EPISODES / WEEKLY COMMENTARY

Inflation Chain Gang: Many Weak Links

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Oct 05 2021
Inflation Chain Gang: Many Weak Links
David McAlvany Posted on October 5, 2021
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  • “Just In Time” inventory management hits wall with COVID politics
  • Mortal Fear is a powerful manipulator
  • Supply, Demand, & Monetary Dynamics all point to long lasting inflation

Inflation Chain Gang: Many Weak Links
October 6, 2021

“Care and consideration of the common man—I have no problem with that, but as so many forms of socialism and redistribution have already been tested and proven to be a failure alongside communism, have we so quickly forgotten the lessons of the past half century? There will be a price to pay, and everyone will pay it. And that is the nature of inflation.” — David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. Now, I’m Kevin Orrick, along with David McAlvany. 

There used to be a commercial on, Dave. It was Doritos. And I remember they would say, “Munch all you want, we’ll make more.” And you think about what we’re hearing about supply chains these days. And there was a lot of confidence in just the phrase, “We’ll make more,” because what do you need? You need the corn, you need whatever they put on those Doritos, the chemicals that make them look like cheese, yeah. 

But there’s just this assumption that the farmer’s going to provide the corn. There’s the assumption that you’re going to be able to bake it and have all the parts to make the ovens work. So munch all you want, we’ll make more, is sort of like our whole system is built on demand. And we just assume that we’re going to have the supply coming in. So we’re hearing about inflation and it’s being blamed on supply chain dynamics right now, because what we’re finding out is Doritos and everybody else is going, “Can we make more? Can we get all the parts?”

David: Consumer expectations have shifted pretty radically in the age of Amazon, where not only can you buy immediately, but you can receive the product by tomorrow morning.

Kevin: Sometimes the same day.

David: I know.

Kevin: My mom, I’ll order her a book and two hours later, she’s got it. She’s in Phoenix.

David: It’s amazing. So there are multiple issues in play with supply chains. Certainly, one perfectly orchestrated piece that worked until it didn’t was that management style Just In Time Inventory Management.

Kevin: Munch all you, we’ll make more, just in time.

David: We think of the product development cycle and the consumer’s interest in purchasing a manufactured good. And there’s so many steps that precede the purchase. The process flow of anticipating seasonal demand and in many cases, continuing creation of a product available for the market on current real-time orders to replenish limited stocks, yet it relies heavily on the existing flows of commodity production, the reliability of delivery, the availability of component resources, the availability of manufacturing labor, the availability of a means of transport for the finished good. And even more labor involved in the final distribution delivery from a domestic hub. They say a chain is only as strong as its weakest link. And I think what Covid gave us was revelation that there’s multiple weak links.

Kevin: This weekend, we had some people over at the house. We had my mom and my wife’s mom over, and it’s just now starting to get cold at night. I realized when I turned my in-floor heat on, that the pilot light wasn’t keeping on. And I was just mentioning to them, we finally got it fixed, but I was looking at the complexity of the system of keeping my house warm. Okay. You’ve got to have electricity to keep the in-floor heat, the liquid flowing. I’ve got to have propane. And then I have to find a plumber when it doesn’t work. And so you talked about labor, but it takes labor and parts. If there would have been something actually that needed to be replaced other than cleaned, he told me there may be a very long delay. So you’re talking about labor. You’re talking about supply, parts. You’re talking about complexity. Fortunately, I can burn wood in the fireplace if I have to. But think about that, Dave. That complexity just in a simple heating system in a house, that’s duplicated all throughout our society these days.

David: I know a replacement for our kitchen dishwasher, which was put on order in January, still has yet to be delivered.

Kevin: Yeah. There you go.

David: Granted, they did deliver one that was for a European electric system. So it was just the wrong current plugin. So we had to send it back, which meant really the January order was perhaps a May or June order.

Kevin: That might have been a mistake. You may have needed to go to the European system.

David: Yeah. Well, the world is neatly divided according to a series of value-added schemes. Labor may be affordable or more affordable in one jurisdiction, while resource extraction is best suited to some low-cost producer somewhere else in the world. So supply chains shine a light on the interconnectedness of business in the 21st century. We’ve had other periods of remarkable cross-border coordination. Again, periods of flourishing globalization where labor and capital and goods moved with confidence and brought lower prices, and was in the context of a peaceful environment of mutual interests. And even if there was a common benefit, it didn’t have to be equal. People still appreciated that there was money moving and benefits to be had for all.

