I'm taking a break from discussing data modeling this issue to focus instead on potentially more contentious issues, specifically supply chains, work from home, and the phase transition of society to a new form.
I do want to preface this with the observation that I am not an economist, though I am something of a system theorist. The arguments presented here may anger some people, but my goal is not to attack political shibboleths, but rather to give people an alternative perspective about how the economy (and inflation) actually work.
With that said, after thirty-five years of watching how trends play out, one thing I've discovered is that the true impact of any event, any disruption, usually does not manifest immediately, nor does it occur in a vacuum. The current computer chip shortage has its origins in a fire in Japan earlier this year that shut down a major production plant there, the pandemic reducing available workforces while forcing more reliance upon shipping, a just-in-time management strategy that business managers used to try to save money by reducing redundancy in the supply, and automobile executives canceling chip orders in 2020 because they thought that demand was going to collapse.
What's notable here is that this has caused a dramatic increase in the price of electronics (which increasingly is everything that's not actually put in your mouth) which in turn is affecting everything else. The same thing is happening for food and gasoline, pushing inflation up dramatically after a couple of decades where inflation seldom reared its head. Monetarists have been pushing hard on the thesis that this has been due to rampant fiscal stimulus (that is, money going into the pockets of ordinary people rather than multibillionaires) despite very little evidence that this is actually happening. These same people have been downplaying the impacts of supply chain disruption, in part because the latter implies poor business decisions were made (reflecting badly on those people) and in part, because supply chains are complex.
A supply chain is not, as its name may imply, linear.
A car, for instance, is made up of thousands of different parts, many of which are components that have subordinate parts. The supply chain, from the perspective of the finished car, is more like a tree or a river delta. For instance, fuel injectors have built-in sensors that regulate fuel flow. In order to be able to put a fuel injector into a car, that fuel injector will need to be constructed at a previous time. No chips, no fuel injector. No fuel injector, no car. If the plant that produces the chips goes offline because of a disaster such as a fire, this creates a disruption. If an outbreak of Covid causes the fuel injector manufacturer to work at 75% capacity because its workers are sick, this too creates a disruption. If the ships that bring the fuel injector to the auto plant are forced to wait at docks because there are too few workers to empty them, this too creates a disruption.
When this happens repeatedly all throughout the supply chain, the disruptions cascade. The market is signaling demand and the suppliers are producing to meet that demand, but the supply is getting snarled in traffic.
Actually, the traffic jam analogy is a good one, because both are systemic effects involving transportation. A disruption, in this case, could be a fender-bender - traffic slows as other drivers move around the two drivers involved, the police show up and get the cars off the road until a tow truck can come. Once the distraction is gone, traffic picks up again. These occur frequently, but their impact for the most part is barely noticeable - people may get home a few minutes later than they would have otherwise.
However, occasionally you get situations such as one that occurred in Tennessee several years ago, where heavy fog caused a seventy car pile-up. This ended up taking more than a day to resolve, because there were only a limited number of tow trucks and police units, because in some cases the police and tow trucks couldn't get through as all lanes were completely blocked, and because local hospitals could absorb only so many casualties. At this point, the situation has become systemic, with interdependencies developing that make resolving the problem far more complicated. In effect, the system has dead-locked.
We are in the midst of a similar situation now, especially with regard to employers and workers. When COVID-19 first hit the US back in Spring 2020, many companies reacted first by furloughing workers, then laying them off in massive amounts, causing the unemployment rate to spike to nearly 20%. As the first wave of the pandemic peaked then receded nearly a year later, companies began rehiring, in anticipation of returning to the way things had been. We are arguably going through the second wave now with the delta variant causing more than a little anxiety with companies that may have restaffed too soon (which adds yet another disruption into the mix).
While it may not seem obvious, labor is still a supply-chain issue. In general, when you hire a person, you are hiring for a specific skill-set (including soft skills) to do a particular set of tasks. To get a person to a certain degree of proficiency in a skill, that same person starts out getting training, acquires self-confidence and facility, and increasingly also learns how to manage others doing the same thing. The goal for an employer is to hire and retain a given employee with sufficient skills and talents at the lowest possible price point for that employer. The goal of an employee is to maximize their salary and benefits while increasing their own value in the marketplace.
When unemployment soared to 20% (i.e., one person in five was unemployed), what had been a local problem became a systemic one. It meant that a whole lot of labor was suddenly available that hadn't been, which would, on the surface, favor employers. However, two factors changed the equation fairly dramatically. The first was that during the first wave of the pandemic, many people made the realization that they could work as or more productively from home than they could from the office due to the state of technology. The second factor was more subtle: once you realize that you didn't have to work in an office, it opens up where you can work (and whom you work with) significantly.
