# Inflation

## Error message

Deprecated function: The each() function is deprecated. This message will be suppressed on further calls in _menu_load_objects() (line 579 of /var/www/drupal-7.x/includes/menu.inc).

## Why Cherry-Picking Price Changes Is Not Helpful

### Tags

One pattern of comments that I have seen is where the person making the comment points out some particular price change, and asserts that this somehow proves that inflation cannot be 2%. This is a criticism of CPI data that does not stand up to even a brief examination of the official data.
Reminder: Feedburner e-mail is being discontinued in July. To get my articles by mail, please go to my free Substack: https://bondeconomics.substack.com/
I will just look at the United States CPI here, but the situation would be similar for other countries. There are eight major groups of prices in the CPI.

1. Food and beverages,
2. housing,
3. apparel,
4. transportation,
5. medical care,
6. recreation,
7. education and communication,
8. other goods and services.

Each of these has sub-divisions, which in turn will eventually be the result of averaging the prices of particular goods or services in a location (coming from an extensive survey).

The chart above shows the dispersion of prices within the CPI, just looking at the major group level. It compares the maximum annual inflation rate across the groups versus the reported (headline) CPI figure since 1995.
As can be seen, the maximum inflation rate since 1995 (which is the period where the U.S. has had core CPI sticking around 2%) has often been 5% or even over 10%. Meanwhile, these are major groups — we expect that we can find individual items that have even higher inflation rates.
Therefore, pointing to some particular goods price rising at 10% does not invalidate the CPI: the CPI data tells us that is happening. However, inflation is supposed to be a generalised rise in prices, which is why we take averages.
Finally, this analysis does not “prove” that the CPI is “correct,” rather, the critic would need to come up with an alternative measure, and show that it is higher.
(Note: this analysis is somewhat fragmentary; I will be writing this up later as a section in my inflation primer book.)Appendix: Economics Platform UpdateThe above chart was generated using some new functionality added to my open source “economics platform” project. It allows us to create functions that are treated as time series. I give a small update describing this on my Patreon (link).
Email subscription: Go to https://bondeconomics.substack.com/
(c) Brian Romanchuk 2021

## Rising prices equal an inflation outbreak (apparently) but then the prices start falling again

### Tags

In my daily data life, I check out movements in commodity prices just to see what is going on. As I wrote recently in my UK Guardian article (June 7, 2021) – Price rises should be short-lived – so let’s not resurrect inflation as a bogeyman – the inflation hysteria has really set in. I provided more detail in this blog post – Price rises should be short-lived – so let’s not resurrect inflation as a bogeyman (June 9, 2021). Yes, I stole the title of my article for the blog post if you are confused. The inflation hysteria really reflects the fact that mainstream economists are ‘lost at sea’ at present given the dissonance between the real world data and the errant predictions from their economic framework. They cannot really understand what is happening so when they see a graph rising it must be inflation and that soothes them because rising deficits and central bank bond purchases have to be inflationary according to their perverted theoretical logic. The financial market press then just repeats the nonsense with very little scrutiny. But given many graphs are falling again, this Pavlovian-type response behaviour must be really doing their heads in. I have no sympathy.

The inflation scare rises on a number

The accelerating inflation narrative was given a boost last week when the US Bureau of Labour Statistics released the May 2021 their latest Consumer Price Index data.

In their ‘The Economics Daily’ article (June 16, 2021) – Consumer prices increase 5.0 percent for the year ended May 2021 – we learned that:

The Consumer Price Index for All Urban Consumers increased 5.0 percent from May 2020 to May 2021. Prices for food advanced 2.2 percent, while prices for energy increased 28.5 percent. Prices for all items less food and energy rose 3.8 percent for the year ended May 2021, the largest 12-month increase since the year ended June 1992.

This set off all the inflation scaremongers but they really should have been more circumspect.

At least the US Federal Reserve Monetary Committee didn’t really blink.

In their June 16, 2021 (released on the same data as the BLS data came out) – Federal Reserve issues FOMC statement – they maintained policy settings and repeated that it was “committed to … promoting its maximum employment and price stability goals.”

It announced that:

The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least$40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.

So no rush to an inflation is out of control narrative.

If inflation is accelerating why are long-term bond yields falling?

