Inflation and trusting your own eyes
I started writing this article after Fathers day in Australia in 2022. I had a very interesting discussion with my grandfather on the weekend about his experiences travelling to Australia as a migrant just after world war two. He told me how he had worked very hard on the railways and that had allowed him to purchase the house that he currently lives in for $25000. In the intervening decades the cost of that same house has gone to over a million dollars. This is increase of over 40 times. Housing has increased in nominal terms, but so has everything else albeit not quite so extreme in other areas. We can tell that the purchasing power of each dollar has dropped enormously if we just look back into the past and remember what things used to cost.
But the harder thing to bring to the forefront is what the cost of time was. The cost of time is the most important thing for just about everyone, how long you had to work to get something you want is far more important than how many dollars something cost for everyone who is working.
I was talking to my father a while back about life and how things used to be in the past. One particularly interesting story he told me was how he got through university. Back then he was living in a share house and was driving taxis to make some money.
In 24 hours of work he got $140 of takings, $70 of those went to the taxi company and $70 he kept as take home wages. This was more than enough to pay rent and essentials. A few shifts per week was enough to get by without having to take on any external debt.
I find it remarkable how previously you could get by on $3 per hour in Australia. A part time job paying $3 an hour was enough to live on, not a life of luxury but you could survive. You could pay your rent and buy food and even have some money left over to go see live music. Unfortunately generational warfare has been promoted as a way to distract the populace from bigger problems so it has because become a bit of a trend to say shit about people from the Baby Boomer generation lately. But one thing I almost never find mentioned is that it was a generation that got its wealth working in jobs that paid amounts like $3 an hour, $5 an hour, etc. These wages allowed people to buy houses and amass real wealth. These days minimum wages are many multiples of the wages that allowed people from previous generations to build up considerable wealth but yet $15AUD/hour would be close to unliveable in modern Australia in many places due to huge increases in the costs of shelter and more recently increases in costs of food.
And jobs were easy to get back then too. Very easy. And not just "bullshit" jobs, you could get a job that actually paid a reasonable amount without that much effort if you were willing to work hard. Now there are lots of people doing extremely hard work full time and not even getting by. I don't begrudge the people of this previous generation for living in a time where hard work was actually rewarded, we really need to reward hard work again to get us out of the economic malaise we are in.
Today you have to put up with Kafkaesque interviewing processes and unreasonable demands to get many jobs. Those jobs pay far more in nominal terms but what you can actually purchase with each hour you work has dropped enormously for many of life's essentials and shows no sign of stabilizing any time soon. Nowhere is this more obvious than the rapid drop in affordability of housing. This drop in earning power is getting worse in the last few years since the monetary policy misadventure that created it has not only continued but has worsened. Structurally there's a lot of reasons why the hiring market has become so broken, but overall regardless of the reasons people are getting fed up by it all.
As of July 1st 20221 the minimum wage in Australia is $21.38 per hour or $812.60 per week. Working 24 hours at that rate ends up being 24*21.38= $513.12 or just over 7 times more in nominal terms than the taxi driving job from a few decades ago. Can you afford rent on that amount of money?
A quick look at postings on real estate sites shows in a place like docklands for a 1 bedroom apartment it's often going to be at least $400 a week. Many one bedroom places that actually have some sort build quality that are somewhat close to the city are already more expensive than 100% of earnings for that hypothetical part time worker. You have to start looking a lot further out from the city to get cheaper accommodation, but then you end up paying with your time and fuel costs if you go that route. Fuel is getting exceedingly expensive now as well, so a large amount of driving will have a large impact on the household budget too. A cost of living crisis is indeed at the door.
When people take a data-first approach to looking at inflation they end up with entirely different conclusions to people who look at this from a narrative first perspective. More than once I've run into people that thought the baby boomers earned more in nominal terms and hence built their wealth that way. The real answer for their wealth is that they simply were paid more in real terms than people today for similar work. But computing purchasing power in real terms is both a hard task and an abstract task, it's not an easy process to engage in. This I think is the cornerstone of why inflation is so pernicious, it is hard to understand and hence hard to rally political support to resolve.
Much research in psychology has shown that the human mind is very much susceptible to narratives. To think of things in mathematical terms takes deliberate training and deliberate effort, the reward for doing so is a much more accurate and valid mental model of phenomena that are driven by the numbers. Even when people have mathematical understanding without psychologically training themselves to trust this as their primary source of truth it is possible for narratives to override more accurate modes of thinking. This becomes a major problem when dealing with economic phenomena that are purely numbers based but have a multitude of correct sounding but ultimately wrong explanations for. The numbers are the truth when it comes to things like inflation and if the narratives don't match the numbers the narratives are just lies.