Kevin: In parables, I’ve been talking a lot about them, but sometimes they contain everything that we’re talking about in all this economic language. For instance: for want of a nail. We’ve all heard for want of a nail, but just think about a pencil. We’ve seen in the past what all goes into just a simple number two lead pencil.

David: I think the famous story of the pencil comes from Henry Hazlitt, where, what is sourced in one place. Carbon from another, rubber from yet another jurisdiction. The assembly of all the various pieces into not just one pencil, but a million pencils, and that process of specialization and cooperation makes everything more economical and more universally available. Again, where specialization, cooperation, and trade become paramount. And it’s not one person setting out to spend an entire week making your own unique and one-of-a-kind pencil. So the bright side of market dynamics is there with Hazlitt’s story of the pencil.

Kevin: But does that also mean that the inflation that’s kicking in here is probably a worldwide phenomenon?

David: It’s becoming more of an issue. So the bright side of the market dynamics are in play. Inflation has become a global issue. Most recently, we got the ECB target of 2%. It’s now, well, 2%. That was the target. It’s in the rear view mirror. The common currency area, their inflation rate’s now to a 13 year high, 3.4% last month. And of course, we had the Fed’s preferred measure, not CPI, but PCE, which is now at 4.3%, a 30-year high. It’s behind CPI, which has a higher number, and PPI, which is an even higher number still. But again, this is a global issue. China’s producer price index, what the producers are paying for their input costs, it’s up 9.5% for August.

Kevin: Okay. So I’m going to bring up something that’s a little controversial. No, not a little, it’s controversial. The restaurants here in Durango, a lot of the reasons they’re not able to stay open, it isn’t just the free money that’s being given to people. But it’s because there are vaccine requirements in various places. Like California, I’m starting to find, I think with all the mandates that are coming down, that’s got to create inflation as well, because you’ve got to go pay more for the labor, the little bit of labor that’s going to work.

David: Yeah. So then the present context, we have the logistical issues, we have product shortages, we have labor crunches, and various factors driving a global inflation. But there’s also a human element front and center.

Kevin: It’s Covid, or the fear of Covid. The fear of mortality.

David: Exactly. And you can say it’s Covid-19 to blame for disruptions. I would say it’s the human choice, and an emphasis on mortal fear, which is equally disruptive. So what the pandemic presented was a series of choices. What governments around the world have orchestrated are complex responses. Choices put in motion to the pandemic. And we are dealing with secondary effects from a complex system of creation and distribution, which doesn’t know how to deal with some of these choices. In many cases, it’s just gumming up the gears in the supply chain machinery.

Kevin: And including the volatility of whether somebody is going to be open on a given day. It’s very hard to plan a month ahead right now.

David: Again, when we’re talking about a complex system where there’s not a lot of tolerances, think of an engineered machine. No tolerance is built into the supply chain for a delay in commodity production and delivery. There’s no tolerance built in for varied labor availability, necessary in the component manufacturing process. There’s no tolerances built into a highly engineered system for border closures or transportation restrictions or certain documentation which had not previously been required and now is, and no tolerances within the remaining links—the labor required to bring a finished product to either a consumer retail outlet or a front door. 

We’ve seen just in the last week in the UK, where the military has been required to step in because they don’t have enough truck drivers. And it’s not as if they just ran out of truck drivers or all their truck drivers are on strike. Something fundamental has changed. The truck drivers who could work are not working. And we’re seeing this in other jurisdictions, too, where, again, we don’t have critical labor at particular places. My wife brought this to my attention with a hospital system and news that she was listening to. I don’t know if an NPR, something like that, where I think you’re going to have to pay your nurses more if they’re going to stay because at the margins, you’re losing help. And at the margins, this is from an HR standpoint, the difference between having a schedule where people are easily accommodated in terms of the workforce, or are pressed to the limits because there’s not enough bodies for the hours required.

Kevin: So wouldn’t you say policy complications? So the policy changes from country to country—state to state. When we drive down to New Mexico, we have to look and see what the policies are at the time.

David: Our own supply chain is disrupted this week. One of our employees was going to go to Europe, but can’t go to Germany because of requirements there, which he meets—or he met until last week. So it’s a never interesting story.

Kevin: Just changed.

David: Can’t go to France because of changed requirements.

Kevin: He can get into Brussels.

David: He can get into Brussels, but he can’t get on a train to anywhere else. 

Kevin: Right.

David: So again, these are policy complications set in motion with varied degrees of Covid concern. And you see the spectrum from a little bit of concern from the Swedes to a lot on the other extreme, from the Aussies and the Canadians, even places like the Philippines. My parents have been trying to get back to the Philippines for four months. They can’t get back in. Five flights have been canceled and they’re in virtual lockdown.

