Can the Fed Kill This Inflation Without Killing Too Many Other Things First?

Your humble blogger has argued that central banks are not going to be able to do much to address our current very bad and getting worse inflation outbreak. This inflation is not the result of excessive demand, as commonly conceptualized, but a marked, and it sure looks like durable, contraction in productive capacity.

Some of that loss is due to Covid. The US has lower labor force participation than before the pandemic, yet unemployment is low and many establishments complain about the difficulty in getting workers. Covid led many, particularly in the medical establishment, to retire early. Covid also got some couples to realize they could get by on one income and they’ve decided they like it that way. Some low wage workers decided they aren’t going back to high risk positions in restaurants and retail. Some got long Covid and can’t work full time. And a million people died, some of them working age. Pilot shortages are the tip of the iceberg of a thinning out among seasoned employees who are hard to replace.

We had supply chain bottlenecks and breakage during Covid and that’s still not cleared up. China has been and will still lock down as needed, and the West be damned. Many ports are still a mess.

And we have yet to get to the elephant in the room, the Russia sanctions blowback. The US and EU would put even more sanctions on if they were not already scraping the bottom of the barrel….even though Russia is not only not bowed, but coping surprisingly well. The central bank just cut rates again to 9.5%, the level they were at before the war, and is worried about the rouble, now at 58 to the dollar, becoming too strong. As we predicted, car parts are a mess, but the latest Levada poll, from May (and remember Levada is the most anti-Putin pollster in Russia) found that only 16% of respondents reported that the sanctions were causing “very” or “quite” serious problems for their family (the next category was “didn’t create any serious problems”).

You can find a vastly more comprehensive and well-documented explanation of where our inflation came from in a Servaas Storm post, Inflation in a Time of Corona and War.

But even though the West is suffering far more from collateral damage of the sanctions, most of all higher energy prices, there’s not even a peep in the press about rolling them back.

So because our policy-makers refuse to do things like make workplaces less scary for the Covid-cautious, or unjam ports, or climb down and admit they were wrong when business survival and citizens’ lives are at stake, they’ll leave it all to central bankers and their blunt instrument of monetary policy.

To reduce things to simple-minded but still pretty accurate terms, since too much demand is not the cause of our inflation, it correspondingly seems likely that central bankers will have to overkill the economy to kill inflation.

We’re not the only ones thinking along these lines. The hedge fund manager who writes as Doomberg passed around this tweet:

I suspect Gromen is fighting the last war. Yes, many experts do expect to see developing nations winding up with debt defaults, but that’s the result of high energy and food costs, and the high dollar. Those bad outcomes are baked in unless the so-called collective West does a fast about face with sanctions, which is not in the cards.

It is true that when Paul Volcker let interest rates go to the moon, he had to relent sooner than he liked due to the Latin American debt crisis, which was particularly imperiling America’s favorite risk-binging big bank, then Citibank, later Citigroup. But the flip side is oil prices had peaked as of April 1980, yet Volcker had even more brutal rate hikes in 1981. Were those necessary, or would have inflation fallen, albeit less quickly, once energy prices started retreating, and at lower cost to the US economy? One consequence of Volcker driving rates so high in 1981, to see them drop in 1982 and 1983, was a big rise in the formerly weak dollar. US automakers lost tremendous share to the Japanese during a 30 month period, and they never got it back.

In other words, we’ll have emerging debt crises whether or not advanced economy central banks act.

Where I see big rate increases doing serious damage is in leveraged activities, and we have hidden leverage aplenty due to far too many years of super low interest rates, plus the Fed conditioning investors to expect the Greenspan/Bernanke/Yellen put to rescue them before things got too awful.

And where is the big leverage bomb likely to sit? In derivatives. Recall the Archegos “family office” meltdown. Bill Hwang used total return swaps to turbo-charge his investments in certain stocks, when Great Depression reforms were designed to limit margin loans against stocks to 50% of the price. Per the Department of Justice, “In one year, Hwang allegedly turned a $1.5 billion portfolio and pumped it up into a $35 billion portfolio.” Admittedly, that was purportedly due to market manipulation too, but that is still a lot of juice.

As we’ve repeatedly pointed out, the financial crisis was a derivatives crisis. Credit default swaps created subprime exposures (and in the riskiest credits, ECONNED explains how this perverse outcome came about) four to six times the real economy value of dodgy loans. If we’d had a mere housing bust, the result would have been a very bad recession, not a near death experience for the global financial system.

And in the runup to the crisis, the authorities knew CDS were a ticking time bomb. The Bank of England’s semi annual Financial Stability report had detailed and clearly concerned discussions about them. We criticized the Fed and Treasury in the runup to the big meltdown in September 2008 for not doing everything they could to map the exposures, since if you don’t know how severe and extensive a problem is, you can’t get in front of it.

But there were no meaningful derivatives reforms. Even though a fair bit of derivatives clearing now sits with central counterparties, many commentators, including this humble blog, have pointed out that these are simply new too big to fail entities. Virtually all derivatives don’t require users to post adequate margin to cover the risk….since sufficiently high margin would make derivatives uneconomical for most purposes. In other words, the reason these markets continue to exist is the implicit state guarantee. It’s one thing to guarantee deposits. But speculative instruments? Where the most profitable uses are for accounting and tax gaming, as in socially destructive purposes?

