless there is a steep contraction of the money supply, I expect we will see ongoing price inflation for the rest of this decade. I think five, six, even eight, percent annual increase in prices will be normal.

What do rising prices do for people on fixed incomes such as pensions and interest from savings deposits? It wipes out their incomes. These people have votes, and politicians want them. So there will be a tendency to want to have interest rates increase, but to have them increase to the level of price inflation would bankrupt governments. National debt levels are simply too high for that.

Anyway, interest rates are a function of the supply of money and the demand for it. Right now supply exceeds demand, so rates are low. Normally what happens in an inflationary economy where interest rates are low is that people realize that they can borrow now and pay less back because money is losing its value. So demand for money increases and interest rates that people are willing to pay rise also. A kind of equilibrium is reached, and historically, real interest rates are about 3% per annum, which means the rates are about 3% above the price inflation rate.

Governments can’t afford that now. Central banks will be bidding up the price of government debt, which is the same as interest rates falling. A government bond pays out its face value at maturity. The difference between what you pay for the bond and the face amount it pays is the interest. The more you pay for the bond, the lower the interest rate will be. So central banks drive down interest rates by buying, and thus bidding up prices of, government bonds.

Since real interest rates are likely to be negative for a long time, what does one do to preserve wealth? If you are a business owner, my advice would usually be not to retire, at least not fully. Keep your hand in the business. It can be like an annuity. If you are investing in liquid assets, pay attention to the uranium narrative. Also copper.  And gold and silver. Over the long haul, some cryptos will do magnificently, but the current hype reminds me of the dot coms of 20 plus years ago.