Kevin: They’re in Indonesia right now, right?

David: They’ve been staying at a hotel in Indonesia for four, going on five months. That brings uncertainty into the mix. Covid can be blamed, but so can mortal fear and the policy responses that has elicited from governmental bureaucrats the world over. Politicians and policymakers are sitting here at the intersection of crisis and opportunity.

Kevin: And it’s not really even all government, even companies have expectations. I’ve got a client who is an executive in a large media firm. I won’t name it. But they said, “No, we’re not going to make the vaccine mandatory. You just won’t be able to meet any people or do your job unless you get it.” So that’s a bureaucratic change within a company. And that also, for people who are making various choices based on the vaccine, that’s going to change the labor flow as well.

David: Well, we’re not past the supply chain disruptions. We mentioned this last week. We should have been. They thought this was transitory. And in large measure it’s because the links in the chain are dealing with very bureaucratic expectations for the workplace. Again, we’re talking about safety protocols. We’re not protesting safety protocols. But when it changes, the coordinated efforts cross country become very difficult, whether it’s travel or transport, and it feeds into every cost structure downstream. For instance, we have DHL. DHL transport is now following the FedEx and UPS announcements of bumping freight rates 5.9%. It goes into effect January 1st. But again, these absorbed costs ultimately have to be passed on. So blame the variants, but blame to the responses, which are impediments to our return to normal.

Kevin: Yes, but there are those who are listening right now who would say, “Yes, but if everybody just got vaccinated.” I was eating dinner the other day. And I heard three guys talking, and that was the attitude. All these problems are just caused by the unvaccinated—

David: Well, and you’re right. You can imagine other lines of reasoning. It’s not just removal of bureaucratic morass. Perhaps the answer is universal vaccination, except that we know from Israeli studies that the pharmaceutical therapeutics engaged in resolving the Covid crisis— So hand out the vaccines to everybody. They were the early adopters. And the benefits accrued very quickly. That’s clear. But they were only temporary benefits.

Kevin: Call it transitory.

David: Right. So whether you’re pro or anti-vax or in-between, certainty and the language of guaranteed protection, it’s a fiction. You may not be looking at a wide enough swath of numbers. Numbers from the UK, numbers from Israel, anywhere where there was early adoption, the folks who were showing up who were vaccinated, who are now being hospitalized, were the early ones to get it. In other words, the efficacy is wearing off. So your boosters and pills are a part of the next chapter in our modern telling. It’s almost like you pick up one of those huge novels, War and Peace. This is the tale of Covid connivance and confidence lost. And yet you have to do what’s right to bring people back into confidence and trust in a system that is working, not failing, in terms of health needs and getting back to normal.

Kevin: You brought up War and Peace. Sometimes it’s best to step away from a situation and say, “What if this were fiction? How would you write the story?” And I’m sure in that story, that thick novel called Covid-19 and Their Responses, or however you would do it, or you would say, Virus And Vaccine, I guess that’s War and Peace. Virus and Vaccine. But you would have the true believers in pharmacological science, who say, “No, no. Everyone should get it.” And then you’ve got the, call ’em anti-vax people. Or a lot of people would like to say, “Oh, these are the un-scienced. These are the people who are just ignorant.” You would write that novel, and there would be a lot of tension and a lot of inflation.

David: Well, and the important part here is the economic consequence. I’m not trying to define what you should do, Kevin, or what I think I will do, and universalize that. Because in essence, why even linger on Covid? It’s a political hot potato.

Kevin: Sure.

David: Yes, there’s social tensions. Families have decided that they’re not going to associate with each other on the basis of this thing. And you’re right. There’s the true believers, where pharmacy is there to help. Big Pharma is solving the problem. And on the other side, it’s the un-scienced Pharma skeptic. But the nature and the course of the virus, the nature and the course of the virus cannot be determined. There’re unknowns which cannot be accounted for. We have new variants that didn’t exist at the beginning. And what appeared to be a solution, a silver bullet, is not so much so anymore. And so again, things are influenced at the margins. Policy responses, which are oriented towards health and safety also have economic consequences. And so at the margins, we continue to see the links, and particularly the weak links, in the chain operate at a very dysfunctional level.

