If you think too much money creation causes inflation, we will get inflation. If you think budget deficits cause inflation, we will get inflation. If you are old-fashioned enough to think that rising costs and increasing economic inefficiency cause inflation, we will get inflation. It really doesn’t matter which economic theory you subscribe to, they all arrive at the same destination — more inflation.
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output,” said Milton Friedman in 1970. Well, we’ve had the money-supply growth; in the ten years to February 2020, M2 money supply increased by 6.3 percent per annum (data from Federal Reserve Bank of St. Louis). The problem is, we did not get the inflation that was promised. Nominal GDP grew only 4 percent per annum in the ten years to the fourth quarter of 2019, so the other 2.3 percent per annum of money supply got lost somewhere. Monetary economists wave their hands and talk about “velocity,” but monetary velocity is supposed to increase, not shrink, as our payments systems get more efficient. For the ten years before the coronavirus, therefore, Friedman’s central principle did not work; we should have had about 4 to 5 percent inflation rather than the 2 percent we actually got.
Since February, it’s a different story, however. In the six weeks to April 6, M2 money supply has increased by 7.7 percent, an annual compounded rate of 90.4 percent. That reflects all the money the Fed has pumped into the system; the statistics are not wrong. But at that rate of money creation, if Friedman is right, we should get inflation close to triple digits, 18 to 24 months from now. You can’t produce money at that rate without the dollar going the way of the continental, the assignat, the reichsmark or the 1946 Hungarian pengo, exchanged for the new forint at a conversion rate of 1029 to 1.
Okay, let’s abandon the monetarists for a moment and look at fiscal policy. The Congressional Budget Office projected a $1.1 trillion deficit in the year to September 30, 2020, to which the recent CARES act added around another $2 trillion. (Updated CBO projections are not yet available, unsurprisingly.) So, in round numbers, the U.S. looks like it will run a $3 trillion deficit in the current fiscal year, around 14 percent of GDP (and with output falling, it is likely to end up higher).
Maynard Keynes would tell you that this is all good, and Keynesians appear to be running our lives right now. But Keynes’s “stimulus” theory depends on there being a recession from outside, so productive resources are unutilized and can be put to use with an extra government boost. (Even in those circumstances, Say’s Law suggests Keynesian stimulus doesn’t work, but let that pass.)
That’s not what we have here. There are not long lines of pathetic, 1930s unemployed fathers of families laid off by the Great Depression, who can easily be put to work. Here we have around 20 million people who have been forcibly prevented from working by the government and the coronavirus. At least in the short term, there is no way to put them back to work and make them productive. The output they would have produced is lost forever; a restaurant meal not served in April cannot be served in August. Hence the extra money inserted into the economy has no goods to buy. That is the position we had in World War II — “too much money chasing too few goods.” It caused inflation.
Okay, take away the monetary and the fiscal arguments. The world economy in general and the U.S. economy in particular were humming like a top as recently as February, running at full employment, producing goods and services through a globalized distribution system that had been optimized over the preceding decade of increasing prosperity. The whole economic machine was running at maximum efficiency, producing maximum output.
Then it stopped. Even where factories could still operate, global supply chains were optimized on the “just in time” principle. That meant if any one supplier in the chain stopped production, the entire output had to be halted until alternative suppliers could be found. So production will not be able to restart unless all the suppliers are in place. Some key workers will be missing, some key factories will have gone out of business.
If you think of the world economy as a gigantic machine, it will no longer be operating smoothly; horrible grinding noises will emit from its innards, and smoke will billow everywhere. Inevitably, that will cause increased costs; it has to. Then there are the costs of shortening the global supply chains and perhaps re-domesticating some production. Entirely without economic theory, simply from observing how the world economy will operate for the rest of 2020 and probably 2021, you come to an inevitable conclusion: There will be inflation.
How much inflation? On that question, the crystal ball is still clouded. But if you asked me for a guess, I’d say low double digits in the United States by the first months of 2022.