“At the outset, the masses misinterpreted it as nothing more than a scandalous rise in prices. Only later, under the name of inflation, the process was correctly comprehended as the downfall of money.” Konrad Heiden in 1944 commenting on the German hyperinflation of the 1920s
Why I'm not invited to parties
Back in 2019 I started to have the first of a series of revelations that completely changed my understanding of how economics and politics really worked. I think many of my misunderstanding stemmed from having an insufficient understanding of the differences between money and currency. Like many people I'd only ever been fed the lie that money and currency were the same thing.
I'd come to realize that many of the things I assumed were true were actually completely false. By revisiting the assumptions I had about how things worked I'd keep seeing these frictions where my old misunderstandings would conflict with something I'd encountered and I'd have to process the cognitive dissonance before moving on. I thought people would find these topics interesting to talk about, a misjudgment I now clearly recognize.
Inflation was one of those topics where I had a flawed understanding. Both of its mechanisms and of how interested people would be in it before they were personally impacted by it.
Milton Friedman really covered a crucial aspect of the inflation issue well:
Inflation is always and everywhere a monetary phenomenon in the sense it is and can be produced only by a more rapid increase in the quantity of money than in output
The mechanism behind inflation is actually extremely simple, the politics of it however are not. This is why you get insane quotes like when President Biden said “Milton Friedman is no longer in charge.”. Absurd on a number of levels considering that Friedman was never in charge.
Politicians have a hard time with economics and engineering topics because the way the world works is not always determined by people and the application of power. For example 2+2 equals 4 not because of anything anyone said or even the actions of any human, but just because that is how the world works. The capricious arrogance of politicians doesn't change the fact that the laws of mathematics are always the law of the land because they are the laws of the universe. Even if no humans existed mathematical truth would persist. This is a hard truth to handle for those who power is entirely determined by getting people to work for them, especially people who are successful at this, as these natural processes remain entirely outside their control.
This might be a hard pill for narcissists to swallow but ultimately the universe is what it is and we as individuals really mean nothing in the grand scale of things. Milton Friedman was just observing how things worked, the concept of monetary inflation was most certainly not something he created, many other people have independently discovered this exact same concept in many parts of the world and at different times in history and in different cultures with different financial systems.
How currency is created will impact the economy in certain ways that are rather dependable. Politicians and other people in power can have significant influence over how currency is created but they have no power over the laws of economics. History is full of examples of the hubris of politicians thinking they are above various natural principles causing utter ruin.
Who creates currency? When individuals try to create currency we call this counterfeiting and we send them to jail. The reason we send people to jail for counterfeiting is that if every individual could create currency whenever they wanted we would have the most extreme hyperinflation imaginable, people simply would not be able trust that money was worth anything if anyone could create it. The government has to prevent widespread counterfeiting because the tax dollars that fund the government would become worthless if anyone could counterfeit them to fund their tax payments in the fiat currency that the government controls. But any stable system of currency needs to have some controls on this process because if it gets out of control confidence in the currency will always be lost. For example in the cryptocurrency world we see systems like Bitcoin that expend large amounts of energy to ensure that the currency cannot be counterfeited, this is essential to the currency having scarcity and hence having confidence. People see the energy expenditure of the Bitcoin network as being wasteful but in reality that's just the cost that has to be paid to prevent counterfeiting, governments expend considerable energy too when preventing currency counterfeiting but that energy expenditure is just less visible even though it very much still exists.
However despite all this energy expended on making sure that currency is not created just by anyone we have had an era where the total amount of money in circulation has increased enormously. So who's creating all this money?
"The paper system being founded on public confidence and having of itself no intrinsic value, is liable to great and sudden fluctuations, thereby rendering property insecure and the wages of labor unsteady and uncertain.
The corporations which create the paper money cannot be relied upon to keep the circulating medium uniform in amount. In times of prosperity, when confidence is high, they are tempted by the prospect of gain or by the influence of those who hope to profit by it to extend their issues of paper beyond the bounds of discretion and the reasonable demands of business.
And when these issues have been pushed on from day to day until the public confidence is at length shaken, then a reaction takes place, and they immediately withdraw the credits they have given; suddenly curtail their issues; and produce an unexpected and ruinous contraction of the circulating medium which is felt by the whole community. The banks, by this means, save themselves, and the mischievous consequences of their imprudence or cupidity are visited upon the public.
-- Andrew Jackson, Farewell Address, March 4, 1837
As you can see people have been aware of the issues around the creation of currency for a long time. I've been aware of these issues for a comparatively shorter time and I wrote an article about where currency is created in the banking sector. When a currency is not backed by something tangible the only thing that allows it to function is large enough number of people having confidence that they can offload the currency for things of use to them when the need arises such that commerce in that currency will continue to occur.