Kevin: Okay. And what we’ve talked about is supply chain problems and how those have come about. Now, there’s an awful lot that goes into the, munch all you want, we’ll make more, Dorito thing. So you’ve got the person who also is buying the nachos. And they need money. They have to have money. And I want to talk about that going down the road here on this conversation, Dave, because fiscal stimulus is a way of getting the consumer the money. So it’s not just supply chain dynamics that are affecting inflation right now. But before that, I want to move to something. You have always been a proponent of reserves, whether it’s an athletic endeavor. We were talking about the Half Ironman that you have done, and you just competed in the world championships. You want to have a certain amount of reserves for those 70 plus miles, that you can tap into. And we read a book on Iron Man when I was training and it talked about your reserves being a little bit like a 24-pack of matches. You want to burn those matches as you go, but you certainly want to have some leftover toward the end of the race. And so when we’re talking about on demand, like we were before, where you just assume that you’re going to have every element needed to create that Doritos so that people can munch more, you also are basically saying that you’re not keeping a book of 24 matches. You’re just going one match at a time.

David: Yeah. And this is a really, from a McKinsey study done back in 2010, they noted that the move towards just-in time management had reduced inventories between 1981 to the year 2000, had reduced American company inventories by an average of 2% a year. And so, this is a refinement in the process. We don’t need as much in reserve. We don’t have to sort of keep everything in stock to meet demand. We will order it and manufacture it and deliver it immediately following the purchase event. So what it allowed them to do is free up capital. It allowed them to expand businesses with that capital that was freed up. It allowed them to do share buy backs, and take that capital and do other crazy things with it. But corporate America has gotten very, very lean. And a part of the leaning process is moving from just that short-term need to short-term need. What you’re describing with an Ironman race is you have to anticipate. You have to plan. You have to think about where am I going to be and what am I going to need at that point? You can’t make it up as you go along.

Kevin: Bodily energy. Liquid. You’re talking about hydration. You’re also talking about how you’re going to feed yourself during that period of time.

David: In a one-hour race, you can cheat that. But in a three-hour, five-hour, 10-hour race, now, all of a sudden, you can’t go the distance without thoughtfully thinking through, “What am I going to need and when am I going to need it?”

Kevin: You know what this reminds me of? You’ve dropped water bottles before and tried to continue. When you drop a water bottle and it changes the entire plan, that’s a little bit like the supply chain dynamic that we’re talking about.

David: Yeah. Absolutely. I’ll never forget Santa Rosa, California. They told us, “You go over the bridge, the seams in the bridge, you’re going to pop your water bottles. Make sure that you have them secured.” And I had two of my nutrition bottles, which had all my calories.

Kevin: Not just your hydration, your calories as well.

David: 10 miles down the road, I look back and both of my bottles are gone. So now it’s water only, no calories to fuel.

Kevin: Changes the dynamic.

David: Changes the dynamic.

Kevin: Yeah. Supply chain dynamic is everywhere.

David: Well, solving one problem, again, this is sort of an attempt to address the health risks of Covid, has perpetuated another series of problems, which in a functional market economy aren’t usually present, but now are a prominent feature in the global economy. And what we have is rising costs, both of goods and services. So the supply chain is a significant contributor to inflation. And yes, there is a case to be made for the transitory nature of the supply chain impediments. You could also describe them as not just supply chain-induced, but policy-induced impediments. 

So again, working around each country’s specific strictures for labor and for movement, these are becoming major issues. So to the degree that Covid remains an unbound problem— Again, we’re talking about the nature and the course of the virus cannot be determined. We cannot have certainty on this. To the degree that Covid remains an unbound problem, there’s no quick solution. It could be months into the future. It could be years. And not based on policy choice, but the evolution of a strain. And we’re talking about an economic strain, real pressure in that sense, but also of epidemiological strain. As it evolves and changes, we’re going to continue to see policies respond to a crisis, a health crisis. And that in itself perpetuates this extension of supply chain issues.

Kevin: Well, and since this is mainly an economics program, let’s go ahead and look at the three main elements of economics. We’ve been talking about supply, supply, supply. You have to have, okay, so you’ve got the baker. Let’s call that the supply. You’ve got the eater, the guy who munches the Doritos. That’s the demand side of things. And when you’re giving the guy on the demand side extra money, that’s going to influence things too. And then of course, I brought the third element up and that’s monetary policy. You give money, and so supply, demand and the money that it takes to meet those two needs.

David: And I agree there’s certain aspects of the supply chain impediments which will go away. But focusing on fixing the supply chain, while valid, if you ignore the demand side of the equation, you’re still going to have issues with inflation down the road. So aggregate demand is an economic concept that captures the total demand in an economy for all sources, including demand for products and services from the private sector—so households; from businesses and the activity of a business—buying products, selling; as well as government—how a government spends through its budget or, in many instances, deficit spending.