I could go on about how valuing complex derivatives depending on being able to hedge them, but hedging is dynamic and the models assume continuous markets. It’s really easy for derivatives traders to blow up in very volatile markets. Look at LTCM or many highly respected quant funds in the financial crisis.

So while a lot of wheels are pretty certain to come off if central banks don’t relent in their drive to kill inflation and other living things, watch for derivatives counterparties to be among the first casualties.

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        1. drumlin woodchuckles

          Even if only by comparison. People who referrence the “greed” of the rich fail to account for the underlying sadism of the rich. They would be happy to lose half of what they have if they knew for a fact that would cause us to lose both halves of what we have.

        2. Felix_47

          Would massive tax increases on the middle class, as defined by Joe Biden as those making up to 500,000, as well as the upper class cause demand destruction in the right demographic? In other words would not raising taxes to 1950s rates with full funding of the IRS, heavy audits and strict controls on tax dodges and a heavy inheritance tax with no tax dodges pull a lot of money out of the system and cause a drop in high end consumption? They say deficits do not matter and the government can spend all the money it wants but somehow I never have been able to understand that. So start to pay down the government debt but make the people with huge fortunes and the high earning attorneys, investment bankers and plastic surgeons carry the heavy load as opposed to the bus drivers and wait staff at restaurants. I would love to see someone at NC explain why that would not work better than what we are doing. I mean a 10% wealth tax on all assets might sober up the economy. And a salutory benefit of high tax rates is that a lot of unnecessary litigation, surgery and financial transactions do not get done because the marginal value of the earnings when taxed at 90% is worth less than time on the golf course. How many doctors and lawyers these days spend Wednesday afternoon together on the golf course when they can do unnecessary surgery or litigation or other procedures?

      1. disillusionized

        Now now it’s also going to make a lot of poor people cease to be concerned with material questions like where will my next meal come from.

    1. Kurtismayfield

      I always think of it as making people unemployed and homeless.. but poor covers that too.

    2. Anthony G Stegman

      Perhaps making people poor is not so bad. We know that radical conservation is needed in order to save the planet. The poor conserve by necessity, while the not poor shop until they drop, mostly for the fun of it. We can’t have business as usual – booming economy, low inflation, yada, yada, yada if we also want to have a liveable planet. Something has to give.

      1. anon y'mouse

        that’s not how it’s going to go.

        the bottom of the ladder will be submerged, while the not-as-poor keep their heads above water by standing on their shoulders.

        it would be one thing if conservation began at the top and worked down. after all, all of those extra homes, yachts and jets of the rich must be maintained in working order regardless if they’re used 5% of the year. but it tends to work inversely, or perhaps perversely.

    3. Mikel

      The Fed’s alligiance to the “wealth effect” – especially these past 20 or so years – has meant those in upper income areas were carrying the majority of the consumer spending.

      However, when it comes time to pay the piper, everybody is included – unlike everybody not being included in the wealth effect.

  1. ndk

    If the Fed does not induce recession and halt inflation, the bond market will do it for them.

    1. Louis Fyne

      and/or oil goes to $250/barrel and gasoline = $10/gallon. which is possible given the global lack of investment in hydrocarbons for the past 8+ years.

      On the bright side, the Japan and EU will implode so we will see what plan if any the Establishment has.

      1. ndk

        I think demand destruction strikes first, personally, but I’m mostly agnostic on the trade.

        J. David Hughes of the Post Carbon Institute wrote a play-by-play assessment (Shale Reality Check 2021) of US shale basins that is very much worth reading (and comparing to the official EIA opinions, as he’s pessimistic). We’re not in a terrible situation for natural gas. We are in a terrible situation for tight oil.

        I think the Canadian oil sands and Venezuelan sour have a distressingly bright future. The environment, not so much, unless we find the capital to invest meaningfully in Gen III/IV reactors, battery-less transit, and HALEU fuel, which probably excludes American companies on both counts. Chinese researchers have found a promising new way to extract uranium from seawater, with biofouling being the only — and very fixable — problem. I don’t think mining will be an issue.

        We would need to build on the order of 200 new reactors a year for decades to replace other sources. Our current operating fleet is 94.

        1. Louis Fyne

          or in other words given the culture wars dysfunction of the US….we are up Niagara Creek with no paddle until (optimistically at the very earliest) post-2024 election.

          No hyperbole, cue Edward Heath in 2023…we will know the hardest Christmas since the War.

        2. Ignacio

          Thanks for the link to the Shale Reality Check. It could be possibly argued that as shale plays are moving outside the sweet spots Russia sanctions might have been engineered to make the new investments profitable, therefore it would be unnecessary for policymakers, (it might be counterproductive) to fight energy-caused inflation. Then, monetary authorities shouldn’t try to go crazy or should be ready to backtrack ASAP if oil prices go down.

          1. ndk

            More than welcome! I’ve been absent for maybe 10 years after having been an active participant during the early days of Yves’ site, and it feels great to be back. Has the same old feeling and a lot of great new folks.

            I appreciate your kindness and time. Take care and enjoy the ride this afternoon!