The main issue with getting the truth about inflation to be broadly understood, aside from widespread innumeracy creating a situation where people lack the conceptual tools to actually understand it, is that having the ability to create currency is extremely powerful. If you really dig deep into the incentives you realize that people who control the money printing don't want to give it up. They have extremely strong incentives to lie about how inflation really works because maintaining misconceptions about how it works is very profitable for the small elite who has the power to create currency. For everyone else inflation is terrible since it is the erosion of their purchasing power that creates the transfer of wealth in real terms to the elites. Maintaining such an unjust system can only occur in a free democracy via ignorance of the masses. Henry Ford alluded to this a long time ago:
“It is well enough that people of the nation do not understand our banking and money system, for if they did, I believe there would be a revolution before tomorrow morning”
On a psychological level this bothered me at least initially because cognitive dissonance is painful to deal with. After a while I'd learn something new about economics and process it fully, then I'd start to notice that most people didn't understand whatever the new thing I'd been researching was. This would create some frictions when talking to people who thought they knew things about economics but didn't. In the most extreme cases people hold beliefs that are easily seen to be false if only they would use the most basic skills of observation. It is hard to come to terms with a situation where so many people have decided to not trust what is directly in front of their eyes in favor of far fetched narratives, even more so when these beliefs are to their direct detriment. Many people had become accustomed to propaganda and have trained themselves to not look at the data. This includes people who have worked in scientific and technical fields, who for all intents and purposes would have had all of the mental machinery needed to figure things out for themselves if only they would trust their own eyes and take a look at what they were seeing. Many of these insights were straightforward to anyone capable of looking at the data and applying some first principles reasoning.
Where I first started to really see this extreme disconnect from reality was in the early discussions I had with people about the repo crisis. In 2019 I had a friend who was talking to me about the ASX200 being completely overheated and that putting a short position on it would be a good thing to do. He was entirely correct that it was overheated, you got this sense very clearly if you spent any time around business circles, things were running hot and people had this intuitive sense that there just wasn't enough real economic activity to justify the high price to earnings ratios on a lot of things.
I remember initially falling for the lie that Quantitative Easing would be deflationary. The lie went something along the lines of saying that QE created these accounting entries called bank reserves but that those entries weren't exactly money and were therefore "trapped" in the banking system in a way that couldn't be spent into the general economy. Lies about how all the new currency being created wouldn't cause inflation were repeated frequently at one point, looking back at the media messaging at the time is almost comical:
Headlines like this are just stone cold lies. The more time goes on the more I think that many people were publishing in bad faith. Or perhaps an even scarier idea is that they are entirely clueless. After doing some actual research and looking through the numbers it becomes entirely obvious that the creation of large amounts of new money via accounting entries will be inflationary, there's just no way it could be otherwise with the way these things were done. The main reason that people claimed it wouldn't be is that they said these new assets would get "stuck" in the financial system. But what happens if a bank or other entry uses these assets to buy treasuries? If they do so they are directly funding the government to spend more. These newly created assets then turn into currency with a very high velocity going into the broader system.
One of the aspects of hyperinflation is best explained by thinking about what happens when existing debt is routinely bought with newly printed money vs what happens if it has to be paid off. In a debt based fiat money system debt is mostly equivalent with currency. In such a system when debts are repaid that "money" actually disappears from the system. This is one of the reasons why high debt loads, are all other things being equal, deflationary in such systems. All the currency that goes towards debt servicing effectively is taken out of circulation.
But if debt starts to be paid off with freshly printed money, then all bets are off. Effectively old debt can be bought at any cost in a fiat currency system that allows such debt monetization. This means the monetary value of that debt decreases as the currency it is priced in gets debased. But the more important thing is that in fiat systems debt is money, so paying off debts by printing new currency is extremely inflationary. This is because in a debt based monetary system when debts are repaid the "money" actually disappears in such a system.
By mid 2020 I had come to the conclusion that hyperinflation was inevitable in much of the world. Debt monetization had started to spread and people didn't seem to even know why it was a problem let alone be organizing to fight against it. I didn't know how it would play out exactly but one thing was clear, the money printing presses would start to run hot to monetize debt whenever political pressure was applied to do so. For inflation to stop being a problem countries would have to stop creating new currency and this just didn't seem to be something that there was political will to tackle. If history is anything to go by then the will to deal with the problem will get overwhelmingly strong, but only after significant pain is felt first.
A psychological experiment from the 1950s
Over the years there's been a number of important psychological experiments that everyone really should know about. For example the Milgram experiment on following the orders of authority is a good one. The results of many of these experiments is disconcerting to say the least, which is likely part of why they aren't talked about all that often by people. The Milgram experiments showed that a majority of people would follow orders to kill someone if the situation was presented in a particular type of environment. The disconcerting thing here is just how many people act against their own better judgement in these situations, they know they are doing the wrong thing but they do it anyway.