Kevin: And government, remember what John Maynard Keynes said, he said, Okay. So if the demand goes away at times, the government can come in and actually munch all they want and they’ll make more. I’m saying it’ll meet the demand. And so was Keynes right in smoothing that cycle out on demand?

David: That’s what he wanted, was to say, look, if there’s pressure in the context of a recession, and all of a sudden household demand declines, they’re not buying goods and services like they used to, Keynes thought it was right to smooth demand volatility and ease the pressures that emerged in the labor market. Because this thing slowed down and all of a sudden you’ve got a rise in unemployment. So to avoid a rise in unemployment, to ease the pressures in the labor market in the context of recession, you basically step in and government spending fills the gap. Even deficit spending was, in his view, a proper course to keep the private sector ultimately and over the longer-term healthy through a very lean spell. 

So we’re talking about aggregate demand and you’re probably thinking, and I have zero interest in this. Well, this is really key because the policy is impacting the supply chain, R&D the lingering issue. Governments continue to restrict return to normal. You get the fears of expanding virus reach, and negatively impacting spheres of responsibility that they cover. But the demand side of the equation, the demand side of the equation is equally interesting from a policy perspective. And it’s a significant contributor to inflation pressures witnessed on a global basis. 

We can easily imagine a world of inadequate demand. In which case, you may end up with excess supply. Again, you’ve produced things and nobody’s buying them, so you end up with extras. That’s the consequence. And what follows from that is a significant decline in prices, too much supply and not enough demand. Again, this is one form of the economist’s dreaded deflation, where you begin to see the prices of things drop. Can you imagine, try to imagine something different. Instead of inadequate demand, can you imagine a world of excess demand. A world of excess demand and where do prices go in that case?

Kevin: It’s so different. We’ve been doing this show since before the global financial crisis. We started in 2008. So let’s call it the GFC. The global financial crisis is when this particular podcast began. And it was interesting because it was before it, so we could walk through it. I would love to go back and listen to those shows and just see. But if you remember the response to the global financial crisis, it was the printing of trillions and trillions of dollars with the idea that it would create a wealth effect that, if we print it, I keep using Doritos analogies, but if we print it, they’ll spend more. That didn’t really happen, Dave, but this is different this time, because you and I were talking. They didn’t IV it into the bloodstream of the consumer.

David: No.

Kevin: Then that’s what fiscal policy would do. If you send people money, that’s like an IV stream.

David: Yeah. This is a contrast here, because following the global financial crisis, you’re right. It was monetary policy response. It was incredibly robust. It happened on a concerted basis all over the world. And the policy choice boiled down to trickle-down economics, essentially, where if you expand net worth, then the wealth effect will show up in the economy. 

But the missing element. The missing element in the initial assumption was that it would work on a broad enough basis to actually move the needle economically. So lots of money in the financial markets boosted asset prices, but it did not become lots of money in the economy. A very small percentage of the world’s population, as a result of that monetary policy response, had their net worth double, triple, in some cases quadruple, and spending increased. But the 1% does not drive sufficient volumes in any tradable goods sector for it to matter. The 1% could increase their consumption patterns 1,000%, and it would not impact the global economy except as a rounding error.

Kevin: Okay. But it did turn into high financial end asset prices. In the financial markets, we saw ridiculous gains. And we saw stupid things.

David: And this is an important point because monetary policy, it’s benefited the balance sheets of corporations: crazy cheap financing costs, free access to capital for mergers and acquisitions, helps with the valuation factor. Again, having low rates allows for a boost in share prices. And certainly anybody who’s being compensated with shares loves that. But it also benefited this limited audience of investors. And last week we went through this. We looked at the Z1 report highlights, and we noted how household net worth was at record levels. That was for the US. But you had similar results because of this monetary policy expansion. Similar results on a global basis.

Kevin: Okay. But I want to go back to the IV. Let’s say I’m sitting in a room with all the anesthetic in the world. If it’s not getting into my bloodstream, it’s meaningless. And I had never been put asleep until I was over 50. And I was sitting there and they put the IV in and they were asking me simple questions like, “Oh, you work at 166 Turner Drive? That’s great.” And then all I remember Dave, after they turned up the anesthetic, I didn’t know they turned it up. All I remember next was waking up in the recovery room. And I’m like, “Wow, that’s a whole lot different than anything I’ve ever experienced before.”

David: That got in fast.

Kevin: But fiscal policy, you start sending people 100 bucks or 500 bucks or 1000 bucks. That’s almost like an IV. 

David: It gets into the mainstream.

Kevin: That’s got to affect inflation as well, because that gets spent.