I gave an after-dinner address to a financial markets conference in Sydney last week and inflation was on everybody’s tongue during the dinner.

I was not surprised how quickly the narrative has turned in this way.

As I noted during the talk, the mainstream macroeconomics narrative is so far out of kilter with reality that proponents are just coping with the dissonance by going back to Pavlovian-type triggers.

See food, and eat it sort of stuff.

In their case, they have been seeing relatively large fiscal deficits and central bank asset purchasing programs and the only thing their defective model says about that sort of conjunction is rising interest rates and bond yields and inflation.

They cannot ‘understand’ the world in any other way.

So their only ‘contribution’ is to scream ‘rising inflation’.

Except that they have constant troubles dealing with the reality that confounds this response.

If the US economy was overheating and inflation was about to break out then why would long-term US bond yields be falling recently?

That is a question I posed to the dinner.

Have a look at the history of the US 10-year Treasury bond yields since the beginning of 2021.

You can get for all available maturities from the US Department of Treasury’s site – Daily Treasury Yield Curve Rates.

As the economy started to opened up a bit in February and sentiment improved, investors started to diversify their portfolios away from the risk-free Treasury bonds and yields rose a little.

Since mid-March, yields have flattened and now falling.

Why does this militate against the accelerating inflation narrative?

For those who are a little hazy about bond markets – or fixed income markets – a bond represents a future flow of cash returns which comprise regular ‘coupon’ (interest) payments that are fixed and the refund of the principal (face value) upon maturity.

Given there is no default or credit risk in holding a US government bond (or any bond issued by a currency-issuing nation) the only uncertainty that a investor faces is the path of inflation over the time that these cash payments are relevant.

I explained the relationship between movements in yields and prices of government bonds in this blog post – Whether there is a liquidity trap or not is irrelevant (July 6, 2011).

We also discuss the difference between primary and secondary markets in that post.

The simple rule is that when bond prices rises (fall) due to demand fluctuations, yields fall (rise).

Expectations of inflation become part of this dynamic because inflation reduces the real value of the these future cash flows.

So if investors expect that inflation is becoming an issue, then they will demand higher yields at the primary issue and will be prepared to pay less for outstanding bonds in the secondary market.

The higher the expected inflation, the higher the risk premium that will be built into required yields.

The bond investors closely watch the central bank’s monetary policy.

If they form the view that the policy interest rate that the central bank sets is too low, then they will up their inflation expectations (because they have been conditioned to believe this state will promote inflation), and demand higher yields at the investment maturities (long-term).

So the so-called yield curve, which depicts the current bond yields at all maturities will steepen.

Here are two visual depictions of the US Treasury yield curve.

The first surface graph shows the movements across the maturities between May 3, 2018 and June 18, 2021.

The second compares yield curves from the beginning of 2021 to June 18, 2021.

You can see in this graph (which is easier to see than in the previous surface graph) that over June (compare the thicker red and blue lines), the yield curve is flattening rather than steepening.

If inflation was about to runaway, then we should not expect to witness that sort of dynamic.

US real wages down 2.2 per cent

One day after the US Bureau of Labour Statistics released the US CPI data, they released (June 17, 2021) the published an article – Real average weekly earnings down 2.2 percent from May 2020 to May 2021 – in their excellent ‘The Economics Daily’ publication, which highlights the big data news of the day.

The BLS reported that:

Real (adjusted for inflation) average weekly earnings decreased 2.2 percent from May 2020 to May 2021. The change in real average weekly earnings resulted from real average hourly earnings decreasing 2.8 percent from May 2020 to May 2021. The change in real average hourly earnings, combined with an increase of 0.6 percent in the average workweek, resulted in the 2.2-percent decrease in real average weekly earnings over this period.

No wages explosion visible there.

Nominal wages grew by 2.6 per cent only.

In May 2020, average (nominal) hourly earnings were $US29.74 and a year later they had crept up to$US30.33 (Source).

Average weekly hours had risen from 34.7 to 34.9 hours.

Which brings me to the data again

Here at the latest FT Commodities graphs – for Metals and Agriculture and Lumber as at June 18, 2021.

Metals

Agriculture and Lumber

Here are two more detailed graphs – for Soybeans and Lumber – over 2021 to June 18, 2021.

Soybeans

Lumber

Where are the screams of deflation?