        3. Anthony G Stegman

          Perhaps you ought to watch the Netflix documentary on the Three Mile Island nuclear disaster. The US can’t safely operate nuclear reactors, no matter how advanced they are. Building thousands of nuclear reactors is utter insanity.

          1. ndk

            No doubt, Three Mile Island was a terrible incident. But we must always bear in mind the far greater number of deaths caused by fossil fuels throughout history. Whether that’s the Great London Smog of 1952 or the myriad natural gas explosions or deaths in coal mining or carbon monoxide poisonings and particulate pollution, the souls lost are innumerable.

            Technological obstacles to safer use of both nuclear power and fossil fuels exist, but I think they are more challenging to overcome for fossil fuels. We’ll of course do our best, but reality will have its way in the end.

            I don’t think fusion will ever fly even with the new 20+T YBCO coils, largely because of divertor material and design constraints. We’re down to tungsten and carbon, with ~7800K and ~6600K melting points, respectively. The former is prone to (economically) catastrophic failure modes, slathering the entire lithium breeder blanket surface with tungsten goo, and carbon is swiftly embrittled in the intense environment of a tokamak. Inertial confinement fusion is probably a non-starter.

            I’d love to be proven wrong.

        4. Pelham

          Hmm. Nuclear plants current supply about 20% of US power. Green sources account for about 14% more. That leaves 66% or so for coal and natural gas. If we were to replace those two with nuclear — and 94 plants indeed account for a 20% power share — we’d need about 300 more plants total, not 200 a year for decades. Right?

          1. ndk

            That’s electricity alone, which represents a surprisingly small fraction of total energy use by the US. I think most feel that something needs to be done to generate power for transportation in particular other than fossil fuels.

            Thank you for checking my numbers!

          2. ndk

            (And, of course, my SWAG also accounts for growth in energy demand that is virtually inevitable over those decades, although we’ve done a laudable job in recent years of reducing that.

            While conservation has played an important role, at least some of decline in demand growth has come through outsourcing electricity consumption to other countries, with steel and aluminium being the most obvious examples. Some of that may be brought back.)

          3. HotFlash

            Help me out here. Electricity was not a serious power, let alone for domestic use, until 1850 absolute earliest (even then, a gleam in the eye), right? So now, apparently, not only can humans not live without it, we cannot even imagine life without it?? How did this happen? Think again.

      2. digi_owl

        Ugh, i am sure that would lead to renewed contention about the polar regions and the untapped fields there…

    2. TroyIA

      I am increasingly beginning to think we will have a recession regardless of what the fed does. Bloomberg had an article about inflation stating that the average household now has to spend something like an extra $450 per month. How will that work if 56% of Americans can’t cover a $1000 emergency.

      The poor and working class are done and right now the middle class is covering the shortfall with credit cards. When they are maxed out later this year the wheels will fall off the economy.

      And the supply chain induced inflation – well being in manufacturing I have PTSD from the total chaos of the past 2 years. Raising interest rates will NOT fix any of our issues.

      Things are about to get very, very bad.

      1. ndk

        I couldn’t agree more. Our savings rates are near the nadirs of the infamous housing bubble using the methodology that had to be revised during it so that we weren’t getting negative prints!

        There needs to be much more attention paid to revolving credit, the fragility of consumers, and sadly once more, the fragility of the banking system that is lending to them. Quantitative tightening will be an interesting process to watch unfold.

        1. flora

          Your second para could describe the situation in the US with easy credit lending to large businesses and small borrowers alike during the 1920’s in the run-up to the Great Depression.

          Credit Expansion, 1920 to 1929, and its Lessons

    3. flora

      Imo, if Greenspan and his followers at the Fed hadn’t kept interests so artificially low for so long, driving pension funds away from relative safe bonds and into the stock market at a larger investment share than considered wise in the old days, including in investing crazy PE plays, CalPERS and many other pension funds would not now be facing a perfect financial storm with no fallback position. Thanks, Fed.

      1. flora

        adding: they didn’t clean up the financial mess in the GFC, they just shoveled billions of dollars into Wall Street and left the bad stuff fester another 14 years. Here we are.

        1. ndk

          Concurred, but it’s not just here we are: it’s where we’re going to be mired for a long time to come. What’s done is done. There’s a lot of investment that is locked in and we’re going to be stuck with dramatic misallocation of economic resources for decades.

  2. Louis Fyne

    — durable, contraction in productive capacity.–

    hypothesis: All these (seemingly abnormal, more than usual) US industrial/agricultural/baby formula accidents are a symptom of corporate rot.

    Covid + vax mandates = experienced workers gone. Shortages/inflation = presumed lack of spare parts. HQ viewing maintenance as a cost-center = cutting corners.

    Combine those three = a perfect storm for a rash of accidents.

    1. Screwball

      I think this is the correct answer.

      Just read the administration is going to ask for more war money. That should help. /s

  3. Kurtismayfield

    So why are we cutting demand when all of this is an obvious supply shock? Shouldn’t we be stimulating supply and shoring up the supply chain/making investments in manufacturing of the items that are in short supply?

    1. ndk

      I’ve been asking the very same question. I think that there is a focus on making do with less rather than supplying more, partially because the supply of goods and services is largely outside of the Fed’s purview and the government is fixated on other things.