David: Yeah. So the crux of my argument then comes. So post monetary policy gaming. And here’s the crux of the argument: then comes the fiscal policies It’s a different audience. Fiscal policies target the everyman. Fiscal policies are for the 99%. Is it a surprise that pressures on consumer goods are increasing? It’s money that does indeed circulate directly in the economy. You can argue, again, kind of going back to definitions of inflation, it’s just too much money chasing too few goods, a result of the monetary choices that were made by Draghi, Bernanke, Yellen, Kuroda in years past, and we’re just starting to see it show up. I don’t think so. 

But you could also argue that the input costs for finished goods are rising because of the manufacturing bottlenecks. And to a degree, that’s true. We talked about that earlier. And again, I hope as we reflected on this a few minutes ago, the bottlenecks that exist, a part of it is issues relating to not being able to get enough product, but it’s also public health policies, which impact labor markets at the margins, and are showing up the diminished laborers, reduced commodities being produced, less components available, fewer truck drivers able to deliver it. It goes on and on. Mandates have consequences. But again, back to the crux. The crux here is not the focus on supply limitations or even Covid, but rather demand excess.

Kevin: Okay. So stop munching all you want because we can’t make more. There’s too many people munching right now.

David: It’s just too much munching from people who were predictably getting a bag and now they’re getting two or three. Fact number one, private sector demand is returning to equilibrium, post Covid. People want to go back to normal. They’re spending it. They’re not freaked out like they were in January, February, March, April of 2000 .

Kevin: You can buy toilet paper.

David: Oil is trading above $80. Not at less than negative 20, negative 30. So we are going back to normal. Private sector demand is returning to equilibrium. What takes the demand dynamic into “excess aggregate demand” in that category is fact number two, fiscal policies, which increase household budgets and drive spending in excessive, previously available resources, all of a sudden are a new source of demand. Is this a transitory factor as well?

Kevin: Well, it’d be transitory if we had fiscal conservatism, when does that return?

David: Right. So answer that and you have a better idea of when inflationary pressures influenced by this particular input will ease. So all markets are symptomatically showing evidence of traffic in, traffic out. Prices drop when there’s not enough traffic in. So this is really a question of liquidity, the dollars flowing. Liquidity or lack thereof matters.

Kevin: And it matters also if you own a corporation. I saw an amazing chart. You saw this too this morning. This is a chart that shows the amount of money that’s been spent in the stock market by consumers, guys like you and me, and Wall Street firms. It’s really hardly changed in the last 10 or 12 years. But the amount of money spent by companies that have had excess liquidity and coming in and buying up all their shares—Dave, that’s been the movement in the market. So this last decade in the stock market, any gains virtually that we’ve seen, are mainly driven by the corporations buying up their own shares.

David: Pretty big footprint.

Kevin: It’s huge.

David: Well, financial markets are most obviously driven off liquidity flows. So if you have excess liquidity, that’s going to drive growth in the price of the asset. And it’ll drive it into bubble territory, where what is excessive in price ultimately comes unsustainable growth. Consumer markets are similarly influenced by liquidity. And that’s what I’m getting at here with excess aggregate demand. Consumer markets, you’re seeing liquidity. It’s the demand element from consumers, which defines the volumes of product which are on order. So you give a consumer living paycheck to paycheck, which defines the 99 %—maybe it’s 98%, to be fair. Give them an extra $100, they’re going to spend it. 

Kevin: They’re going to spend it. They don’t save it. 

David: That’s new demand, in excessive, previous private sector demand. And more impactful to the economy and consumer prices than other forms of government spending. Again, if somebody gives you $100 and says, “Hey, I want you to go have a nice night at the town.” Okay, great. That’s different than military spending on Humvees or missile systems. I can tell you, the building up of the wealth within the military industrial complex, that doesn’t circulate around either. So you can increase government spending. And from a GDP standpoint, you can smooth out a decline as the private sector disappears and the government spending steps in to fill the void. But we’re talking about a different kind of government spending. You’re talking about government subsidized demand through the private sector to existing private sector demand. Those two things added together and you begin to get excess aggregate demand.

Kevin: Well, unless we forget, most people have not had an increase in income over time. And so when they get extra money, these people are saying, “My income hasn’t gone up for years. Thank you for the 100 bucks,” or “Thank you for the 1,000.”

David: Well, and before moving past this point on excess aggregate demand, it’s not a surprise that the trade deficit is hitting a new record. Again, our imports, what we’re buying from other places, what we want, what the consumer is requiring now, click and get free shipping, which isn’t really free, or won’t be much longer. August tacked on another $73.3 billion. A new record for the trade deficit.