I could have shown the movements in energy prices, which have been used to give credence to the accelerating inflation narrative.

Here is the OPEC – Basket Oil Price – from 2003 to June 17, 2021.

Sure enough oil prices have risen in the last few months as more cars are returning to the roads.

This is just a reversal of the price falls that occurred when the cars left the roads during the lockdown.

Note that the current level did not yet reach the pre-pandemic level and in recent days has started to taper off (see the next graph).

This graph shows the data from April 2021 to June 18, 2021.

Conclusion

I realise that it is easy to just be trapped by the data of the day, which doesn’t disclose underlying pressures and just reinforce one’s views.

And, to understand the inflationary potential one has to appreciate the levers that can be stimulated by some cost or demand triggers to generate a new inflationary spiral.

The point is that there are price pressures at present but I consider them to be transient as our economies and markets adjust to the massive disruptions in the global supply chains that have arisen during the pandemic.

And while in another era, these might have triggered a real wage-profit margin struggle between labour and capital, I cannot see the institutional machinery in place now to facilitate such a ‘battle of the markups’.

Trade unions are too weak and pernicious legislation has made it very hard for workers to fight for higher real wages.

That is enough for today!

## The G7 jolly – a symbol of everything that is wrong with the global economic system.

### Tags

Picture by Andrew Parsons / No 10 Downing Street Creative Commons License: (CC BY-NC-ND 2.0)

“The kind of transformation that is now required [to address the climate crisis] will happen only if it is treated as a civilizational mission, in our country and in every major economy on earth.”

― On Fire: The Case for the Green New Deal by Naomi Klein

Let’s start this week’s GIMMS MMT Lens with some good news! It might be from across the pond, but it is heartening to learn that this week John Yarmuth, Chair of the House Budget Committee, spoke on public television about the federal budget using an MMT framework. He explained that the US government is not money constrained and mentioned Stephanie Kelton’s book The Deficit Myth. Is this a defining moment? Can we make further progress within the ever-shortening timescale to address the key challenges the world faces? Let us hope so.

﻿﻿

The deficit hawks and doves that have hitherto ruled the roost, basing their ideas on the false premise of monetary scarcity, will surely have to acknowledge the reality of how governments like the US and the UK actually spend? Unless they want to find themselves in the dock for wilful harm.

The challenges before us are vast; from addressing the climate emergency to the existing and growing global inequalities that have been driven by the toxic economic system which prevails and dictates policy around the world. Watch this space!

At the same time as Yarmuth revealed the truth about monetary reality to a US public who, like many, have been coached to believe that the state money system operates like their own household budgets, in the UK we still have politicians pulling the wool over the eyes of its own citizens.

In an interview with Andrew Neil on the newly launched channel GB News, the Chancellor Rishi Sunak suggested that we would have to take some difficult decisions to get the public finances back on track. He claimed, disingenuously, that in order to deliver the Tory manifesto of ‘more nurses, more hospitals, police officers, levelling up and investing in local communities’, they had had no option but to cut foreign aid, because apparently the government has a finite pot of money. Harking back to Margaret Thatcher’s lie that ‘There is no such thing as public money. There is only taxpayers’ money’, he said:

“Of course, I’m a fiscal conservative because it’s not my money, it’s other people’s money and I take my responsibility for that very seriously.”

“All governments have choices to make. [We are] making sure that we can invest in our children’s future and not have them constantly paying for the past.”

Apparently, even in the midst of the greatest challenge humanity has ever faced, one which affects both rich and developing countries, we still have politicians falling back on the lie of monetary scarcity; thereby suggesting that saving ourselves is unaffordable.

Politicians who claim that the choices governments have are limited by the tax they collect or their ability to borrow, and that balanced budgets should be the aim of spending policy to avoid a debt burden on future generations, are misleading the public. Either through their own ignorance (debatable perhaps given the growing awareness of monetary reality) or more likely with the objective of driving through a political agenda favouring global corporations, whereby the State has become a cash cow for their operations. All at the expense of publicly funded and provided services that serve the nation’s interests.

The last 10 years have been a case in point, as austerity drove cuts to government expenditure on public and social infrastructure, on the basis of the lie that there is a limited pot of money with which to deliver government policy; resulting in a decaying infrastructure and severely impoverished sections of society. What a terrible price we have paid.