In addition to this, quite a number of people who were laid off were getting within a few years of retirement (or were at the age where you can retire and get benefits) and realized that they simply didn't want to get back into the saddle again. In 1955, the peak of the Baby Boom Generation was born, which meant that in 2020 they turned 65. Given the size of this generation at its peak, this took a large swath of people aged 63 and older out of the workforce, and we are now facing a declining older workforce from now until the mid-2030s, made up primarily of the most experienced people within companies.
A second issue emerged with the pandemic and the strong anti-immigration stance of the Trump administration - outsourcing opportunities declined in 2020, forcing many companies to start sourcing workers more locally.
Finally, wage inequality had been rising throughout the twenty-first century, primarily as wages failed to rise with inflation even as investment income increased dramatically. At the same time, the ability to create a business mediated by the Internet has become more and more feasible over time, to the extent that younger people have built up secondary streams of income over the Internet that were beginning to mature when the pandemic hit.
The upshot of all of this has been that companies went back into hiring expecting to hire back people at as low a rate as possible, only to discover that the combined need for specialization, greater mobility due to working virtually, the decline in the availability of older, highly skilled specialists and the hollowing out of the mid-tier of workers to outsourcing meant that wage expectations had risen dramatically (or put another way, wage inflation was also increasing).
This too is putting pressure on supply chains. You have fewer people working farms, fewer people driving trucks or manning ships, fewer people interested in working retail even as malls reel from a year of reduced traffic compared to online sources, fewer restaurant workers.
In general, local disruptions tend to have little impact on the status quo. but systemic disruptions almost invariably do because their time frame is so much longer. As we head into the Delta Variant Winter, it now looks like we won't be through the pandemic until Summer 2022, assuming that other variants (such as Mu) don't repeat the cycle next year.
Supply chains are networks. The strength of networks is that they adapt under stress over time, strengthening certain connections and patterns while routing around others. However, the longer this process takes place, the more that the networks end up favoring those new patterns over the old ones, especially when the changes due to the stress had already become trends before the stressors took hold.
This has huge ramifications. The workforce is becoming decentralized, and, at least in the arena of knowledge work, more global. Part of the reason that income inequality exists has been the fact that it has generally been far easier for US companies to outsource work (and take advantage of wage differentials) than it has been for US workers to work for non-US companies. However, that is now changing, as remote work begins to dominate, and, in many respects, the danger that represents to US companies is fairly profound: foreign companies are increasingly in a position to poach US talent, and many of those foreign have deep pockets.
There is a great deal of mythology surrounding inflation, and as inflation heats up, that mythology is being spoken once again by the movers and shakers. There is, for instance, a persistent belief that stimulus spending causes inflation. There is, ironically, almost no evidence for this. The last major era of inflation came in the mid 1970s through the early 1980s, with another period starting shortly after the Second World War and going almost into 1960.
It's worth looking at each of these eras. In the late 1940s and early 1950s, GIs had returned to the United States after the war, the economy was still geared up to produce weapons, artillery and military-issued goods. The process of converting those factories from wartime to peacetime production took quite some time, and at the same time, the GIs were going to college on the GI bill, then marrying their high school sweethearts, buying houses in the suburbs and brand new cars, and pumping out kids. In other words, demand was outstripping supply - for new houses, new cars, new clothes, new kitchens, new nurseries and playground equipment and on and on.
It also took a while to sort out labor for all the new factories being created or converted. The supply-chains were needing to be built, and until they were, there was too much demand for too few goods, causing the prices of those goods to shoot up in value. Because labor was tight, the same thing was happening with salaries. So the first period of inflation was due to supply-chain disruptions, and they eventually eased as production caught up with demand.
The second period of inflation had to do with a decision made originally in 1944, at Bretton Woods, New Hampshire, when 44 countries gathered to hammer out a post-war agreement on economic recovery (Germany had not yet declared defeat, but it was becoming obvious that it would happen by that point). One of the major stipulations was the agreement that oil, in heavy demand at this point, would have a fixed price per ounce of gold. Since gold was not in fact all that useful a mechanism for currency, the US further declared that they would fix US dollars to gold as well, so that if you wanted to buy oil, you would have to do so in dollars. How do you buy dollars? You sell gold, or you buy property, stock or bonds. As the US was the last man standing, most of the rest of the countries involved in the summit reluctantly let them do it.
During the fifties, this was great for the US, rapidly filling their coffers and making America the world's wealthiest nation. However, the population was expanding in the US faster than it ever had, and this meant that there wasn't enough available paper money to allow for population growth or to make loans. John F. Kennedy raised the USD/GLD rate, Johnson raised it again. Finally, Nixon tried to do it again, but De Gaul of France retaliated by demanding that US redeem the gold that France had sold them as part of the accords. Nixon responded by closing the gold window, which ended Bretton Woods and left much of the world holding American dollars.
