Inflation for DummiesJan 31, 2022
Greetings and salutations to you as we’re now about a month into our new year of 2022! So far, it seems a lot like 2020 and 2021, with new pandemic threats, durable hopes for a return to normalcy - or at least a stable new normal, and business disruptions and supply chain challenges…and yet the world goes round and in many ways things seem good. As always our thoughts and time are mostly consumed with the navigation of life, but we may take a few minutes here and there to check in with the markets and to scan the news. Big in the news lately is that scary little term no one likes to talk about, but which has been making too many headlines - Inflation.
In this month’s blog, I’ll be taking a high-level flyover on the topics of money and prices and supply and demand, and finally zeroing in on inflation - what is it?, where does it come from and how does it behave?, and what actions can we take at the micro and macro levels to confront this dragon who consumes?
First, some news - we have a new intern at Team LoCo, helping us level up and have more consistency in our social media game. She’s from Venezuela, and frankly she stalked me on LinkedIn because she was interested in our model of business, and wondered if we needed any remote work done. Alma’s cup was overflowing and social media is not a great love for either of us, and so here we are with a new teammate, at least for a season and I hope for longer.
Gabriela is a 3rd-year engineering student, remote education at present - she’s actually staying with family in Brazil - and not optimistic about finding an engineering job in Venezuela when she has graduated. Where there is no construction, there is no great demand for engineers. So, finding connections and possible pathways outside of her home country has become her second major. Equipped with Alma’s bilinguality and her penchant for process, and my willingness to try new things and follow my gut, I think there’s a nice opportunity for a win-win-win, with no great bias as to what that might turn out to be.
I’ve a soft spot in my heart for Venezuelans, and it’s in part because of an interesting chapter in life we shared with a young lady named Carolina Sacco - Caro she preferred because she thought Americans wouldn’t be comfortable with a strange name like Carolina. Which made me smile because we have two states that share the name, and I’ve yet to meet another Caro. So anyway, I met Caro in 2016 at the dog park off Lake Street in midtown, when my (20 lb) dog Tucker defended her (60 lb) dog Key (pronounced Kay) from an aggressive dog (90 lb.? German Shepherd of unknown name). She was in Fort Collins for cancer treatment for her dog, which was one of two that she kept - and which were her key helpers in her dog training business. Caro had a very successful dog training business in Caracas, Venezuela, and had a new branch in Mexico City, and was working on the logistics of another branch in Panama.
Saying that Mexico City and Panama were branches is perhaps overstatement - at that time it was more like they had become financial refugee areas where her key employees had escaped to from Venezuela and they had a brand and training system to work with. The economy in Venezuela was melting down, battling hyperinflation and corruption and also battling economic warfare from the US to punish those naughty socialists. Caro is the daughter of an oil industry economist, and to my surprise her principles were very libertarian and natural rights oriented - much like my own. Though she was an upper-middle class business owner in Venezuela, her B’s (the local term for Bolivars - the national currency) were quickly becoming worthless when it came to paying dollar-denominated vet bills from CSU. Though the official exchange rate was still ~10 B’s to the US Dollar, no transactions ever occurred at that rate - when Caro and I met the (black market) exchange rate was about 1,000 B’s to the Dollar, and within 9 months that spread had gone to 10,000 B’s to the Dollar!
We became friends, she visited my Rotary club and joined my wife and I for church and dinner occasionally - and she gave us some lessons with our dog Tucker - you knew that dog training is just as much human training, yes?. As the savings that Caro had were becoming increasingly futile to address her US dollar denominated vet bills, I decided to apply for a grant from my employer at the time - Thrivent Financial - and we turned our annual backyard dinner party into a fundraiser for Key’s cancer treatment. We raised some funds - and Thrivent paid for the party costs - and it was a beneficial event overall.
Thanks to CSU, Key survived his brush with cancer and remains strong, and Caro has successfully rebuilt her business into a truly international brand, with operations in 5 countries and headquartered in Denver, CO where she remains. You can check out Canine University’s website if you’re curious or if you and your dog need training - she’s a maestro at it! One of her specialties is training your dog to participate in your wedding as a ring-bearer or bride accompaniment - how Colorado is that?! It’s been amazing to see how quickly Caro has rebuilt her life and her business - great challenges often bring resilience and strength - but that’s a lesson for another day.
The lesson for today is inflation, and in the example just delivered - hyperinflation. To get there though, we have to have a quick primer on money. Money is what we say it is, historically and especially today with fiat currencies predominant in exchange. Money can really be any rare thing - you’ve heard no doubt of shells being used by native tribes - and then commonly it was rare metals for many generations. Silver and gold especially, with the less-rare copper relegated to the pennies. Money is a medium of exchange, and a store of wealth - and the value is based on a marketplace just like anything - it’s supply and demand! If we had a comet vaporize in our atmosphere, and it rained quarter-sized gold nuggets down on the world for two days - you can bet the price of gold would decline!
The US dollar is our medium of exchange, and it’s got some extraordinary features that serve as demand enhancements - making our dollar worth more than it otherwise might be. First, it’s still the world’s reserve currency - meaning that central banks around the world hold dollars as a more-stable store of wealth than their own currency - and for differentiation and to defend their currency. Another is that oil is transacted in US dollars - so if you’ve got yen and want to buy some oil from Saudi Arabia, you gotta trade your yen for some dollars and then pay the Saudi’s for your oil - another demand enhancement. Another - and perhaps most important reason why demand for the dollar is boosted - ‘Merica. We are the wealthiest, most innovative and diverse economy in the world, and we remain a nation of laws and individual rights. People all around the world want vacations and property and lives here in America, because it’s safer and better and offers more opportunity than other options - and to find their way here they need to get dollars.