      I feel the same way about the quandary you raise as I do about public transportation: first you must supply it, and supply it very well, before people can be reasonably expected to use it. If you build it, they will come. Let’s be the chicken and make some eggs.

    2. eg

      Because the entire “independent central bank” regime is premised upon your elected representatives abdicating responsibility for the state of the economy by pretending that monetary policy (appropriately the remit of the central bank) has primacy over their own fiscal policy levers. It’s a lie, of course, but a convenient one for your elected representatives and the donors they serve, all of whom benefit from the ongoing exploitation of labour.

  4. KD

    As Caligula cured the persistent cough of Gemellus, so too will Powell cure the persistent inflation of America.

  5. orlbucfan

    I didn’t major in finance/banking nor economics, so the lingo throws me at times. But my small posse is set for $10/gal. gas and the resulting fallout. That’s about all I or anyone who is middle class can do.

    1. Louis Fyne

      This is what I find fascinating….the people most “credentialed” are the ones most in denial, while people who have their “boots on the ground” see the storm brewing even if they don’t have a PhD in econometrics

  6. Mikerw0

    We empower an independent, zero accountability institution called a Central Bank with nearly unlimited power over the economy, fill it with elite insiders, watch as it screws things up multiple times, with each time things getting worse, while making sure Wall Street prevails over Main Street every time and expect things to be different this time.

    Anyone looking for a spare bridge over the East River? (Which isn’t actually a river.)

    1. Karl

      …fill it with elite insiders, watch as it screws things up multiple times, with each time things getting worse…

      Good description of the MIC inside the D.C. beltway, with Ukraine as the latest screw-up.

  7. Tom Pfotzer

    Yves said:

    Where I see big rate increases doing serious damage is in leveraged activities, and we have hidden leverage aplenty due to far too many years of super low interest rates, plus the Fed conditioning investors to expect the Greenspan/Bernanke/Yellen put to rescue them before things got too awful.

    And where is the big leverage bomb likely to sit? In derivatives.

    Further into your post, you mention that derivatives offer marginal social value, and put the public on the “privatize profits, socialize losses” track.

    So, why are you (seemingly) not in favor of rate hikes?

    The housing market is way overheated, asset values are way too high (free money, lots of leverage)…seems like rate hikes are a perfectly reasonable way to address several very severe structural problems.

    And rate hikes will squash inflation.

    Demand exceeds production, so a reduction in demand may not be such a bad thing.

    I am not entirely sure I agree with the “demand reduction = making people poor” notion, under the current scenario. The main putative driver of inflation is production bottlenecks, but I am not on-board with that one, either. I think a great deal of price increases have been just plain old opportunistic gouging.

    Regarding the Covid-induced supply disruptions …if these companies can’t formulate operations plans which accommodate the Covid disruptions – it’s been a few years now – they need some new managers.

    Ports, for example, are not that complex. Crane operators and ship/stevedore crew are highly skilled activities, and that could be a problem, if that’s where the bottleneck is (I don’t think that’s it). But the rest of port operations is truck drivers, rail car loading, etc. and that isn’t nearly so hard to train for. 24 months should be plenty of time to get that situation back on its feet.

    ====== Separately, and noteworthy…

    Did you see that President Biden has called the oil co’s out onto the carpet to explain the gasoline shortage. Can’t wait to see how that plays out, could get rather fun.

    1. Yves Smith Post author

      We were opposed to ZIRP and criticized Bernanke for losing his nerve with raising rates in the 2014 taper tantrum.

      However, the objective now is not to get rates out of ZIRP but to raise them enough to stop inflation. To destroy enough demand to lower oil prices even to below $90, absent an end/reduction of the sanctions, will require killing the economy stone cold dead.

    2. RobertC

      “the oil co’s” know an elderly lame duck when they see him. Shareholder dividends and executive pay come first. Story over.

      1. Tom Pfotzer

        Unless President Biden has some political sense left. He may.

        If I was President at this moment, I would be hammering upon the oil companies with every sledge I could lift.

        Production of oil could be way up above where it is. And diesel and other “sour/heavy crude” products are available all over the world, and markets can – and certainly are – “accommodating”.

        If you want it, it can be had.

        I would be on those petroleum marketers, shippers, refiners like white on rice. And I’d trumpet it to the high reaches of the mountains while I was at it.

          1. Tom Pfotzer

            Indeed. Thanks for the link, RobertC.

            I have less of a problem with depletion allowance than some others do. We allow any business to write off plant and equipment (charge “depreciation” against revenue, as a “cost”). The depletion allowance is somewhat constrained by “write off up to the amount you invested in resource recovery”.

            This doesn’t offend my sensibilities too much.

            However, let the foregoing not detract from the point you’re clearly making, and that is “no constraints on oil profits will be tolerated”.

            OK. I see your point, and now let’s see if not only the environment, but also the entire economy will be sacrificed for quick profits to the few.

            Because letting energy prices float this high, under these circumstances – if it continues – will do major damage to the real economy, and to households in particular. Food and gas get paid for first, the rest gets what’s left over.

            That leaves us even more dependent upon the fin economy. Inflation, and the Rest of the World are both busy helping us vacate that position.