As this was going on, the US hit peak oil in 1971, when the country was forced to start buying imported oil even as everyone else realized that they were holding fiat currency that was not backed by much of anything. OPEC, which had been around since the 1950s, began to nationalize their oil production, in many cases, seizing control of existing (US) oil companies, and the price of oil, temporarily unmoored, rose dramatically to about four times it's previous value (about $13 a barrel, compared to about $2.50 a barrel in 1970. This had the effect of causing an oil shock, resulting in the 1971 recession and significant dislocation, and because the US was now consuming more oil than it was producing, commodity prices soared even as wages and economic activity collapsed, resulting in weak hiring.
This was again a supply-chain problem, though having to do with passed costs rather than significant supply-chain disruption. The cost of producing goods became prohibitive, and forced a great number of companies out of business quickly. disrupting supply even more. Add on to this the fact that Boomers, which hit their birth peak in 1955, were hitting the age that they would ordinarily start families (in their late twenties and early thirties, which is the period of peak demand). The history of inflation during this period was actually somewhat anomalous, in that the oil shock had largely faded by 1975 and inflation was on its way down, then it began expanding again into Ronald Reagan's term (partially through secondary oil shocks due to the fall of the Shah of Iran
Paul Volcker, as Fed Chairman, raised interest rates dramatically under Reagan, but not at his behest (in fact, Volcker managed to avoid being fired because Fed members cannot be fired during their term, but he lost considerable sway from that time on). This did cause a recession that slowed the recovering economic activity sufficiently that the impact of the Boomers on spending had passed.
Monetarists, including Milton Friedman, had long argued that it was "reckless" deficit spending that causes inflation, but if you replace the words "fiscal stimulus" with "lower and middle class tax cuts" (which is what such stimulus really is), it's worth noting that there's surprisingly little correlation between tax policy in general and inflation. Tax cuts that favor the rich tend to get reflected in the stock market (and income inequality) but have comparatively little impact on the economy, as the Trump Tax cuts in 2017 demonstrated clearly, at a time when the economy was actually at near full capacity. Obama's tax cuts (sorry, "stimulus") were fairly limited, and I think it is arguable whether the tax cuts should have been larger, but the result of that was a long, slow recovery. It likely did increase the velocity of money in the economy by enough to keep the recession from worsening, but not enough to significantly increase economic activity.
I don't know whether or not Friedman's thesis about the link between monetary supply and inflation is correct, but I do believe that supply chain disruptions play a much bigger role than they are credited for in causing inflation, as does demographics. When a population is growing, to maintain the same level of economic activity you have to increase the available money supply, which means that a certain degree of inflation is actually desirable. When Friedman was writing his thesis, the population was increasing dramatically, and that created supply-chain shocks. Today, the population is increasingly far more slowly (and should actually peak by 2050, incorporating immigration. Without immigration, the US, like much of the OECD, would actually be shrinking).
My assertion, then, is simple, if disturbing - as population growth cools, most inflation will be caused by supply-chain shocks rather than monetarist policy, while there will in fact be an underlying deflationary pressure as the population plateaus then begins shrinking again. In the short term, the pandemic and not fiscal policy is causing inflation, and once the pandemic is brought back under control, inflation itself should fade away as supply-chain disruptions are mitigated. Monetary policy can help or hurt those most vulnerable to economic disruptions, but so long as there are competing pressures, the long term effects of monetary policy will largely cancel out.
There are two caveats and a final observation to this. The first is that I believe the potential for supply-chain disruptions will grow over time. The US (and the whole world) had the hottest summer on record in 2021, in what has been several decades filled with records to the upside with comparatively few to the downside. These cause localized disruptions, but as with the multi-car pile-up example given earlier, enough localized disruptions can create systemic disruptions. This means spikes of inflation battling an overall trend towards deflation.
The second caveat is that as such disruptions are becoming more frequent (and there is evidence that this is happening) then inflation may not be the worst part of it. The economy of the United States in particular has been predicated upon population growth leading economic growth through most of its history. As that paradigm fades, several assumptions about how the economy itself works will need to be revisited. For instance, does no one think it odd that interest rates have been effectively zero (and sometimes negative) for more than twenty years, with no apparent untowards effects?
The final observation is that the likelihood of the United States suffering a Weimar-like hyperinflation event is, in my mind, non-existent, except perhaps in the face of political dissolution (and maybe not even then). A hyper-inflation event is a currency collapse, and usually occurs only once a government becomes perceived by a majority of the population as being defunct but there is no solution to recover it. The strength of the United States ironically is that should dissolution happen, what would likely take place instead is devolution - the country would become four or five smaller nations, each with reasonably healthy economic systems. Hyper-inflation in that scenario is not a cause but a symptom of a collapsing state.
Kurt is the founder and CEO of Semantical, LLC, a consulting company focusing on enterprise data hubs, metadata management, semantics, and NoSQL systems. He has developed large scale information and data governance strategies for Fortune 500 companies in the health care/insurance sector, media and entertainment, publishing, financial services and logistics arenas, as well as for government agencies in the defense and insurance sector (including the Affordable Care Act). Kurt holds a Bachelor of Science in Physics from the University of Illinois at Urbana–Champaign.