When you’re Venezuela though, and Hugo Chavez’ legacy has committed education and health care benefits and transfer payments to the poor, and to pay for it you’ve taxed your formerly-healthy oil and agricultural sectors nearly to death, and then the global market for oil drops from the low $100’s / barrel down below $40 / barrel due to the fracking boom in the US - and your government is corrupt and heavily in debt and is running huge deficits…nobody wants your Bolivars! And so you print more of them to pay your existing bills and the budget shortfall, and then print more to pay your bills and the shortfall, and then repeat - by 2018 it was the equivalent of $1,000,000 Bolivars to the Dollar - my example from earlier was just the beginning of the meltdown. I’m told that nowaday one can vacation and/or live very well in Venezuela on about $9 / day - provided you don’t get kidnapped and held for ransom by desperate citizens because they’ve noticed you’ve been spending US dollars.
So, that’s hyperinflation - it often comes from governments overextending themselves (and their currencies) to the point where the future value of the currency is in serious question. Inflation is basically the same thing, only a little at a time. In our current situation, through the combination of pandemic stimulus, credit programs for business, and unemployment benefits - we’ve grown the supply of money in the economy - thus increasing demand for the goods and services of the world. At the same time, due to pandemic shutdowns, the great resignation, and the dreaded “supply chain challenges” - the available supply of goods and services is constrained. Increased demand + reduced supply = increased prices - Economics 101.
There’s a pair of factors in this really - the simple supply and demand as discussed in the prior paragraph, and also the notion that cutting the pie into smaller pieces doesn’t increase the amount of pie available. When new money is created, it devalues the existing money - just like the asteroid raining down gold nuggets from earlier in this discussion. You’ve probably heard that headline or meme - 40% of all US dollars in existence were printed in 2020 - but it’s actually worse than that according to this article in Tech Startups, approaching 80% of all money in the last 2 years! So of course the value of dollars is going to go down - it’s been raining money from the sky!
When we try to have a discussion about how inflation behaves, it’s really a discussion about how people behave. When prices are going up, it encourages people to spend their money right away - because next month this thing I want will likely cost me more! In doing so, it discourages savings, which is what allows us on a micro level to purchase homes and automobiles and build wealth.
As we start to creep toward the macro level, inflation gets a lot more complicated. Because prices for inputs and labor are going up, the business owner must raise prices to maintain a profit margin - which they fear due to the possible negative effect on demand from customers who are already paying more for their other wants and needs. But raise prices they must if they wish to sustain the enterprise, which contributes to increased prices in the greater economy. Ultimately despite these measures profit margins tend to decline, which leads to declining taxable incomes, which leads to declining government tax receipts, which leads to greater deficits which must be funded by the printing of new money, which leads to the devaluation of the existing dollars, which creates more inflation. The reason we pay so much attention to inflation generally is because it’s known to be an economic strangulation device.
But for those who already have lots of assets - it’s not as painful. Your $500,000 home becomes worth $1,000,000 in just a few short years, and your stocks are up - at least for a while. And if you owe a bunch of debt, like most Americans and especially our government, it’s kinda nice because you can remember the days when $29 Trillion seemed like a lot of money! But, for the debt issuers it sucks, as well as for the savers, because they can’t do nearly as much with those repaid dollars and interest earnings as they could have before they sacrificed to save.
One of the reasons other countries want US Dollars, is that historically it has been a stable currency. The Federal Reserve has what is called a dual mandate - but which is actually a triple mandate, of maximum employment, stable prices, and moderate long-term interest rates. I would argue that the extended accommodative monetary policy of the post-2008 crash is largely to blame here - we’ve been goosing the economy with artificially low interest rates for a decade, trying to foster business growth, but also burdening the economy with an ever-increasing debt load and regulatory tangle.
At the same time, the US and the world have been subsidizing renewable energy (that isn’t ready for primetime) to such a level that Texas nearly lost it’s power grid last year because of an aggressive winter storm and stupid policy decisions. Texas!! - where they have over 150,000 oil and gas wells! Despite what you might read, wind and solar cost a lot more to produce power than coal and natural gas and nuclear, and so to transition to a lower-carbon economy it is likely to cost a lot more for your energy and heat. As more and more copper wires and silicon panels and fancy-pants windmill blade metals are needed to transition to this quiet-streeted and bird-bereft new world - it’s likely to make those renewable energy sources and electric cars even more expensive! Greenflation, it has been called, and it’s real - read more about it in the Financial Times if you’re interested, or Bloomberg. Energy is basically money, and if we raise the price of energy, it serves to keep all the poor people poor - they’re already energy-starved.
The challenge is - business goes where the economics make sense. China is wealthy now because the US largely outsourced its manufacturing to China over the past 50 years, due to their lower wages and less-stringent environmental standards. Now, the place is a mess environmentally, but their people are much better off financially. So, as the western world pushes on the gas pedal with low interest rates, and applies the brakes with decarbonization efforts and crippling deficits - what could go wrong?!
A lot could go wrong, and if the US were to lose reserve currency status the impact on our currency and living standards would be near-catastrophic for American living standards. What’s likely needed is a rapid increase in interest rates and a slow decrease in the money supply, and the pain of a recession to combat the dragon of inflation and put it back in its’ cage. Just stop, in other words, take your foot off the gas pedal and off the brake, and coast to a nice stable equilibrium, where we can maintain price growth in the 1 - 3% range, and work off our debt for a while.
It’s hard, on both a micro and a macro level, to live within your means, and harder still to pay off the debts from your extravagant days during leaner times ahead - but we must. No more stimulus checks, no more infrastructure spending bills, no more money printing no more credit card spending - and no more voting for those who promise more than they can budget for. Dummy is as dummy does, and I don’t think you’re a dummy at all.