            To the .001%: Is this really what is best for you?

            1. RobertC

              Tom — I was replying specifically to your

              ====== Separately, and noteworthy…

              Did you see that President Biden has called the oil co’s out onto the carpet to explain the gasoline shortage. Can’t wait to see how that plays out, could get rather fun.

              In various ways President Biden has frittered away any opportunities to jawbone the seven “oil co’s” into significant adjustments in pricing and profits. An example is his blaming “Putin’s Price Hike” which voters saw past in a few days. Another is his falling approval rating as voters question his competency. That leaves Executive Actions such as price controls which apparently he will not exercise.

              So, as I said, story over.

        1. digi_owl

          Most likely he is one of them, and that Hunter was off in Ukraine to oversee the family investments there.

          By now it should be clear that congress is not in the pocket of Wall Street, they ARE Wall Street. Just look at Pelosi’s husband.

  8. juno mas

    When the ethos of a capitalist society is “caveat emptor” what could possibly go wrong?!

    When business regulations become onerous the grifters and shysters simply invent workarounds (derivatives) to extend the Ponzi scheme. What’s not to like?!! /s.

  9. Robert Hahl

    Nobody has mentioned all the appropriations of foreign property lately. The US has spooked many holders of dollar reserves, and they are certainly divesting while trying not to make it obvious. This inflation might just signal the end of our free lunch.

    I don’t see how raising the interest rates will stop this. We need to raise taxes, especially on capital gains to encourage using money inside firms providing employment rather than for stock buybacks. You know, good old capitalism.

    1. ndk

      You’re right, Robert, and this is very important. Not only did we effectively confiscate as much of Russia’s reserves as we could — for the paltry good that did, given how fast we’re replenishing them through higher prices and our SWIFTly self-inflicted wounds — but we even forced them to technically default on some of their USD-denominated bonds. I can’t imagine other asset holders or issuers would dare invest in us now.

      Contrary to popular opinion, that’s why I think the USD has quite some room to run: we will need to compete to attract capital rather than receiving it by default as we had in the past, which means higher real returns on investment, which generally means higher real interest rates, which ceteris paribus means a stronger currency.

      There’s a lot of ceteris in that paribus, but physics should prevail. It is definitely the end of the free lunch, and hopefully we are willing and able to work for ours now. I honestly hoped that with Setser at Treasury, we would have achieved better than this.

      I agree on the taxation rotation, but I would go farther on the “good old capitalism” bit. We’ve amputated our invisible hand through hordes of zombies with hoards of zombie money, investing blindly through index funds. Your company’s investment merit now depends on its market cap rather than any intrinsic business factor, which makes me sad. The Bogleheads have won, and the damage will take decades or longer to repair, if we ever manage.

      On the plus side, it does make life a whole lot more rewarding for active investors.

      1. Robert Hahl

        How will present value calculations be explained to American economics students from now on? They always use US Treasuries as the example of a risk-free bond. Biden just rendered 75 years of economics textbooks obsolete.

  10. Dave in Austin

    Yves pretty much sums it up when she says: “To reduce things to simple-minded but still pretty accurate terms, since too much demand is not the cause of our inflation, it correspondingly seems likely that central bankers will have to overkill the economy to kill inflation.”

    So this is like the diet for the 400 pounder. Cut the food to slowly and the person doesn’t lose weight fast enough; cut the food too quickly and the person may have a seizure or suffer from a cardiac arrest.

    How do we tamp down demand where it matters (SUV production, commuting and airplane leisure travel for oil examples) while leaving enough for the folks making less than $40,000/year? We need a better Bernie. Fuel and basic food are the major issue for average people, plus housing and medical care. For the average person the Ukraine is a sad TV show, Chicago Fire with far-away victims.

    I’m in the LBJ archive these days looking at the 1964-68 Copper crisis; too much demand, not enough supply and a war that would require huge amounts of copper to make brass shells. The side effects of all choices aimed at cutting demand and boosting supply were sobering. We are now there again.

    But now we have a more dysfunctional national government. The Democratic party is based on ethnic and gender interest groups and led by a dwindling base of aging, out-of-touch, goodhearted NPR liberals funded by rich coastal elites. The Republican party is based in small cities and rural areas which, for understandable reasons, believe almost nothing they are told by the mainstream media.

    Reading both the memos from 1965-68 and the political speeches of the time, I’m reminded how much both parties have pulled away from the center and now speak in codes designed to energize the fanatics and never communicate with the surprisingly large majority of troubled people in the middle.

    The old political bosses were not pretty, but they gave us Trumans, Eisenhowers, Stevensons and Tafts. The move toward more “democratic” selection processes like primaries has made our system more prone to select candidates disliked and distrusted by the insiders who actually know them and produced the present world of well-funded candidates with perfect haircuts. The first of the new breed was the decent JFK; have you noticed how perfect the new breed of candidates’ wives look compared to Bess Truman and Mamie Eisenhower? It isn’t really “1984”. That takes planning. It is more like the movie “Nashville” with the perfect nonentity candidate Hal Phillip Walker who talks constantly and says nothing while the public drifts past living their own lives.

    Such leaders are unlikely to bridge the gap which separates the red and blue worlds.