Kevin: Yeah. So aggregate demand is obviously, it’s like you said, it’s global just like inflation is global. That’s why we have the trade deficit that we do. But let’s go back to the person who’s saying, “I’m listening to this program. I have not experienced this great wealth effect.” So this fiscal stimulation is the first impact on many people’s lives. And they’re going to go spend that money. One of the questions during Covid is, how are you going to spend your stimulus money?

David: Yeah. Thomas Piketty—I’m not a fan, but he’s in the literature and he has to be read—pointed out that over the past 30 years, the bottom half of the global population has seen zero increase in income. Thirty years, zero increase. Now, has there been minor inflation along the way? Yes. Or major inflation. So it’s understandable to see where there’s some social pressure. The top 1% have seen incomes grow by 300% over the same timeframe. And I’m not trying to pick a fight here or create conflict.

Kevin: No, you’re trying to actually contrast the people who are getting the money right now are the ones who have not experienced this in the past.

David: But this is where politicians see an opportunity to exploit the extremes and ride a wave of populism for many years to come.

Kevin: I thought populism ended with Trump. Is populism here to stay?

David: The Chinese are seeking their version of it in the common prosperity. They will now take what was concentrated wealth in the hands of a few and make sure that everyone has a “better life.”

Kevin: Didn’t that happen in the ’60s with us, when Johnson started doing the guns and butter? The butter part, that was feeding into populism.

David: Yeah. So we’re talking about different eras and different ideas which ran the show, so to say, in those periods of time. For the Chinese, the newest, latest iteration, it’s like, “Yeah, we did what we needed to do. We experimented with a phase of economic growth,” which was capitalism with Chinese characteristics. And now we’re going back to communism—

Kevin: Redistribute.

David: Whether it’s developed countries or developing countries, we’ve got a lot of versions of this coming on stream, various versions or iterations of redistribution. And I would argue that the degree of actual distribution, like Johnson’s war on poverty back in the ’60s here in the US, the degree of actual redistribution will drive the degree of excess aggregate demand. It will drive the degree of excess aggregate demand and ultimately influence the timeframe for which inflation is a major US and global issue. Do you want this to be resolved tomorrow? Stop the redistribution process. You want it to continue or inadvertently accidentally continue for the next decade? Then change your policy course, give everybody an extra $100, $1,000. The move ultimately sponsored by modern monetary theorists is towards universal basic income, where people get something for nothing, spend it. Or they get something in addition to what they already had. And that’s where the real inflation happens.

Kevin: It’s so interesting when you listen to another generation talk. And I had my mom here this weekend and my mother-in-law, my wife’s mom. And they were talking about what would be smart with the stimulus money. And they just continued to repeat, “Wouldn’t it be smart for people to keep their job, go to work, make money, and take that stimulus money and save it for something for another day?” And it was just interesting to hear them continue to talk about that as we talked about, “Well, what restaurant can we go to? Well, no, this one’s closed because they can’t keep labor.” We’d looked at another one, and it’s like, “Well, we can’t really have the reception that we were going to have at this one restaurant that we always go to because they can’t keep labor.” So this variability that we’re talking about, and it does cause inflation, but what about the older generation looking at the younger generation saying, “Why don’t they save? They’re getting free checks, why don’t they save?”

David: Yeah. It’s a generation of savers versus— I mean, I’m not saying categorically that we have a generation of spenders, but you are talking in your case about gals who are from a generation of savers. And if you have excess money, then you put it away for a rainy day. And that is not the same pattern we’re seeing today. More people, if you tend to 99% with more money, that will be spent, will drive more demand for goods and services. 

Again, we have production limits. We’re witnessing now, again, some of this due to arbitrary policies, policy choices. And you can argue, okay, they’re necessary. Fine, they’re necessary, but you’re still dealing with production limits and bottlenecks. And if you’re going to increase the demand side of the equation and you can’t multiply the supply side, you’re going to have an issue. Prices are going higher. 

The post pandemic politicians in the EU, in the US, in China, do you think they’re going to return to what we’ve had for 40 years? It’s been a great 40 years for the Chinese. It’s been a great 40 years for the European Union. Think about where we were 40 years ago. The iron curtain existed. You’re talking about a fractured geography, where there were no healthy cross-border relationships. Trade, currency, all of these things were non-cooperative. So the EU has been transformed over the last 40 years in favor of capital formation, with the result being private wealth accumulation.

Kevin: Well, when you say capital formation, which you’re actually talking about is free market economics.