At the same time as Sunak promoted his fiscally conservative credentials, Labour, under the newly appointed Shadow Chancellor Rachel Reeves, announced that the country had ‘lost’ £16.7bn in tax revenues over nine years due to slow economic growth caused by government policies, and compared the amount that could have been in the Treasury ‘coffers’ had the UK grown in line with the OECD average.

The Shadow Chief Secretary Bridget Phillipson referred to ‘a decade of misspending of public finances and waste’, which she said had ‘weakened the foundations of the UK economy and severely hampered Britain’s growth’. And indeed, one might make a very good case for criticising austerity, which cut public services to the bone on the false premise that it would grow the economy, a premise which has been exposed as a cruel falsity, both in the light of its consequences and also of the vast spending that has been undertaken by the government to keep the economy from tanking during this pandemic, when up till that point successive Chancellors were promoting fiscal discipline. However, setting aside the drive for growth for the moment (we will come back to it) Labour is still talking about taxes funding spending. What’s changed? Growth may indeed increase tax revenues, but those increased tax revenues have absolutely nothing to do with paying for government spending, paying down the national debt, reducing a debt burden on future generations or whatever other nonsense is masquerading as fiscal correctness.

If we genuinely want to address the climate emergency and the vast global inequalities that exist, it’s a story that needs to be consigned to the dustbin of history.

And as for Treasury ‘coffers’, the government doesn’t have any. None of this narrative is true. It represents the continuing smoke and mirrors of monetary scarcity played out daily by politicians, the media, and orthodox economists. As was pointed out this week by an MMT activist, if everyone knew how the money system worked the UK Chancellor would never get away with the austerity nonsense pedalled by his predecessors and other politicians for the purpose of delivering a political agenda, and which has done so much damage over the last 10 years to the UK’s public and social infrastructure.

The government, as the currency issuer, has as much money as it needs to deliver its political agenda within the context of available resources. That is its only constraint. It does not rely on growth to fund its spending through the increased taxes such growth might bring. In plain speak, the government is not a household and is not constrained in its spending priorities either by the tax it collects (for vastly different purposes) or by borrowing. It needs to do neither. Such narratives are deliberately constructed to justify the pursuit of a damaging economic ideology that has been exposed by the pandemic as unnecessary and indeed vastly harmful.

That should be the starting point for the public conversation on what comes next, not whether the government has been fiscally prudent by balancing its budget or needs to cut back its expenditure to do so, however appealing that message is to a public still firmly ensconced in its household budget comfort zone for understandable reasons. If you hear the narrative enough times, you come to believe it must be so. We must therefore double our efforts to challenge and unpick the false narratives. Much depends on it.

Last week the G7 met in Cornwall and showed yet again not only its myopic, status quo vision for the future, but also its contempt for the pressing challenges we face. As world leaders flew in from around the world, the Prime Minister arrived in Cornwall after a short carbon-intensive flight from London, whilst laughably at the same time lauding his commitment to addressing climate change with his usual hypocritical bluster. It was also revealed that trees were cut down to provide meeting rooms for the heads of state who were there to address the climate emergency, amongst other things. Those very same trees which play a vital role in planetary health!

The final communique detailing the deal that had been struck by G7 leaders was criticised heavily for its failure to bring new cash to the table. The Build Back Better mantra vaunted by politicians and global institutions such as the World Economic Forum and the World Bank, is nothing but a toothless symbol defined by empty political rhetoric.

Max Lawson from Oxfam said of it, ‘Never in the history of the G7 has there been a bigger gap between their actions and the needs of the world. We don’t need to wait for history to judge this summit a colossal failure, it is plain for all to see’. A rich nation’s club in service to a rotten economic system at the expense of the well-being of the planet and citizens across the world.

The G7 jolly, in which guests were wined and dined in luxury, also showed huge disrespect for a region impoverished by government decree, and the local inhabitants whose lives were disrupted to accommodate the event. A symbol of everything that is wrong with the global economic system. You couldn’t make up this nonsense! The huge chasm between words and actions is getting wider and wider, as the climate realities continue to bear down upon us and are reported on almost daily. From the report this week that despite the slowdown in air travel and industry over the past year, carbon dioxide levels in the atmosphere reached 419 parts per million in May – the highest measurement of greenhouse gases that have been recorded in the 63 years covered by the Mauna Loa Atmospheric Observatory in Hawaii, to the UN’s warning that urgent action is vital to address the growing global problem of drought which is affecting both developing and developed countries.