    1. .Tom

      Seems to me that we could contract the consumer economy, discipline the FIRE sector, and protect people if we had an overall strategy that coordinated policy in a number of areas. Unfortunately pols in most “developed” “western” countries have sworn off this kind of grand planning and I have the sense most voters either disapprove of it or don’t believe it is feasible under contemporary electoral politics.

    2. Yves Smith Post author

      You are oddly overlooking the elephant in the room.

      The thing we could do that would have the biggest impact on inflation would be to end sanctions on Russia. Within 3 months I guarantee the price of oil and gas alone would drop substantially, diesel more so, and deflation in those prices would get inflation below 5%, probably in the 4% range. Improving access to fertilizer would take longer to take the edge off food price inflation but that would help too.

      1. Tom Pfotzer

        Yes. That’s clearly the case, and is an easy technical fix.

        The politics of appearance are quite different, and politicians … are weak, here in the U.S., at this time. As I mentioned in previous threads, there’s a great deal of climb-down to be accomplished between now and election day. Tuff pill to choke down, especially under “enemy fire”.


        Some of you may notice that I said “President Biden” in comments above. That’s a measure of respect that I know many of you may not endorse, and for good reason.

        I used that honorific out of a sense of hope. I hope that someday, maybe soon, we’ll have a President that deserves our respect, and with that in mind, I respected the office, if not the incumbent.

        Yes, I am a hopeless, and rather naive. As a counter-weight .. I have a plan. While I’m hoping, I am also busy do-ing.

        Trust, but verify.

      2. Karl

        While a technically easy fix, ending sanctions now would be admitting what many warned: economic sanctions wouldn’t work for the purpose intended, i.e. to intimidate Russia into withdrawal from Ukraine.

        Admitting this would also mean admitting to a pitiful lack of understanding of Russian intentions/motivations/military capabilities, and/or stupidity at the top.

        Rather than admit these things, all Biden can do is “try this, try that” and keep improvising to maintain a facade of leadership and control. He’ll try anything — even beg to the murderous Saudi Crown Prince — but he won’t end sanctions.

        What this means is that this President is showing his risk preference: better to risk a global recession than admit that 1) sanctions were stupid and 2) Russia will win anyway. Better global economic suffering than political suffering for our President. And yes, the political suffering (for him) will be excruciating. In many ways it already is.

        Among the jobs to be lost for this denial are those of Democratic Party office holders after the November mid-terms.

        Good job, Joe! And to think that I once naively hoped that this guy, with a 30-year career as foreign affairs “expert” in the Senate, would be smart on the global stage as President!

      3. Robert Hahl

        If it is true that US sanctions have never worked to change a target government’s policies, perhaps blowback from US sanctions won’t work to change its own policies either.

  11. Susan the other

    Instead of killing the economy – which is just another form of denial – we need to allow inflation to happen as we change our economy. Crushing inflation implies that we don’t want to change, we want everything to stay static, and a mess. But letting inflation fly, funding all sorts of urgently necessary activities (the list is long, mostly green and social) to keep everyone employed at ever higher wages in order to buy the essentials is the best thing we can do. Let the dollar fall. It needs to fall. And we’ve got tons of work to do to create sustainability and to clean up a staggering amount of pollution. We can pay everyone good wages to do good constructive work in a zillion fields of necessity. And our exports will be more affordable – not that exporting should be our goal, it should not. Our domestic economic health should be our goal and maybe then exporting that expertise. Inflation is not the problem. Denial is.

  12. Glen

    Unfortunately Obama had the perfect opportunity to fix the Fed, SEC, and any other number of regulators back in 2008, but (in his defense), he did what he was paid to do which was throw whatever amount of money was required at all that fraud and corruption, and leave all the deregulation intact. After all, they did a pretty good job of defanging Wall St after the Great Depression with the Banking Act of 1933 (Glass-Steagall):,Roosevelt%20in%20June%201933.

    So what’s interesting about the above linked Fed essay is it fails to mention that even though you can now get interest on your savings account, that deregulation has caused periodic crashes (your 401K is a slot machine) and Fed policies that made the price of housing approach unobtainium for normal Americans. So Obama could have fixed some of it, but several other major problems have also caught up with us.

    Before we had banks that were TBTF, we now have central banks that are TBTF, and we have created a whole generation of elites that had NEVER had to face reality. (These idiot elites/PMCs are a huge problem, they infest our society, corporations, and government.) Russia/China and a multipolar world is reality. Climate change is reality. A hollowed out America is reality.

    Our elites have been kicking the can down the road for decades, but it got kicked into a toxic waste dump burn pit, and the can, our illusion of reality, is melting. What will this bunch of corrupt narcissistic elites do next?

    We should be acting to mitigate the very real problems in out country, but we still are not, not with the urgency these problems demand. I strongly suggest we start by selecting leaders that are going to have to live through this mess, the current crop of 70-80 year olds (except for a handful) do not care; they don’t have to, they will be dead.

  13. Winston S

    Very few people really understand inflation, least of all the ones who’re supposed to, the economists. And even less so, those economists who subscribe to Milton Friedmans dictum that inflation is always caused by printing too much money.