Back in the 1950s an extremely important series of psychological experiments were conducted by Solomon Asch. These experiments were set up to test how much people were influenced by what other people had said prior to them when given a question.
The way the test was set up was to give a series of simple perceptual questions to a group that were related to vision, the other group members were actors who were there for the purposes of running the experiment. The actors would give their answers to a question first and the subject of the experiment would answer after seeing members of the group give their answers. Here's an example question with a graphic:
Asch found that people were willing to ignore reality and give an incorrect answer in order to conform to whatever answer the group was going with. These experiments showed that social pressures are strong enough to sway people from trusting their own eyes in very simple situations with concrete correct answers staring them in the face. When the group of actors unanimously declared an incorrect line was a match many people would fall in line with the actors, despite this obviously being incorrect.
Since 2008 in almost all of the world we have been living in what would have been called an economic depression in any other era. So why don't people call it that? I think part of it is that the mainstream media along with the politicians constantly boast about how good the economy is, and perhaps for them it is. But for the average person it's not so obvious there's been much progress lately. But getting past this constant bombardment of misleading messaging is hard, usually some sort of event has to happen to make people even question that narrative at all. For example seeing local businesses close down due to hardships is something that makes people question those "best economy ever" narratives.
Many commentators who have directly studied the data have said that this last 10 years have been a silent depression. Technological progress is probably the only thing that's held off a large drop in the quality of living. But we see concrete signs of the ill effects of the last 10 years, the highest numbers of people moving back in with family, more adults living in shared non-family accommodation, massive inflation in the skills and qualifications needed for the same jobs, increased precariat work conditions, etc. And now we are starting to see monetary policy issues which are resulting in massive currency debasement and inflation.
Despite the economic mediocrity of the last decade we have been fed an endless stream of narratives that the economy is strong. This consistent stream of messaging has been going on ever since the stated "end" of the Global Financial Crisis of 2008, although in reality that crisis never cleanly "ended" which is why the last decade has had such poor economic health. The most recent absurd part of this is politicians attempting to say that the 2022 economy is strong, this despite the second quarter of GDP contraction which is the actual technical definition of recession. This literal "up is down" level of outright chicanery is a sight to be seen. But as we see from the Asch experiments many people will fall for this, hence why these lies continue.
So what I think has changed in some senses between 2020 when I first started making my calls that inflation would really heat up and supply chains would break down badly is an example of group psychology. The powers that be have a vested interest in saying that everything is good, no candidate wins an election saying "the economy is terrible", even in democracies there's a strong political incentive to lie about the strength of the economy.
People who don't understand these dynamics and misaligned incentives take those authority figures at face value. Then you have commentators who will succumb to pressure to publish things that aren't quite right because authority figures pressure them to do so (see Milgram experiment).
Talking about hyperinflation at parties
After a while of extreme frustration with living in a society that was completely blind I started to do some hard research into answering the question "how the fuck did we get here?". Of particular interest to me was how we had so many "educated" people who seemed to have such little understanding of how economics worked at any level. Initially this was a dark time for me, I had yet to fully come to terms with what was going on and why people were unable to see what was right in front of their eyes if only they would look. The Asch experiments go a long way to explaining what was happening, at the beginning of the inflationary crisis the mass media was pushing hard messaging to say it wouldn't be a problem and a lot of people on the fence just fell in line with that. After a while most people would just run into people who had a similar impression and the easy thing to do is just to go along with everyone else. I'm sure I was less than pleasant to talk to at times when these topics came up. This was in part because I was going against the social grain at the time, but now things are far worse in terms of inflation and everyone has experienced it personally, the group dynamics have started to change. Sometimes I'd get very much into the weeds when talking about economics if anyone had asked but only later did I start to see how everything connected together. The disconnected facts that didn't fit into some sort of coherent narrative doesn't make for conversation that people tend to enjoy, in any case a weak narrative will not sway people who are being subject to the combination of a social group pressure combined with pressure from what they see to be "authorities" even if the statements are perfectly factual.
At first I remember I was mostly interested in commodities as I just couldn't understand why these were so cheap but yet still available in large quantities. I just looked at things from a first principles point of view and asked "why are these valuable things that our entire civilization depends on so underpriced?". Especially at the beginning I wasn't engaging in the sort of thinking where the crowd looks at what the crowd is doing. Soon after the absurd situation where oil futures prices went negative I wrote an article about what negative futures prices look like because oil, that most critical of modern commodities, was trading at negative prices on the futures markets for a while in there (important to note that this was the futures market prices, spot oil never went negative and that fact indicates an especially important market dynamic that most people never talk about). For something to become this extreme was good because it completely blew away a number of misconceptions I had about how things worked and forced me, and others, to ask hard questions about how such an event was even possible. But all this came about with the backdrop of looking directly at the data and talking to people who had a diverse range of ideas about what was going on. I had a bit of a crisis in mid 2020 when I realized that many things I had assumed were either poor assumptions or outright incorrect.
