By Philip Pilkington, a writer and research assistant at Kingston University in London. You can follow him on Twitter @pilkingtonphil
While it is probably true that no one has ever gone broke underestimating the intelligence of the public, it is also true that many who try to turn a profit from stupidity often become the victims of their own nonsense. As we have discussed previously, the fear industry that has grown up since 2008 – mainly centred on the gold market – is a manifestation of this dynamic. Their clarion call is that hyperinflation is inevitable and could happen at any moment.
We will not debunk their false claims that Quantitative Easing and other monetary easing programs will lead to hyperinflation because these programs do not contribute to aggregate demand, as we have discussed earlier on this site. Instead, we will peek behind the hyperinflationist’s mask. Although the proponents are often loud and shrill they rarely explain their reasoning in any sustained manner – probably because they don’t fully understand it themselves. However, if you are familiar with the economic theories that they hold you can reconstruct their reasoning. This is what we propose to do here together while showing that, even if we accept their reasoning, economies will not generally react to increases in demand as the hyperinflationists think they will.
Like Spinning Plates
And this just feels like spinning plates…
I’m living in cloud cuckoo land…
– Radiohead, ‘Like Spinning Plates’
Why do economists build models? This is a very good question. Personally, I’m not a fan. I think that models are misleading and somewhat silly. However, the reason some economists build them is their recognition of the limitations of human cognitive capabilities. After all, it is much easier to think about a closed system with well-defined parameters than it is to look at the complexities of the real world. This, it seems, is why some economists seem to believe that modelling is important.
When considering economists and their models I have learned an important rule of thumb: an economist’s competence is inversely proportional to their need for a model. In addition to this, we can also add that as an economist’s need for a model increases we will often find that the model they rely upon becomes substantially more restrictive, lacking in nuance and stupid.
If we apply these criteria to the Austrian economists – the group that are undoubtedly the ones who spread the hyperinflation message with the most zeal – we will quickly see that their competence levels are rather low. Although the pundits rarely talk about the model they are basing their analyses on it is one of remarkable simplicity and, not coincidentally, one that is completely lacking in nuance.
Okay, so let’s look at this model. Imagine an economy in which full employment exists in perpetuity. Every time someone loses their job the wage decreases because the unemployed worker accepts a wage cut to regain their employment with a competing employer. But, although the wage falls, prices also fall in response to the lower cost of labour – and hence the purchasing power of workers is maintained. In addition to this we must assume that factories are working right up to capacity. Every last bit of output that can be cranked from the machines is being squeezed out because, after all, why would an entrepreneur have machinery that they are not currently using? (Yes, for those of you who actually understand how factories and firms operate… I am indeed being facetious… and, for those unaware, we will see why in what follows).
As we can see, this is a very rigid system. It is perfectly balanced but, like a spinning plate, anything from the outside that might intrude will knock the system off balance and cause it to spiral out of control. Let us remember that this is not a representation of reality. It is the thought structure of a particular group of economic commentators. The fragility is not in the real world, but in the ideational constructs of these commentators. We should always keep this firmly in mind. This sort of thinking represents the mental structure of those who propound it, it does not reflect the real world.
Now, imagine that a government bureaucrat saunters in and dumps a pile of money into the economy. What happens? Well, assuming that the workers do not hoard it and instead go out and spend it, the results should be obvious. The workers will now try to buy more goods. But since the factories are operating at full capacity and the workforce is fully employed the result will be that prices begin to rise. If the government continues to pump newly printed money into the economy prices will continue to rise and both producers and consumers will begin to anticipate these rises. Thus they will begin to spend the newly printed money faster and faster until… you guessed it… hyperinflation!
We should pay attention here because it highlights a strange truth about your average right-wing libertarian economic commentator: namely, that they view a capitalist economy as being a remarkably fragile organism. Rather than being a robust machine that grinds over external disturbances, the right-wing libertarian views the system like a spinning plate: impressive to watch, beautiful even, but ultimately fickle and feeble. This, of course, is what reinforces their conservatism – because, the truth of the matter is that right-wing ideology, whenever it goes beyond crude self-interest, is almost always grounded in fear and insecurity.
The reality, however, could not be further from this. In fact, as history has shown us so many times, capitalist economies are extremely robust. They are dynamic, flexible and absorb change like no other socio-economic system. The second we move to the real world even if apply the strict implicit criteria the hyperinflationist holds to, we will see that capitalist economies have inbuilt mechanisms to absorb excess monetary demand without sparking a hyperinflation. It is to these that we now turn.
Capitalism: A Robust Machine
So, what is the reality of the situation? Well, in fact we have ample evidence of what occurs when demand outstrips supply in a capitalist economy. Most of our experience comes from wartime – especially World War II and the Korean War – but there have also been a few brief periods in history when major industrial economies were running at full employment. Before we go into detail about this, however, readers should be reminded that at the moment of writing almost every advanced industrial economy in the world is operating with significant amounts of excess capacity and unemployment. There is literally no reasonable argument that says that under these conditions higher demand would lead to inflation rather than higher employment and more goods and services being sold.
But let’s take the hyperinflationist’s model at face value. Let’s say that an economy is running at full employment and let’s say that enough money is dumped into the hands of consumers so as to increase their purchasing power by 10%. What would happen if everyone rushed out to spend this new money? Would consumers bid up the prices for goods? No. In actual fact, the first thing that we would see would be shortages. There is a myth that says that shortages cannot occur in a capitalist system. The idea behind this is that if more people go to purchase more products than there are available the price of the product will rise and the highest bidder will get it. Thus price inflation will occur rather than shortages. But this is simply not the system we live in.