In the words of Mami Mizutori, the UN Secretary for disaster risk reduction,

drought is on the verge of becoming the next pandemic and there is no vaccine to cure it. Most of the world will be living with water stress in the next few years. Demand will outstrip supply during certain periods [and will be] a major factor in land degradation and the decline of yields for major crops’. Mizutori went on to make it clear that ‘Human activities are exacerbating drought and increasing the impact threatening to derail progress on lifting people from poverty.’

The United Nations World Food Programme has warned that unprecedented levels of drought across many African countries are threatening human existence in those areas, as land becomes parched and consequently infertile, and famine takes hold.

California and Arizona have been hit by multiple wildfires this week; hundreds of thousands of acres have burned as long-standing drought continues to affect the area. Scientists referring to it as a ‘mega drought’ say that it should be a wake-up call, as water resources providing crucial supplies to 40 million people and feeding the needs of agriculture are at risk, and may force drastic and perhaps unpalatable action. The nation’s largest reservoir is on track to reach the lowest level ever recorded. Cities like Las Vegas are baking in temperatures reaching historic highs and researchers are predicting that this heatwave will be one of many likely to hit the US South-West before summer ends.

In the UK, the government has equally shown disregard for the growing threats as a result of the climate crisis and continues to learn no lessons.

The 2016 report on Exercise Cygnus which simulated the consequences of a fictitious influenza pandemic, warned that ‘the UK’s preparedness and response, in terms of its plans, policies, and capability [was] not sufficient to cope with the extreme demands of a severe pandemic that will have a nationwide impact across all sectors.’

It should therefore not be surprising to learn that the same is true of the Climate Change Committee’s risk assessment on climate crisis preparedness, also published in the same year. The 2016 report warned that the UK was poorly prepared for water shortages and floods. In 2019 it repeated its warning that the UK still had no proper plans for protecting people from heat waves, flash flooding and other damaging impacts arising from climate change.

The government responded that it ‘welcomed this report and will consider its recommendations closely as we continue to demonstrate global leadership on climate change ahead of COP26 in November’. It is difficult to know at this juncture whether to laugh or cry. Just more bluff and lies from a government which promises lots and delivers nothing.

As US President Joe Biden plans a huge fiscal injection to revitalise his country’s decaying infrastructure, which has arisen over decades through the overriding obsession of both Houses with balanced budgets and neoliberal dogma, our own over-privileged Chancellor is still bamboozling people with his nonsense about being a safe pair of fiscal hands. The only conclusion one can draw is that balanced budgets must trump human survival.

As the economist Daniela Gabor wrote in a recent Guardian article:

‘Climate activists should be prepared to fight the battle against fiscal fundamentalists with a simple message: the government is not a household.’

Also writing that:

‘We cannot rely on private finance to lead us out of a climate crisis it has systematically contributed to. We have to disempower carbon financiers, and we do that by making the democratic state – not investors – lead the way forward.’

The government has the capacity to be the real powerhouse in terms of both its currency-issuing and legislative powers, and contrary to popular opinion is not beholden to corporate dictat. Equally, in a truly democratic state as the economist Professor Bill Mitchell says, ‘The government is us’. We could be the real arbiters of change through our votes.

However, currently we have a democratic deficit reinforced by a toxic media which, as Raoul Martinez, the philosopher, artist, and filmmaker so rightly notes:

‘As long as the vast majority of wealth is controlled by a tiny proportion of humanity, democracy will struggle to be little more than a pleasant mask worn by an ugly system.’

Whilst the data shows that the world’s wealthiest 1% produce double the combined carbon emissions of the poorest 50%, and the Musks and Bransons of the world obscenely seek to exploit finite resources for thrill-seeking trips into outer space, such wealth inequality and unequal access to real resources are a degrading consequence of ceding power to the unelected, whose wealth buys them political influence.

We should instead be looking at how we reduce consumption of those same finite resources and at the same time put those we have to better use by creating a fairer and more sustainable planet. As it stands, their wealth brings the rich huge advantage, while the rest pay the price in increasing poverty, inequality, and planetary degradation.