Self assessment isn't something that most people tend to ever do voluntarily. Typically people have to have something bad happen for them to get to deeply questioning their core beliefs, in 2020 and 2021 I had a lot of bad things happen. Also during that time I was so bothered by what I was seeing that I had to ask "why did I have such a misinformed view of things?" which then led to a period of heavy research where I had a burning desire to get to the bottom of why I was so ignorant. It was abundantly clear that the price setting mechanisms of the markets were not functioning at all "normally" but I didn't understand why. Initially I'd instigate some of these conversations but eventually I gave up when I realized most people were either not interested or were more emotionally invested in denial than seeking the truth. Denial and shooting the messenger was the easy response to these sorts of topics because frankly they aren't easy to deal with. It felt alienating to see people basically mindlessly wandering towards their economic demise, and a large contingent, although probably an extremely astroturfed one, cheering on policies that clearly were going to hurt everyone.
I remember someone telling me in 2021 that they had taken bets about how long it would take for me to talk about commodities at a party. I got the message pretty clearly that people just didn't really care and didn't want to hear about it. After that I remember disengaging with that group of people on those topics. That same group of people today is complaining about inflation and I can't help but wonder if any of them actually hedged themselves against it, I know a few people did but most I think did not.
Interestingly enough 2 years later in 2022 some of those people remembered what I was saying in 2020 and had started to realize I was onto something but still didn't have a mental model that was accurate as to what was happening. I was at a party and someone else brought up the topic of inflation, I said I wouldn't be surprised if inflation hits 30% this year in Australia. The immediate gut reaction to this was of disbelief from some people, but honestly I'm shocked that anyone could be shocked by this.
From what I could see I had daily data points about how much inflation had taken off. 10-20% price jumps for all sorts of goods and services had happened this year. Which really is indicative of the sorts of rates of inflation that were really going on. All this 2% inflation bullshit was clearly a lie but earlier on in the crisis people hadn't pieced it together just yet that inflation couldn't be 2% if everything had gone up by 10-20%. Part of what was driving the lie was the insidious practice of shrinkflation that's been happening over the years:
TODO: shrinkflation meme
Shrinkflation is the process whereby prices inflate by the amount of goods being packaged being subtly reduced. This can very quickly add up to double digit inflation without there being a nominal increase in prices due to getting less goods for the same price. Shrinkflation isn't new either, it's been a staple of the currency debasement process that's been robbing us of our real purchasing power for at least a few decades now. Shrinkflation has become more popular in recent times because keeping track of prices has become a lot easier due to the widespread adoption of electronic payments. Put simply it's easier for consumers to look back and get angry that they are paying more for the same amount of goods, so what can be done is to keep the price stable but reduce the amount of goods.
TODO: shrinkflation images
Eventually this would end up with absurdly small packages so the way in which this cycle works longer term is to eventually create a "bigger size" box which is just the size of the original item and to bump the price only at that point in time. The general playbook is to point out as aggressively as possible the "new bigger size" when this step happens.
Since then there's been a number of high profile examples of day to day costs of items going up. When these items are psychologically important for some reason this sometimes even reaches the legacy mainstream media. A good example of this was seen recently in Australia where the 7-11 chain had for a long time had cheap coffees which were always $1. These were bumped up to $2, a good example of 100% price inflation hitting all at once. In the age of the pandemic of mindless contactless payments many people don't actually register that is a 100% increase because instead of giving over two coins it's still just the same mindless tapping of a plastic card against a terminal. Contactless payments give an opportunity for mindlessness that just didn't exist before and are as such a crucial pillar in people's ability to not trust their own eyes with regards to price inflation. Contactless payments are also directly an important pillar for currency debasement and inflation, since they remove pesky obstacles like having to print bigger denomination banknotes or mint coinage.
There's a lot of lies about the definitions of hyperinflation. A bit like how the definition of a recession was attempted to be changed by politicians who just don't want to have to admit that we are in one already. We have central bankers and other elite groups who play very fast and loose with definitions as it suits their interests to do so. Unfortunately many people miss the changes in definitions.
