A Review of American Inflation in the Past Hundred Years
It has been nearly 3 years since the outbreak of the new crown pneumonia epidemic in early 2020. From 2020 to 2021, in response to the economic recession brought about by the epidemic prevention measures, the US government and the Federal Reserve have implemented unprecedented loose fiscal and monetary policies. The U.S. government sends money to most families and exempts some small and medium-sized enterprises from taxes. The Federal Reserve slashed the federal funds rate and implemented a large-scale quantitative easing policy in the context of zero interest rates.
The effect of generous easing policies is still obvious. The U.S. economic recession is not large, and the stock market still has a certain degree of rise. But everything is too much. In recent years, the “Modern Monetary Theory” (Modern Monetary Theory, referred to as MMT), which is actually followed by the Fed’s large-scale quantitative easing policy, is bound to leave sequelae if it is abused. “Modern Monetary Theory” believes that the money supply does not have to be linked to any commodity or foreign currency, but only needs to correspond to future taxes and public debt. There is no nominal budget constraint on currency issuance, only the real constraint of inflation. This theory advocates functional finance, which can monetize fiscal deficits: as long as the whole society can tolerate inflation, the central bank can supply money indefinitely.
The epidemic has entered its third year. Just as the U.S. government and the Federal Reserve are complacent about their achievements in saving the U.S. economy, the U.S. economy is in trouble. It’s just that this time it’s not because of “unoptimistic expectations” that companies are afraid to invest and residents are afraid to consume. is high inflation. Entering 2022, the inflation rate in the United States will be as high as 6% to 7%, and the year-on-year inflation rate in June will reach 9.1%. After July, although the inflation rate dropped, it remained at a high level above 8%. The common people complained about the sharp decline in the purchasing power of the banknotes in their wallets, and the Federal Reserve hurriedly adjusted its monetary policy to curb inflation. After raising the federal funds rate by 25 basis points in March and 50 basis points in May, the federal funds rate was raised by 75 basis points in June, July, September and November. While raising the federal funds rate unprecedentedly, the Federal Reserve terminated the quantitative easing policy in time, announcing that it would sell 47.5 billion U.S. dollars of undue bonds to the market in June and July to withdraw currency; billion in outstanding bonds.
Will the Fed’s aggressive interest rate hike achieve its goal of curbing inflation? To answer this question, we must first analyze the causes of inflation. Here we have to mention the research on inflation nearly 100 years ago by the famous American economist Irving Fisher (Irving Fisher, 1867-1947).
Fisher has long studied the relationship between currency circulation and inflation, and is recognized as the pioneer of modern econometrics and mathematical economics. He not only made outstanding achievements in economics research, but also founded several lucrative consulting companies, and was also an important partner of the famous Rand Corporation (Rand Corporation).
Fisher’s most famous research result on inflation is called Fisher’s exchange equation: MV=PQ, where M is the average amount of money in circulation in a certain period of time, V is the velocity of money circulation; P is the weighted average of the prices of various commodities Q is the transaction quantity of various commodities. The left side of the equation roughly represents the demand side of the market, and the right side roughly represents the supply side of the market. The larger the amount of currency M in circulation, the faster the velocity of money circulation V, and the greater the market demand for commodities. On the supply side, the larger the quantity Q of commodities, the easier it is to meet the demand, and the price P is not easy to rise; if the supply Q of commodities cannot keep up with the demand, the price will rise.
In his thin but informative book “Money Illusion”, Fisher mainly discussed the formation mechanism of “absolute/relative inflation and deflation”. Fisher made a simple analogy to allow readers to better understand his theory: spread butter on a piece of bread, the thickness of the butter represents the price level, the size of the bread represents the quantity of goods, when the total amount of money in circulation increases, and When the quantity of goods does not increase, the price of goods will rise, just like spreading too much butter on a slice of bread will cause the butter layer to thicken. The amount of butter and the size of the bread together determine the thickness of the butter layer, that is, the amount of money The size of goods (demand side) and the quantity of goods (supply side) together determine the level of inflation.