At the same time, after an exceedingly difficult year of human suffering and economic pain, governments around the world are seeking yet again the holy grail of growth to keep the whole capitalist shebang on track and rolling. Often it is erroneously described in terms of delivering ‘green growth.’ This is a contradiction in terms, but invites us to believe that cosmetic changes will be enough to save us, and that we can continue pretty much as we are using new technologies; some of which are still in the land of imagination or have as yet to be proved.

We have reached a crossroads for decision making for the sort of society we want to see. As Jason Hickel, the author of ‘Less is more’ tweeted recently.

‘If your economy requires people to consume things they don’t need or even want, and to do more of it each year than the year before, just in order to keep the whole edifice from collapsing, then you need a different economy.’

Across the planet in both developed and developing countries, the prevailing economic system is built on the exploitation of humans and other real resources for profit at any cost and which is leading us down a path to no return.

And yet in the light of this, on the one hand we have the Conservative Chancellor promoting fiscal discipline and on the other, a Shadow Chancellor still grinding on about collecting tax from the rich to pay for public services, in a party beating its breast with mea culpa for there ‘not being any money left’ when it left office in 2010.

The continuing smoke and mirrors of public accounting will keep the lie going at huge cost. As climate change and the problem of the finite nature of real resources breathes down our collective neck, politicians are still asking the same old tired and irrelevant questions as to whether we can afford to save ourselves. All total baloney of course!

The G7 meeting has proved itself to be yet another talking shop and yet another of Boris Johnson’s ‘roadmaps’ to nowhere. The climate summit in November will undoubtedly take us even further down the greenwashing road to the maintenance of the status quo, given the current government’s ineffective, wishy-washy responses so far.

Worse, possible action is still viewed, at least in the UK, in terms of the state of the public finances and affordability. The government’s action on cutting foreign aid must put into question its commitment to bringing about change and addressing the vast global inequalities that exist largely as a result of neo-colonial domination and exploitation. We urgently need to acknowledge the vital role government can and must play in driving a real green agenda, not an apologist one serving the status quo.

The problem is this. What government that seeks re-election (unless you live in one of those countries which are suffering from the toxic consequences of capitalism and the neo-colonialism which continues to exploit and impoverish them, and who are unrepresented at the G7) is going to want either to deal with the hard truth or tell its populations that concrete transformational change to the way we live is needed. Not a change that aims to deprive people and make their lives miserable, but a revolution in the way we do things with the aim of changing our perspective, from one of endless consumption of stuff, to one of creating sustainable communities that put people and the planet at the heart of policymaking.

The sad truth is that governments currently exist for the benefit of global corporations, where profits matter more than people and the planet, and the rich are already looking for escape routes to safety – Mars might be a good choice. As the waters rise metaphorically and actually and nations start to fight over real resources, our children’s children will be the inheritors of the mess capitalism has made. Unless we do something different.

As Johnson spluttered on about the G7 rising to the challenge of ‘beating the pandemic and building back better, fairer and greener’, and bringing an end to entrenched inequalities’ after Covid, it seemed he had totally forgotten, as had his colleagues, that those inequalities didn’t just happen by themselves. They happened as a result of decades of neoliberal ‘free market’ dogma, subscribed to by political parties of all shades, and which has been firmly rooted over the last 10 years in unnecessary austerity policies in many major economies and also imposed on indebted developing countries. And does he recognise the global inequalities that have been created by the same toxic ideology, whereby the resources of developing countries have been exploited at a terrible cost to support the living standards of the West, and upon which the green revolution is planned? This is the same man who has been happy to go along with cuts to foreign aid because apparently we have spent too much and must look to counting the pennies to get the public accounts in balance. The word hypocrite comes to mind. With such a scarcity narrative, it might seem an uphill struggle to address the challenges.

What happens next will be determined by political will and public support. It is rooted in the reality that the Blue Dot we inhabit is all we are, and all we have. Seen from that perspective, it should be an invitation to explore how we can do things differently. MMT offers a lens on how we can achieve that. The road might be bumpy, and we might make mistakes along the way, but in the end, we’ve nothing to lose.

#### Upcoming Event

##### Phil Armstrong In Conversation with Mike Hall

Sat, 3 July 2021 – 15:00 – 16:30 BST

GIMMS is delighted to present another in its series ‘In Conversation.’

