Inflation is already rearing its head
Houses are expensive, and they’re not getting cheaper. In fact, real estate prices are still skyrocketing, even despite the terrible economy of 2020. This isn’t really shocking news, but have you stopped to think about exactly how much more houses cost relative to other commodity goods in our society? For example, let’s take an average house in an average suburb in a major US city. We might expect it to cost around $500,000. Now let’s take the price of a 50 pound bag of rice, which is around $20. How many bags of rice does our current economy deem a house to be worth? According to these numbers, that answer is 25,000 fifty pound bags of rice. That’s 1.25 million pounds of rice.
It’s somewhat shocking when looked at this way, isn’t it? We deem food and shelter to both be essential necessities of life, yet one is so much vastly more expensive compared to the other. There is an idea in economics called the relative prices of commodities, or how much things cost in relation to each other. For example, one ounce of gold costs around $2000 dollars today. A very well tailored suit costs around the same price. Rewind back 200 years to the 1800s, you’d have found that the tailored suit would still have cost around 1 ounce of gold, even though the actual price tag may have only been $50 at 1800s currency levels. That’s because the relative price of commodities tends to stay constant over time and through inflation.
However, modern trends have changed the relationship between certain commodities. Mass production has hugely increased our supply of food and consumer goods. As a result, the prices of mass producible items have fallen sharply compared to the items that cannot be mass produced, such as gold, land, art, or human labor. This is the reason why while prices of consumer goods have fallen steadily over the years, the prices of land or hand crafted items have still increased. Labor is now worth more compared to the cheaper mass produced consumer goods. As a result, we now cannot afford to have anything hand made anymore, and we don’t bother to repair broken possessions either, choosing instead the cheaper option of trashing it and replacing it anew. Almost everything which we own now, if we aren’t hugely rich, is a product of mass production. The masses are becoming priced out of almost anything else.
But still, this might be ok, right? Mass produced goods are in fact good for quality of life. We’re better fed now, and more entertained now than we have been at any other point in all history. The increase of quality of life under our modern economic system is a good point, but there are various counterpoints to consider as well.
One is that the nature of our economy makes it susceptible to periodic crises, which we’ve all painfully experienced during market crashes. For example, the 2008 financial crisis was the result of a liquidity crisis. What really happened during the 2008 crisis? Some banks made bad loans in the housing market, which ended up defaulting. The increasing number of defaults put the banks in a bad position. That was because banks loan out more money than they actually have. The cap is a ratio called the Reserve Requirement, which was at 10% before March 2020. This meant that the banks can lend out 10 times as much money as they hold in their reserve accounts. It is currently at 0%.
So the banks were lending out more money than they actually had, and when they were unable to recoup the investments from their loans, they came up short handed and began to fail. As these banks failed, other banks which had invested in the failing banks began to fail, as everyone began to realize the loans were all a house of cards that didn’t actually have real value. As a result, trust in lending crashed, and money stopped flowing around the economy, resulting in the halt of economic activity. That was the liquidity crisis.
So what did the US government do to solve this liquidity crisis? They implemented a program called Quantitative Easing (QE). QE is not quite the same as the government printing money, but it is a very similar concept. The difference is that the government made money, instead of paying off government debts, goes directly into the economy as an attempt to increase the money supply and therefore encouraging lenders to lend, stimulating economic activity back into action. Where in the economy does that money go? To the banks, of course. The Federal Reserve purchases securities and other financial instruments from banks, and credits them with money they created with the stroke of a key.
So, the Federal Reserve increases the money supply, makes it available to banks, who lend the money out into the economy. Thus, QE does not tend to cause massive amount of inflation on consumer goods and services because the money actually encourages economy activity in that sector, stimulating output with the ultimate purpose of lowering the cost of these items.
However, the increased money supply is not without its drawbacks. Firstly, a condition that the increased money supply would not cause massive inflation on consumer goods and services would be that the supply of goods and services increases at a rate proportional to the additional money, therefore keeping prices stable. This is one reason that economic growth is so worshipped by politicians. If the economy failed to keep growing, the system would experience a nasty shock of inflation given the extra money injected into it without a corresponding increase in economic goods.
Secondly, the increased money supply is actually making the rich richer and the poor poorer. By giving banks almost the entire portion of the increased money supply, which they then lend, we are ending up with an economy which is owned more and more by banks and top investors. Sure, the successful companies which are spawned by the loans do profit as well, but the banks and financial institutions still own a major portion of that output increase, all derived from Federal Reserve QE money.
This brings us back to the initial point in the beginning: we are starting to see the inflation of goods which cannot be mass produced relative to goods which can be mass produced. Sure the Federal Reserve can keep printing more money. Sure, manufacturers can keep producing more goods, and service providers, to a certain extent, can provide more services. Yet scare commodities such as land doesn’t come out of nowhere. Gold doesn’t come out of nowhere either.
Why has the stock market continued to rise in 2020 at the same time that economic output has fallen? It’s mostly because the Federal Reserve has been implementing QE to new levels during this time. With the extra QE money, banks and financial institutions have been injecting money into the stock market, driving prices of stocks up, even as the production of many companies experiencing exploding stocks fell, or did not nearly rise as much as their stock did. It is the first sign of inflation in certain areas of our economy.
Our economy has entered a dangerously absurd phase in which the problems of wealth inequalities are being addressed mostly by increasing production of goods and services. While this may work in pacifying the masses to a certain extent, this strategy will come to a reckoning. We cannot have a true abundance of everything, and once the items that are truly scarce inflate out of reach to most except the elite, a huge amount of discontentment will follow. If the inequality reaches such a boiling point, not even modern monetary theory will be able to come up with an adequate response.