When Fisher wrote the book, the US Federal Reserve System had just been established, but he had already foreseen in the book that by adjusting the money supply and the base interest rate, the Fed would be able to control the stability of the currency value to a certain extent.
The reason why it is said that the Federal Reserve can only control the stability of the currency value “to a certain extent” rather than “completely” curb inflation is because inflation is not simply a problem of excessive currency issuance. For example, in the period after the 2008 financial crisis, the Federal Reserve released no less money than it does now, but it did not lead to significant inflation. The inflation rate in the United States even fell short of the normal target of 2%. On the contrary, some people believe that the long-term low inflation in the United States is because the U.S. dollar is the reserve currency of most countries in the world, and all countries in the world have absorbed the currency that should have remained high for the excess currency issued by the Federal Reserve like a sponge. swell. This statement seems to make sense, but before the collapse of the “gold standard” in 1972, the dollar could not be oversupplied because it was linked to gold. However, there were many major inflations in the United States between the end of “World War II” and the 1970s. Therefore, the cause of inflation is not unilaterally caused by the money supply, it is the result of an imbalance between the demand side and the supply side.
The Fisher exchange equation has also been confirmed by the inflation and inflation problems in many countries after World War II. From 1946 to 1947, a large-scale inflation occurred in the United States. At that time, the smoke of World War II gradually dissipated, and society returned to normal work and life. A large number of able-bodied young people returned to the United States, and the industrial system was restored from the military-industrial system during the war to the commercial system that mainly produced civilian goods. They quickly found jobs, and the money in people’s hands quickly increased. The government also removed the price controls imposed during the war. The wealthy citizens suddenly found that after several years of concentrating resources on war, there was an extreme shortage of consumer goods, and it was time to buy new products and get rid of old ones. So people went all out to buy, buy, buy. According to historical data, 140 million people in the United States bought 20 million refrigerators and 21.4 million cars in one year. The entire business community can be described as “crash buying”. Such a violent buying wave made it difficult for the supply side to resist, which naturally caused a rapid rise in prices, and the inflation rate reached a peak of 20% in 1947.
Entrepreneurs can’t help being elated when they see the people’s high purchasing enthusiasm and strong purchasing power. So they cranked up production frantically, and the supply side immediately caught up. Within a few months, the shortage was quickly reversed, and commodity prices miraculously dropped before the outcry forced the central bank to take steps to curb inflation. In the next year or so, the United States even experienced deflation. Cheap and high-quality goods filled stores, and the United States ushered in its first great prosperity after World War II.
Inflation ended in 1948, and three years later, in 1951, the United States ushered in another inflation. The reason for this inflation is the Korean War. The American people still remember the nightmare experience of currency depreciation, material shortage, and labor shortage during World War II. Prices jumped 10% that year. However, the public soon discovered that this war was only a local war, far less in scale and duration than World War II, and the domestic production capacity of civilian commodities was basically unaffected. So, within a few months of the commotion, prices dropped by themselves.
After the armistice of the Korean War, the world entered a period of relative peace. The economy is back on track, global productivity has been advancing by leaps and bounds for nearly two decades, coupled with the deepening of globalization, the processing industry has been shifting to Eastern Europe and Southeast Asia where labor costs are low, and inflation in the United States has been kept low for a long time. With continuous technological innovation and new products emerging one after another, the U.S. economy is increasingly showing a thriving scene. Just when most Americans thought that the good times would last forever, the nightmare of inflation came again. This time the inflation was ferocious and lingered throughout the 1970s and early 1980s.
From the late 1960s to 1982, the U.S. economy experienced a long period of low growth, but inflation never came down, at a level of 5% or even 10%. In 1980, the most serious period, the CPI rose as high as 20%. Economic growth is slow, but inflation remains high. Economists use stagflation (Stagflation) to define the economic conditions of the United States and developed countries during this period. After the 1930s, the tried-and-tested Keynesian strategy to solve the problem of economic growth also gradually declined because it was not effective.