GIMMS Associate Member Phil Armstrong will be talking to MMT activist Mike Hall.

Mike is a retired engineer and a liver of life of many parts including as an Industrial Controls Engineer, Windfarm Engineer, General Manager of IT refurb resale small business, Worker Co-op founder and local authority Co-op Development Worker. He studied for a Masters in Business Administration at Cranfield (UK) and has been an MMT activist for 11 years. He is also a grandfather and a lover of Jazz!

Register for this free event via Eventbrite

#### Support us

The Gower Initiative for Money Studies is run by volunteers and relies on donations to continue its work. If you would like to donate, please see our donations page here

Share

Tweet

Whatsapp

Messenger

Share

Email

reddit

Pinterest

tumblr

Viber icon
Viber

## Forward-Looking Markets Should Not React To Lagging Data

### Tags

I ran into an amusing article by a certain mainstream economist, but I have used up my quota for dunking on him in Q2, so I will just make a more generic point related to an underlying issue that often comes up in discussions of the bond market by people who are not fixed income strategists. The argument is straightforward: the “common sense” belief that a jump in measured inflation will cause a rise in bond yields is incorrect. The reason is straightforward: the bond markets are forward-looking, while measured inflation is a backwards-looking measure (and is normally considered a lagging economic indicator).
(Note: I have a big consulting project is ongoing, hence this article is light. It is exceedingly likely that I have written a variation of this article many times. I am just repeating it since it is somewhat topical, and there is a chance that I picked up new readers when I launched my Substack.)
REMINDER: Feedspot email support is being discontinued in July. E-mail subscribers need to opt-in to the mailing list on my Substack to get my articles mailed to them. Link: bondeconomics.substack.com.
The “common sense” belief is extremely common, and I assume that it is the result of showing up in some decades-old mainstream Economics 101 textbooks. Over my years of hanging around fixed income, I have seen many variations of this from comments from the broad public as well as economists.
I would summarise the belief as follows: a rise in inflation causes bondholders to “lose money,” and so bond yields will mechanically rise by the increase in inflation to compensate (creating a further capital loss). Strangely enough, bonds are the only asset class (other than possibly cash) which “loses money” due to a rise in inflation. Even if equity and bond returns are the same, a rise in inflation causes losses for bondholders, yet equity holders are unaffected.
The Economics 101 part of the story is that bond investors “demand” a constant real yield. (The real yield is defined here as the nominal bond yield less spot inflation, which is not the same thing as the quoted yield on an inflation-linked bond — like the U.S. TIPS.) Therefore, since the real yield is fixed, nominal bond yields must rise by the amount of inflation.
If one wishes, one could scour online economic time series databases and try to torture the data to “prove” this belief. However, I will merely assert that we really cannot see such a relationship in the data. Maybe it worked one time, but it failed horribly the next.
Why does it fail? There are a number of pillars.

• Bond investors mainly work for institutions, and they are not normally benchmarked to inflation. (Admittedly, this is the case for some portfolios.) Their job is to make money. And if they are levered — and a lot of price determination is done by levered investors — prospective returns are supposed to much higher than quoted bond yields. If I were involved in structuring a trade in U.K. gilts, the change of price of Toad in the Hole in the local in Middlesmoor was something that I would have had zero interest in.
• Bond investors cannot “demand” any particular yield; they are stuck buying at whatever the market is trading at. If yields are too low, they can go short duration versus benchmark, but risk-taking capacity is finite. This means that they cannot force real yields to any particular value.
• Finally, bond prices reflect expectations about the future, while the inflation rate is the change in the price index from a recent past month versus the year before.

The final point is not entirely obvious, and has some entirely pointless controversies associated with it. The fair value of a bond is supposed to equal the “expected” return of a money market portfolio over the lifetime of the bond (with the same credit risk as the bond) plus an added “term premium.” Back in the day, the working assumption was that term premia were positive, but nowadays, anything goes.
The “expected” return on a money market portfolio will roughly equal the “expected average” of the policy rate, set by the central bank. That is, it is based on what bond investors think will happen. Published inflation rates are what happened.
Nevertheless, there is a way to make the “common sense” belief work: the central bank needs to react to past inflation. And if we look at the more incompetent central bankers in the past (cough ECB cough), that is how they behaved. However, say what you want about the New Keynesian whiz kids running central banks, they tend not to overreact to backwards-looking data. That said, not everyone in the mainstream (and elsewhere) got that message.
It is a mistake to argue that inflation does not matter under any circumstance for bonds, but you need to be extremely careful about what inferences you draw. Markets are hard to beat, and some market participants can forecast inflation data a few months ahead relatively accurately. This means that anything you read about in the papers about the latest CPI print is likely to have already been priced in.