The main driver for hyperinflation is always a psychological shift and really is not any specific percentage number of annualized inflation rates. Regular inflation hurts the middle classes and the poor badly, but for the most part people don't go out of their way to think about finance unless they have to. Even in hyper-financialized societies, like many we find in the world in 2022, many people don't want to think about finance because frankly finance is just not something that many people are interested in. Hyperinflation is a situation where it is impossible to avoid thinking about the declining purchasing power of your money. When people who don't want to think about a topic are forced to think about it on threat of starvation, destitution and/or poverty they will tend to think about that topic, but they won't be happy about it. Throughout history there are stories of this shift in thinking whenever inflation runs out of control:
“The price of tram rides and beef, theatre tickets and school, newspapers and haircuts, sugar and bacon, is going up every week. As a result, no one knows how long their money will last and people are living in constant fear, thinking of nothing but eating and drinking, buying and selling. There is only one topic on everyone’s lips in Berlin: the dollar, the mark and prices.” Eugeni Xammar, Spanish journalist in Berlin, February 1923
I saw an example of a few of these subtle shifts in psychology when talking to someone at a party earlier in the year. Given my conscious decision to talk less about the impending hyperinflation and economic turmoil at parties quite some time elapsed where the topic didn't come up. By things were changing in the broader community, I started to be pulled into discussions about inflation by other people, sometimes people who remembered my correct calls from the 2019/2020 era and sometimes completely cold without that context. It was notable that we were entering the part in the cycle where other people who weren't so economically focused were starting to talk about inflation in early 2022, this has only continued as the year has gone on.
Perhaps the most standout examples of that was talking to Chris earlier in 2022 who is a research scientist who works in Physics research. He's highly intelligent and has numeracy skills, but despite this he had bought into the lie that inflation was under control. I don't think he actually knew how he had come to the belief state that he had, but I think it's likely that it came about as a response to exposure to narratives on the topic that had no connection with real data. If he had engaged his more numeracy oriented thought processes with some of the raw data I'm fairly sure it would have been impossible for him to have come to the position he had been at. Much of what's reported by the central banks is completely intellectually corrupt, and it's hard to come by a better example of this intellectual corruption than the forecasts for the inflation rates:
Perhaps everyone has just got jaded by the replication crisis that spread through academia like an out of control wildfire but seeing a chart like this should immediately make you think "intellectual dishonesty". The headlines are just more of the same sorts of dishonesty. After two years of deliberately lying about inflation being transitory that lie has become too hard to maintain, to claim inflation was low is just so absurd that it cannot be believed, so new lies are being invented to replace the old lies in the mainstream discussion. The most devastating part of the inflation situation is that even if tomorrow the rate of inflation stopped dead at 0% the high prices would remain since inflation is a rate of change. See this blog post for more information on how that works.
At this party we were standing around in the backyard around a wood fire in a pit, the night was very cold at least for Melbourne standards and we were near the fire to stay warm. It was very early on in the winter but the night was very cold. This was a somewhat ominous sign when I think back, I knew that an energy crisis was on its way but many people hadn't quite come to that conclusion yet. People think of energy in terms of fiat money, when really the way it works is the other way around, energy is what allows fiat money to have any value. Speaking of energy, burning wood is one way in which you can heat things, and people are talking about it a lot more now.
TODO: Google trends for firewood
Thankfully Australia is relatively warm place and a winter in Melbourne with minimal heat would be survivable even if this was a miserable affair. Tonight as I write this article the low will be around 5 degrees celsius, unfortunately many houses in Australia are built in such a way that they are poorly insulated. This is a trend that started long ago, the house I'm in right now is about a hundred years old. Despite better technology now much of the construction here is still shit for heating for various reasons. But despite all this its possible to get by without burning too much energy for heating though the coldest nights are unpleasant for sure if you go this route. The same cannot be said about many places in Europe where the cold weather will quite literally not be survivable for many without heating energy being available. I remember my time in Canada clearly, a big learning experience for me was having to understand that the cold weather would literally kill you if you didn't prepare accordingly. On some level that's an understanding that everyone over there naturally has, but in terms of putting it into words it might not always be so easy.