Why did the two major inflations after the “World War II” die down in a year or two, but this one lasted for nearly 20 years? The reason is that this inflation is fundamentally different from the previous inflation ratio. Previous inflation was a demand-side problem—for some reason, a sudden release of exuberant purchasing power pushed up prices. Once the supply side catches up, inflation will soon subside. However, compared with the previous big inflation after the 1960s, the most important problem lies in the supply side, and there are more than one problems. This makes the U.S. government press the calabash to solve the inflation disaster, and the price cannot be controlled for a long time. .
So, what are the problems that lead to inflation on the supply side? The first was the collapse of the Bretton Woods system. Immediately after World War II, developed countries held a meeting in Bretton Woods in the United States to establish the international monetary system. At that time, except for the United States, other developed countries were basically in ruins. Therefore, in order to maintain the stability of the international financial system, countries agreed to peg the U.S. dollar to gold, and then peg their currencies to the U.S. dollar. In the past 20 years, the global economic aggregate has doubled several times, and the inflation rates of various countries are uneven. Therefore, the “dual peg” established by the Bretton Woods system is becoming more and more unsustainable. In 1971, the Bretton Woods system finally came out into history. After decoupling from gold, the dollar depreciated rapidly, and Americans needed to spend more dollars than ever before to buy goods at home and abroad.
Secondly, from the 1960s to the 1970s, two Middle East wars broke out in succession. Oil-rich Arab countries have been annoyed by Western countries such as the United States supporting Israel, and they have imposed an oil embargo on the West as a weapon against them. As a result, the price of crude oil soared, from $3 a barrel in 1970 to $40 a barrel in 1980, an increase of more than 13 times. Petroleum is not only energy, but also the basic raw material of many industrial products. The rise in oil prices has led to a surge in transportation costs and raw material prices, and the commodities on the shelves are finally setting record prices.
Thirdly, after World War II, there has been no all-out war in the world, and economic globalization has developed rapidly. In order to reduce costs, many processing industries in developed countries have shifted to Southeast Asia. This has largely contained inflation. However, from the late 1970s to the early 1980s, the “four tigers” in Asia took off, not only completing economic transformation, but also greatly increasing production costs. Their potential to provide cheap products to developed countries has almost been tapped, and countries such as the United States urgently need to find cheaper processing industry production bases.
None of the above three supply-side problems can be quickly resolved in the short term. The first two are caused by currency depreciation and rising oil prices. Even if the U.S. government makes great efforts, it can only be partially resolved, which means that the world will never go back to the past. The third problem, due to a series of inevitability and chance, was solved quickly.
In 1980, Ronald Reagan was elected President of the United States. He is an active advocate of neoliberal economic policies. Since 1982, Reagan has vigorously promoted economic reforms, emphasizing free market competition mechanisms, opposing state intervention in the economy, and loosening market and price controls on a large scale. At the same time, he suppressed the power of trade unions and said no to the excessive welfare demands put forward by trade unions. Several years of liberal reforms have led to an unprecedented explosion in the U.S. economy, productivity has begun to increase rapidly, and the U.S. has shown a new vitality.
Although the cost has dropped significantly under the free economic system, the cost cannot continue to fall when the cost drops to a certain level only relying on the United States to continuously tap its potential. Coincidentally at this time, China began its magnificent reform and opening up. China’s manufacturing industry, which has more than one billion low-cost laborers, is too attractive for the United States. In the early 1980s, the income of a worker in Mainland China was only 1/40 to 1/30 of that of a Hong Kong worker. A large amount of foreign capital has invested in the construction of factories in mainland China, and at the same time brought relatively advanced technology and management. Commodities produced in mainland China have also been continuously imported into the United States. In 1986, Vietnam also learned from China and started reform and opening up, which brought about a new wave of globalization. The supply of U.S. goods has greatly increased, and the cost of production has been further reduced.