    Blair Fix (per his own words, for the uninitiated: “Political economist. Blogger. Muckraker. Foe of neoclassical economics”.) has written a superb long form blog post/analysis about this, really recommend this and everything else he posts – original and clever thinking.

    Some quotes:

    The real story of inflation — the one that goes largely unreported — is of wildly divergent price change among different groups of commodities.. In the real world, Nitzan observed, price change is always ‘differential’, meaning there are winners and losers. The consequence is that inflation is not purely a ‘monetary phenomenon’, as Milton Friedman claimed. Inflation restructures the social order.

    It is this real-world feature of inflation that is most important, because it means that inflation signals a change in society’s power structure. Predictably, it is this real-world feature that mainstream economists ignore — largely because it conflicts with their tidy theory of inflation as a ‘monetary phenomenon’. Fortunately, the evidence is clear. Inflation is (and has always been) overwhelmingly differential. Inflation is restructuring

    1. Tom Pfotzer

      I’m riveted. Please detail what the restructure is: what’s up, what’s down. Who wins, who loses, and why.


      And of course, and Yves has posited above, inflation is also a production phenomenon – supply constraints caused price rises. Those particular price rises had nothing whatever to do with money supply. Note I didn’t say that the money supply hasn’t sharply expanded, and I didn’t say that said expansion isn’t (potentially) a powerful inflation force.

      And China’s ascension to the world trading theater profoundly impacted inflation (lots of great goods had cheap!). Inflation was thereby contained during an enormous money supply expansion.

      So there’s another non-monetary force that affected inflation (contained it).

      1. digi_owl

        In the end, if all accounts, everywhere, could be adjusted to fit inflation over night, inflation would be a non-issue as it would just be akin to moving the desimal point in the ledgers.

        But economists love to ignore such things as time, outside of handwavy statements about short and long runs. And time is what makes inflation painful, because there is a time delay between the price adjusting and the wage adjusting (if at all).

        I really really wish that Steve Keen’s work on a modern computer model of economic flows, very much a continuation of Philips’ hydraulic model, would be far more adopted in the economics world than it has.

    2. eg

      Never mind that old goat, Friedman — inflation is always and everywhere a distributional phenomenon, and therefore inescapably political.

      There’s a reason the subject was originally called “Political Economy” and that propertarians paid handsomely to send the history of the subject down the memory hole …

    3. Foy

      Great article, thanks Winston

      “Notice how this evidence changes your view of inflation. It makes it hard to blame government for the problem. You see, if big business is systematically benefiting from inflation, it implies that these big corporations are raising prices faster than everyone else. In other words, it is oligopolies that are driving inflation.

      “So it seems that in the real world, inflation looks nothing like it does in economics textbooks. Yes, inflation is a ‘monetary phenomenon’ — as is anything to do with prices. But more importantly, inflation is a power struggle over who can raise prices the fastest.”

  14. Mikel

    “Some of that loss is due to Covid. The US has lower labor force participation than before the pandemic, yet unemployment is low and many establishments complain about the difficulty in getting workers…”

    And all the shootings add up. Mostly young being killed. That is workforce participation being removed now and in the future (school shootings).
    And all the opiod crisis numbers add up…

    You get the picture.

    But what also gets my gourd is when some say “it’s the lockdowns” that caused the problems. First, entire states didn’t really lock down for any significant period. Second, (and actually the biggest issue) it’s the health care system, stupid. An overwhelmed healthcare system doesn not make for “carry on, business as usual” environment. And it is healthcare system capacity has still NOT been addressed.

  15. eg

    The Fed is feeling intense heat from all the scrutiny and is compelled to be seen to be “doing something.” Since all it has is a hammer (the blunt instrument of rate hikes) it will go on pounding nails into the working class until labour is crucified upon a recession.

  16. GeorgeSiew

    The idea that raising interest rates to trigger a recession will always stop inflation is misguided and unproven. The example always given is volker but did raising interest rates really do the trick? If china did not enter the global supply chain during that same period how long would the recession have held inflation down? 1yr? 2yrs?

    Raising interest rates doesn’t just lower demand it also kills investment. Facing the problems today you have to ask yourself will the economy benefit more from suppressed demand or will it suffer more from reduced investment?

    If inflation is caused by supply constraints then the best treatment is low interest rates and high prices which drive investment higher. High interest rates hurt rather than help with that problem. It address instead the problem of runaway and accelerating demand.

    So is the current CPI inflation caused by runaway demand? Are Ppl gorging on food, building pyramid stacks of toasters and burning gasoline for fun? Or is the current inflation cause by rising real costs for all the inputs we use to maintain the same standard of living we had yesterday? Is our inflation just a neutral inflation leaving relative real costs unchanged as we would expect with just money printing or are the real costs of living being repriced higher? The answer to all these questions suggest to me that the current inflation is primarily a real rather than monetary phenomenon. That means addressing it with high interest rates and recession will be disastrous. We may get lower inflation for a few quarters while businesses get liquidated but afterwards the investment destruction will mean that we will be in even worse shape for inflation in the long term.

    Our economists that run things are blind fools. They only know how to make things worse.