“Few families can afford meat more than once a week, eggs are unprocurable, milk terribly scarce and bread already 16 times the price of a few days ago… The expensive restaurants are full of well-dressed people drinking wine and eating of the best of Munich, but they are either German-Americans or Ruhr industrialists… No one expects political disturbances but hunger riots are another matter… and the cold, no one can afford central heating. No one images the Rentenmark will help.” Robert Clive, British consul-general in Munich, October 1923
Almost 100 years later Germany is facing another situation where many people will not be able to afford energy for things like heating. This is because energy prices have gone parabolic in Europe:
TODO: Energy prices in europe
People can survive without as much energy provided of course that they get enough for their essential living, which is something that is increasingly not looking to be a certainty in many parts of the world. However many sectors of modern industry simply cannot operate without abundant energy. The impacts of this are deeply non-linear, in many cases less energy doesn't mean less products, less energy means no products can be produced. The same is true for energy prices, production is very non linear with respect to input costs in many cases. Whole industries like aluminum production can only exist in their current form with abundant electricity, and countless other industries rely on raw goods and materials that have prices directly tied to energy. When you consider the entire supply chain you start to see that an industry that relies on aluminum will be impacted by electricity prices even if that industry doesn't on the surface appear to use that much electricity itself. We saw an enormous spike in production costs in Europe in 2022 due to the lack of availability of cheap energy. This reflects directly in the Producer Price Index charts for Europe, see for example Germany:
Many people only think of the Consumer Price Index (CPI) when thinking of inflation because this is what they are told to think about. Few people understand the intellectual corruption that's directly baked into this index via hedonic adjustments and even fewer understand why this discrepancy is no accident and who this discrepancy serves. The Producer Price Index, which tracks how expensive it is to make things is a very important piece of inflation data but yet rarely gets mentioned in non-economics circles. I meet regularly meet people who don't even know what this is. the PPI is an important leading indicator because if things are getting more expensive to make then they will eventually either have to become more expensive to buy when existing inventories run out or demand destruction starts to kick in meaning demand for those goods will drop. The quality of an economy is measured in what goods can be produced not dollars. So the PPI will always be an important measure of the real health of the economy as opposed to just the financialized portion of it. And the numbers are grim, very grim.
When things get extreme we start to get outright discontinuities in the markets. We have already seen things like Mortgage backed security products go no-bid and we have seen scarce assets like Nickle first see a short squeeze, then a trading halt on the LME then eventually fail to trade at the spot price. Eventually the unprecedented step of retroactively cancelling completed trades on Nickle was made. Energy shortages will make such market instabilities even worse, and as shown with nickle market instabilities can cause the rules of established markets to become unstable.
Linear increases in the costs of energy cause non linear increases in the cost of goods. Eventually what happens is that certain industries just can't make a profit and are forced to shut down entirely if energy is too difficult to acquire. Economic decisions start to becomes a lot more complex in terms of Kolmogorov Complexity, because assumptions that make commerce and trade much easier start to break. This extra complexity is what led to this quote from the Raven of Zurich:
We see this right now in the UK, many companies will be forced to close due to a hyperinflation of energy costs. It is simply not profitable to stay open for many businesses so they will either have to not pay their energy bills or close their businesses. This causes real economic and political pain for everyone because the economy is only as strong as the goods and services it can provide. Political entities are in turn only as strong as the economies that support them.
This is why there's a growing movement to not pay energy bills in the UK and in Italy and probably many other places. People simply can't afford to pay, so they aren't paying. The mainstream media is going to exceptional efforts to not cover this despite it being a massive global movement. I'm reminded of my time in Ontario when energy bills jumped up enormously, it was only when a large number of people stopped paying their bills that political change occurred. That also got minimal media attention at first, but such non payment in the UK is not unprecedented. The game theory of this is actually quite simple, when people realize they have no possible way to legitimately pay their debts the incentive to maintain high credit scores is removed. When that incentive is removed the only way to get people to pay their debts is military force, and I say this very literally, you have to be willing to kill members of the populace to try to get them to pay debts when you remove any positive incentives for them to do so. But such military action is extremely expensive, and not just in terms of finances, it is also extremely expensive in terms of the political capital that is burnt by going that route. Modern economies simply cannot be centrally planned and ending a free market by imposing martial law in that market will therefore come at huge cost economically, not to mention the political costs associated with such a move. The brutal calculus of power may mean that it's not actually feasible to attempt to enforce people to do something so far from their own best interests as defined by the game theoretic equilibrium for choices around energy. This is an important dynamic of a currency endgame that comes as a result of an energy crisis, it ends up becoming impossible to enforce debts denominated in the fiat currency because to do so requires energy expenditure and if the energy doesn't exist the capability to collect also doesn't exist. This is just one of the reasons why countries do default on debts in their own currencies, printing the money is actually more painful over the longer term than just defaulting on the debts or having a debt jubilee of sorts.
“…state bankruptcy is a one-time surgical intervention, while inflation is a permanent poisoning of the very bloodstream of a society.”
When I have started to talk about things from a first principles approach I often encounter initial resistance but you often see the moment of enlightenment where someone puts it all together. I remember talking to Chris and I remember the moment when he got it. For anyone who's highly numerate this always happens when the raw data around inflation is revealed, the numbers are undeniable and people who have trained themselves to be numerate and to trust the data will be swayed by the extremely strong evidence that can be seen in the data.