At the same time, a new revolution is quietly taking place, further releasing unimaginable productivity. This is the technological revolution brought about by digitization and Internet technology. Digitalization has greatly reduced the previously high communication and operating costs, and greatly improved production efficiency. For example, computer-aided design, CNC automated production, remote transmission, electronic customs declaration, fund transfer, transaction settlement, etc., can now be completed at low cost through digitalization. In addition, digitalization can also produce many products that are basically copied at no cost, such as programmed software. It costs almost no cost to sell an extra copy, but the external benefits generated by this are very high. Digitization has significantly reduced production costs while substantially increasing labor productivity.
After the 1980s, the explosion of productivity and the reduction of labor costs brought about by globalization made the supply side almost completely meet the requirements of the demand side. In the past 30 to 40 years, the Federal Reserve has issued a large amount of money. The United States has experienced technology bubbles, real estate bubbles, energy bubbles and even the subprime mortgage crisis. However, inflation has remained at a very low level. 2% target and a headache. Alan Greenspan, the former chairman of the Federal Reserve, once said confidently: “Don’t worry about the growth of the money supply causing inflation. As long as labor productivity increases faster than the growth rate of money, there will be no inflation.”
After reviewing history, we return to the essence of inflation. The Fisher exchange equation: MV=PQ is roughly correct. Inflation occurs partly because of rising costs as certain resources are depleted, but more because of an imbalance between supply and demand. If the demand side is greater than the supply side, the solution is relatively simple. The Fed can raise interest rates to tighten monetary conditions, enterprises step up production, and the supply side catches up, and inflation will be resolved. Just like the first two inflations after World War II. However, if there is a problem on the supply side, it will be more difficult to restore the balance between supply and demand in the short term. At this time, the Federal Reserve’s interest rate hike can curb demand to a certain extent to match the supply side, but the risk is that both the supply side and the demand side are sluggish, which can easily trigger an economic recession. Therefore, there is only one way to solve the inflation caused by the supply side – to increase productivity. The fundamental reason why there has been no inflation in the United States over the past 30 years is the explosion of productivity.
Former Federal Reserve Chairman Alan Greenspan
On the other hand, is the inflation facing the United States today caused by problems on the demand side or on the supply side? It should be said that this inflation is caused by the joint influence of the demand side and the supply side. The reason on the demand side is relatively simple, that is, in order to avoid the economic recession brought about by the epidemic, the US government and the Federal Reserve have implemented an extremely loose policy of “flooding”. Now that the epidemic situation is gradually easing, the Fed’s continuous rate hikes and withdrawal of quantitative easing are necessary means to alleviate excessive demand. After continued tightening, it should not be difficult to reduce the overheated demand.
Looking at the supply side, the lockdown measures at the beginning of the epidemic have been completely stopped in the United States, and the domestic labor shortage has basically disappeared. However, in today’s world of economic globalization, American products are more dependent on other countries. Some countries have implemented strict epidemic control, and the supply chain has been seriously injured. The epidemic has prevented production and transportation, and the supply-side problems that caused this inflation have not been resolved. However, it should be noted that the current supply-side problem is not a systemic problem caused by productivity bottlenecks, but a supply chain break caused by the epidemic. Productivity has not shrunk in essence. Once the “world factory” returns to normal life, or American companies rebuild their supply chains in countries with loose epidemic prevention and control, at that time, without external stimulus, the supply side will soon recover, and the inflation rate will It will also come down.
The U.S. government is eager to reduce the inflation rate, and U.S. companies are even more eager to increase supply and earn more profits. It is foreseeable that American companies will accelerate the transfer of supply chains to countries with relaxed epidemic prevention and stable supply. In the process of supply chain transfer, the WTO mechanism will be further virtualized and replaced by bilateral and multilateral free trade agreements between consuming countries and producing countries. This trend of “friendship procurement” is becoming more and more obvious. For a country that is dominated by the processing industry in the world industrial chain, if the supply chain cannot resume operation quickly, then it is equivalent to voluntarily giving up a large export market, and will become a loser in the transfer of the supply chain in the next few decades.