    1. Tom Pfotzer

      George: That was a first-rate post. Thanks for making the effort to put it out there. Here’s the part I zeroed in on:

      is the current inflation cause by rising real costs for all the inputs we use to maintain the same standard of living we had yesterday? Is our inflation just a neutral inflation leaving relative real costs unchanged as we would expect with just money printing or are the real costs of living being repriced higher? The answer to all these questions suggest to me that the current inflation is primarily a real rather than monetary phenomenon.

      Let’s examine “rising real costs for all the inputs we use”, since it’s central to your point.

      inputs we use a lot of include energy, fertilizer, cement, lumber, petro-feedstock, iron, nickel, copper.

      We’ve noted elsewhere that petroleum production is constrained by producer-decision (or national policy decision re: embargo), not production-capacity caps, so that addresses to a major degree the recent energy, fertilizer, cement, and petro-feedstock price rises.

      Why would these costs (not price, but _costs_) go up by 9 percent per annum (current inflation rate)?

      Did the mines suddenly run out? Did the petroleum and gas reserves underground suddenly deplete faster?

      I am having trouble accepting that premise. Most mineral deposits get depleted on a gradual basis, and certainly not at 9% per annum (on the aggregate; certainly you can get that rate of depletion on a mine that’s nearing end-of-life).

      I’m asserting that the underlying resource base is not being depleted at a rate substantially different than it was pre-inflation-bout.

      What about the other production costs, like labor and equipment? I am not hearing reports of wages increasing at 9% annually. Nor am I hearing of equipment wearing out at a rate that’s different than pre-inflation-bout.

      I ask: are you reading about cost of production increases re: materials, and if so, what’s the basis of the cost-rise?

      Thanks again for your excellent post. Definitely takes the discussion in an interesting direction.

  17. Grayce

    Let’s talk about the givens of “The Economic Engine.”
    Rugged individuals take risk – get rewarded financially. So far, so good.
    “Investors” are the most important stakeholders in a corporate business. Is that so?
    Entrepreneurs create brand new business and deserve our thanks. Two directions that can go.
    1. Entrepreneur #1 invests his/her own assets for future gain. Succeeds. Makes a profit. Sounds fair.
    2. Entrepreneur #2 borrows assets for future gain. Expects the same profit as #1. Sets prices to cover cost to produce PLUS cost to pay off interest. Consumers complain. Economists call it a “wage-price spiral.” Was it? Or was it a profit-interest-wage-price set of dominoes?
    In the 1980s, Human Resources admin began to shift from staff development and compensation to cost center reduction. Intellectual assets were reclassified as labor cost.
    Productivity measurements shifted from Output divided by Input, in the same timeframe, to Output, from inventory or parts in house, divided by reduced workforce, in a later timeframe.
    This faux productivity was not sustainable at the same time (1980s on) that CEO salaries and bonuses moved from 4x average worker to 40x average worker. Each year that productivity included total payroll, forty people had to be fired.
    The observation of less productive capacity is accurate. It is weighed down by out of sight executive comp.
    So, the unrecognized factors of interest in private enterprise (real estate development?) and executive comp in corporations, are ripe for New Economists to create a few new paradigms.

    1. ndk

      “Investors” are the most important stakeholders in a corporate business. Is that so?

      This is actually a very interesting question. I can think of governments, customers, employees, and perhaps there are others. How do you weigh those interests?

      I’d love you to expand on your thoughts on this for us slower thinkers.

    2. Tom Pfotzer

      I think your framing the issue as “what behaviors to reward” is fruitful, and I hope you’ll expand on that some in later posts.

      I also think you’re conflating HR policy with the general, long-standing objective of replacing labor with capital via technology. It’s not an HR decision so much as an owner/management imperative. This is why organizations buy machines (of all sorts, including computers with software).

      This relentless pursuit of productivity via technology has the natural, perfectly appropriate effect of replacing (relatively) expensive labor with less-expensive machinery. Doing so requires a lot of skill to accomplish, and it confers a great deal of benefit to the owners of the enterprise, hence the big (out-sized) rewards to management and owners.

      That trend has been going on a long time. It’s accelerating, and the effect, of course, is to reduce the pool of potential buyers of the organization’s products. Why? Because the potential buyers have been factored out of the income stream.

      That’s what all the stimulus, transfer payments, etc. are for: to support demand in spite of the fact that the buyers really aren’t making enough to buy.

      That also explains why capitalists are constantly in search of new markets. They’ve saturated the buying power of their domestic markets.

      This trend has also been going on since the turn of the 20th century, and this fact explains why the temper tantrum happened when the West started to get shut out of Asia.

      Lastly, if the stim-paks and transfer payments get curtailed due to inability to borrow, or increased interest rates, then this issue of insufficient demand to soak up (a very, very high degree of extremely labor-efficient) production will come to the fore.

      It’s been masked and obfuscated and can-kicked for decades, and possibly it’ll be can-kicked a while longer, but I think we may be on the cusp of a sea-change.

      Why? Because it’s about to get much harder to borrow, and much harder to money-print (inflate).

      This is the box the Fed and all of industry has been feverishly trying to avoid since the mid-80s.

      1. c_heale

        Capital and labour are completely dependent on energy. If we are at the beginning of the end of the oil age, then we are going to have a massive downturn in economic activity.

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