The politics of hyperinflation
From an economic point of view if we want to understand the situation for what it is we have to look at the primary data. We need to trust what we see with our own eyes more than the narratives sold to us about inflation.
“The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”
- Thomas Sowell
It's much the same with the politics of this situation. Many policies are being sold to the populace that have no connection to reality. It is much easier to talk about fixing inflation than it is to actually fix it. This is especially so with policies that are effectively just debt monetization or money printing hidden behind thin veneers of justifications that they will fight inflation. Printing more money to "fight inflation" is like throwing more gas on the fire in an attempt to put it out. But yet this is exactly what many politicians are doing worldwide.
None of any of this is remotely new. The politics of currency destruction has been tried many times before, always leading to depravity and violence and the overwhelming destruction of real wealth. Another quote from "the raven of zurich":
Governments that embarked on the policy of cheapening their currencies relied on two arguments: the example of their enemies and the impossibility of financing the war in any other way. The grandiose slogan that insisted on concern for the Fatherland being more important than concern for the worth of the currency was even then repeated ad nauseam… Thus it was that defrauding the saver became a patriotic virtue, and remained one with short interruptions for an entire generation: inflation, that is confiscation without legal authority and without any limits, was the incubator for both Bolshevism and Hitlerism. When we began to raise our voices in warning back at the beginning we were condemned as money-obsessed, and ridiculed as hard-hearted financial types and gloomy hand-wringers. But even our most pessimistic forecasts were far exceeded by the dreadfulness of the actual consequences.
We have already seen the cheapening of the currency going on for a number of years. This has made the chances of war go up radically while making the quality of living for everyone go down. For some time a financial war has been going on where financial instruments have been used not to create wealth but to pursue other geopolitical goals. Confiscating wealth to burn it away in negative-sum-games for economic warfare really sets the scene for military conflicts to pop up. A scary parallel in 2022 is the insane amount of warmongering and the amounts of money that are being sloshed around to this effect. For example we now see Canada looking to offer war bonds, not for their own countries protection, but for fighting a war they aren't even deployed in over in Europe. I don't know if this is unprecedented in the post-colonial era and I also don't know if this move actually has popular support, though the general populace I'm sure doesn't understand the long term consequences of this move. Too many people get caught up in the political fervor of the terrible situation in Ukraine and don't stop to think of the economic consequences. Given that the war there is ongoing economic factors become increasingly important, no modern war can be sustained without significant economic impact. For better or worse modern warfare is highly industrialized and relies heavily on technology, an armies ability to project force in such an era is directly constrained by the capacity of the economy that powers their supply chains. An obvious consequence of the conflict seems to be yet more inflation as funding this war has been given a very high priority and funding via deficit spending or money printing seems to be the path of least political resistance, at least for now. War is a destructive endeavour and the destruction of the purchasing power of the citizens of the warring countries is a direct result.
Meanwhile we have various pieces of legislation being proposed worldwide in the name of fighting inflation that will most surely make the inflationary crisis worse. Europe printing Euros to give to people to "combat" higher energy prices will also lead to a sharp increase in inflation. Certain suggestions around debt jubilees like student loan forgiveness likewise have the potential to really add to the inflationary problem. All these examples are situations where more base money is effectively created because they remove debt out of the system by printing new money to cover that debt. If this gets into a price-wage spiral whereby ever increasing amounts are required to purchase goods or labor then hyperinflation could hit fairly quickly. Rational actors will be forced to increase their prices to survive due to these dynamics. Unfortunately it is likely that if we start to see these spirals start that politicians will reach for price controls to try to combat it, which is something that historically almost always ends in disaster.
High debt loads were one of the few things keeping a lid on inflation because high debt loads create demand destruction. But when debt is bought with freshly printed money the demand destruction of debt is removed. If debt is to be bought with freshly printed money then debts can be turned into base money supply. Because these days we live in an absurd world where there's far more debt than there is base money supply we have a situation were a monetization of that debt will cause extreme hyperinflation the likes of which many people have not seen in their lives. Given the huge debt loads of both governments, corporations and individuals even small fractions of debt monetization will cause large amounts of inflation.
It is looking more and more certain that the debts of the 2020 era will never be paid back. On the current trajectory this is now pretty much a guarantee. But the way in which they are not paid back will be an extremely crucial detail. What path this goes next remains to be seen, the debts will either be cleared by an explicit series of defaults or by a brutal process of inflation whereby the debts are monetized and the currencies in which they are denominated in are destroyed.
Throughout all of this it will be extremely important to know the economic structures that are in play and to trust your own eyes.
Having read much about hyperinflationary times in history it is important as an author, and just as a general citizen, to start making notes of what time things cost what amount. Price stability is basically gone right now which in turn might make the figures in this article get entirely out of date in a very short period of time. ↩
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