One of the things I noticed when I moved from Dublin to London was that shortages are quite common in big cities. In Dublin shortages are almost unheard of. But in London it is quite common to go into your local shop – even big chain shops – and see empty shelves. This is because at higher levels of population density it becomes increasingly difficult to maintain a constant flow of stocks. For our purposes, however, we need only make clear one thing: prices do not instantly rise in the circumstances of excess monetary demand. If I walk into a shop and there is only one loaf of bread and three other hungry customers we will not engage in a bidding war. The person who gets the bread will be the person fastest at grabbing it and throwing it into their cart.
If purchasing power suddenly began outstripping supply in a full employment economy the first thing that happens would be that shortages would occur. The hyperinflationist will then say “Yes, of course, but then when the shop gets another order of goods the prices would rise”. This is simply not true. Prices in modern capitalist economies are not perfectly flexible – in fact, the vast majority of prices for manufactured goods don’t rely on supply and demand at all, they are fixed. Multiple studies over the past century have shown this beyond a shadow of a doubt.
So, how then would the suppliers respond to this new wave of demand? Well, they would increase production. “But,” the libertarian will say, “the economy is at full employment”. Yes, indeed it is – but history tells us that this does not mean that it is at full capacity. Firms do not, contrary to what silly economic models claim, operate at full capacity even in times of full employment. Firms build extra capacity into their plant – that is, excess machinery that they can activate should demand increase. The engineers that run these factories – I know some of them – are in no way stupid, they anticipate fluctuations in demand and design their factories accordingly. So, if the factory started receiving lots of new orders they would simply start paying their workers overtime and turn on the excess capacity.
Back Down to Reality
Are we claiming that there would be no effects at all on prices? No. The prices would eventually rise, but not for the reasons that the hyperinflationists might suppose. Remember we said that the increased level of production would require overtime? Well, if this were to be maintained for any significant period the firms would pass the wage costs on to consumers. Some economic theories claim that this cannot happen, but the historical record simply does not lie in this regard – this is what happens.
“Aha!” says our libertarian friend, “That’s when the hyperinflation kicks in!” Hardly. We have postulated a fairly massive shock in a full employment economy. We have assumed that enough money gets dumped into consumers’ hands as to increase demand by about 10%. Chances are that the economy would respond to this without too much disorder. Being a fairly robust machine it would likely absorb this shock quite quickly – maybe only after a few days of minor shortages. If price increases due to wage payments did occur they would happen very gradually and, because the dumping of money was a once-off event, it would only be a once-off price increase. So, this would not even be a sustained inflation and it would not trigger consumers to go mad and start emptying their bank accounts.
But also consider this once-off aspect: we have imagined a singular dumping of money that increases purchasing power by 10%. This is only a once-off increase and so, as we have said, we would only see a once-off increase in the price-level. In order for an inflation to be sustained the amount of purchasing power would have to be continuously increased despite the fact that it was causing price rises. But why would such a thing happen? Why would the government, for example, keep dumping tons of money into the economy?
Well, let’s stop for a moment. Prior to this we assumed that the 10% increase in purchasing power was for no apparent reason. But let’s be more realistic. Let’s say that the government did this in order to buy up a big handful of resources in order to build a space rocket. Fine, that makes sense. But what would motivate them to snatch up more and more resources? Historically, in Western countries, the only reason that they have ever done this was in order to facilitate full-scale war.
In wartime the government does need to snatch up most of the resources being produced in order to send them to the front. In this circumstance there is a risk of running into substantial inflation – not hyperinflation, mind you, but certainly high inflation. This is why in wartime governments impose shortages on their citizens by using ration card systems. But outside of wartime there is simply no reason to assume that the government would ever engage in any action that would threaten any very serious level of inflation – let alone hyperinflation. After all, what on earth would they be doing with all the resources they are buying up? Dumping them in the ocean? Even the most paranoid libertarian cannot believe that fairy-tale.
The responses I will get to this piece from the hyperinflationsts are predictable, so let’s be clear about a few things in advance. First of all, I am not advocating increasing aggregate demand by 10% in a full employment economy. This was simply a thought experiment so that we could actually think through what would happen rather than just screaming “Hyperinflation!” like a hysteric.
Secondly, it will probably be pointed out that since World War II there have been periods of sustained inflation in capitalist economies that were below full employment levels. This is true, but it was an entirely different type of inflation that was mainly due to rising oil costs which was in turn due to political turmoil in the Middle East. For some reason it is ingrained in the common/libertarian mind that all inflations are a case of too much money chasing too few goods. In fact, these inflations are very rare in modern economies and inflations are far more likely to be due to rising commodity prices. Weimar and Zimbabwe will be brought up too. These hyperinflations were due to entirely different reasons and the interested readers can read up on these here.
Thirdly, and I cannot stress this enough, the above is a thought experiment to engage with the simplified and crude model of the economy that implicitly underlies the hyperinflationist argument. This is NOT where we are today. In an economy with significant unemployment and idle capacity any increase in aggregate demand will lead to unemployed people and machines being put back to work. There is literally no rational argument to the contrary and it is only because hyperinflationists pander to the primitive, irrational and fear-ridden parts of peoples’ brains that anyone buys into the hyperinflation narrative in a time of chronic unemployment.
Finally, I would implore those that buy into these crude arguments: stop thinking with your stomachs. Yes, the hyperinflationist argument is appealing in many ways. Daily life under advanced capitalism is rather dull and many imagine that after a hyperinflation society will turn into a sort of Wild West where things get a bit more interesting; especially given their stocks of guns and gold. This is just a fantasy and if you truly are into the whole “Road Warrior” thing and find it appealing at some level then man up and move to Somalia or join the army. Oh, and if you’re making investment decisions based on the iron-clad belief that hyperinflation is coming and that you know this and the professional financial community is just blind… well… I don’t have much to say to you other than: good luck and try not to bet the house.