David: Are we going to go back to that? Is that what the Chinese are signaling? Is that what we’re seeing in US policy circles or in EU policy circles? Or are we returning to a global era of labor prioritization, of wage growth, of redistribution of income to the 99%? If our social values have shifted, we had better prepare for rising costs and an enduring inflation trend. And I think that’s economics 101.

Kevin: When Margaret Thatcher said, “Socialism works until you run out of other people’s money”, that’s what you’re talking about. A lot of these policies, whether it’s Covid policies— I’ll bring one up, Dave, and this’ll probably cause people to get red in the ears, but the environment. When things are working economically, you can say, “Well, we can all pay a little bit more to clean things up.”

David: Yeah. So think about the unintended consequences of increasing consumer demand. If you give the 99% more money—and I’m not arguing against it. I’m just saying, let’s look at logical consequences here. If you give the 99% more money, increase and move to a state of excess aggregate demand, this is more products that have to be produced. This is really interesting because this is a policy sacred cow. Driving consumption patterns higher by increasing household share of global income, it suggests that commodity prices and finished goods are moving higher in price, moving into an era of increased demand and thus higher costs and higher prices, if that makes sense. 

There are production limits with every commodity. So if demand dynamics are likely to be influenced by fiscal policy choices, feeding the cash drawers and the piggy banks of the 99% versus the last cycle— Again, the last cycle, this was monetary policy benefits for the 1%. Lowering rates, lowering rates. We’ve been lowering rates since 1980. It’s been beautiful for corporations. It’s been beautiful for entrepreneurs. It’s been beautiful for speculators. And the accumulation of wealth is second to none at any other time in world history. The last cycle was about monetary policy benefits for the 1% and their marketable assets. Are we supposed to believe that the next cycle with a priority on the 99% is going to leave inflation as transitory?

Kevin: No, we’ve got all those elements. We’ve got the baker. We’ve got the guy who munches the Doritos. We’ve got the money. We’ve got the policy changes and the things that you’re talking about. So this is not merely a Covid issue.

David: No, you’re right about that. And so the earlier discussion on that, again, it’s not to anger or frustrate people, but so you can see that we’ve had a catalyst. We’ve had a catalyst, where Covid transitions us from one era of abuse—that of monetary policy accommodation in extremis—now to a new era of fiscal policy abuse. And I fear it will be in extremis as well.

Kevin: So populism can come in many forms. We talked about Johnson, what have you. Populism can be socialism, can go towards socialism, or it can go toward Trump administration, like we saw back for the last four years.

David: Right. You can have populism on the right, populism on the left. It comes in many forms. And what the media and politicians feared from Trump’s version of populism, again, largely because it was not their ferocious energy to control. They don’t mind ferocious energy as long as they’ve got a leash on it. They’re comfortable believing that they can harness, even refashion, rebrand, and properly exploit this next populism. And it’s populism of the left, what we had under Johnson, what we saw in the War On Poverty. And it seems to be an opportunity the current administration is interested in jumping on.

Kevin: Okay. But the market, which sometimes seems nonexistent when a government can print money and buy its own bonds, that market force always comes back. And it’s the player that’s the invisible player, but it does set things right in the long run. Leftist populism only can be funded really by the market. And then once you run out of other people’s money, you have to start over.

David: I know that monetary accommodation goes back farther than just 40 years. But really we’ve seen some incredible experiments with credit in the last 30 to 40. And it clearly has favored the asset owner. So that’s where we see monetary policy as benefiting, from a market perspective, one particular group within society. Have we so quickly forgotten the lessons of the last half century? Because we already have experimented with redistribution processes and policies. The market economy, you can look at what we’ve had for the last 40 years, and it’s not fair and it’s not perfect and it’s not equal, but it does harness an energy and the motivation, which brings a much improved life—has brought a much improved life to billions. Even if you look at what has developed over the last 30 to 40 years, post Deng Xiaoping, in China. China is a place where there is opportunity and dynamism that frankly did not exist prior to 1970s.

Kevin: And is it going to stay now?

David: Care and consideration of the common man. I have no problem with that. But as so many forms of socialism and redistribution have already been tested and proven to be a failure, alongside communism, have we so quickly forgotten the lessons of the past half century? There will be a price to pay, and everyone will pay it. And that is the nature of inflation.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. And I’m Kevin Orrick along with David McAlvany. You can find us at McAlvany.com. That’s M-C-A-L-V-A-N-Y.com. And you can call us at (800) 525-9556.

This has been the McAlvany Weekly Commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new addition of the McAlvany Weekly Commentary.

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