Email subscription: Go to https://bondeconomics.substack.com/
(c) Brian Romanchuk 2021

## Price rises should be short-lived – so let’s not resurrect inflation as a bogeyman

### Tags

It’s Wednesday and I am somewhat besieged. So just a few reflections today before we delve into our latest music offering. I had an Op Ed published in the UK Guardian today (my time) which analysed the latest inflation scares that have been dominating the popular media. More and more mainstream macroeconomists are coming out and asserting that economies will overheat. The usual gold bugs have been delighted by this shift in the narrative back to the obsessions and manias that keep them occupied on a daily basis. What was interesting to me was the responses of the commentators to the Guardian Op Ed. If the sentiments expressed represent the state of macroeconomic knowledge (presumably mostly in the UK) then we have a long way to go before Modern Monetary Theory (MMT) and the sensible policies that it might inform gain any serious traction. Given the GFC, the stagnation in the aftermath, 30 years of Japanese history, the pandemic, which have all combined to demonstrate why the mainstream approach is dysfunctional and provides no guidance to what might happen in the real world, the commentators continued to rehearse these failed ideas about inflation, interest rates, bond markets etc. Quite dispiriting.

UK Guardian article

The UK Guardian published an Op Ed from me late yesterday (June 7, 2021) – Price rises should be short-lived – so let’s not resurrect inflation as a bogeyman – which provides a different view to some of the inflation question that is occupying peoples’ attention at the moment.

There is an art in writing just 900 odd words and the author has to make every phrase count and become a container for implicit and sometimes very complex propositions.

One hopes that the curious reader will pursue some of these issues in more depth elsewhere if they are unclear what the emphatic point being made is.

The article attracted 451 comments before the moderator closed the commentary section off.

I read some of them and was astounded how many of them (probably the vast majority) had not taken time to read the words carefully.

There is scope for disagreement always.

But reconstructing what an author says to suit your own pre-conceived and factually incorrect version of reality is not particularly illuminating.

For example, I write:

Inflation ‘hawks’ claim that the large deficits and central bank bond buying (quantitative easing) programs – mischaracterised as ‘money printing’ – will deliver Zimbabwe-like outcomes. However, they just misunderstand how governments spend and are ignorant of the history of hyperinflations.

All government spending is facilitated by central banks typing numbers into bank accounts. There is no spending out of taxes or bond sales or ‘printing’ going on. All spending – public or non-government – carries inflation risk if nominal spending growth outstrips productive capacity. As full employment is reached, governments have to constrain spending growth and may have to increase taxes to curtail private purchasing power. But we are a long way from that point with elevated levels of unemployment and largely flat wages growth.

Many comments claimed that, of course, the central bank is printing money and that will devalue it because it will lead to an explosion in spending.

But the point I was making, which is intrinsic to some of the differentiating knowledge that Modern Monetary Theory (MMT) offers is that all government spending involves new currency entering the system.

There is no spending from taxes.

Or spending from bond sales.

Or spending from ‘printing money’.

These are the options that mainstream macroeconomics teach their students, which conveniently suit their framework, that is used to disabuse politicians and policy makers from running continuous deficits.

All government spending involves new currency entering the monetary system.

There is an inflation risk to that – but to gauge that risk we have to go beyond the monetary aggregates and explore the spending impact on real resource availability.

They also claimed that QE was printing money and would be inflationary.

Mainstream economists claimed QE would result in an avalanche of bank lending and inflation. Modern Monetary Theory (MMT) demonstrates that QE involves central banks buying government bonds by adding cash to bank reserves. Bank lending is not constrained by available reserves – they are never loaned out to consumers. Rather, lending is driven by demand from credit-worthy borrowers, who are thin on the ground in deep recessions. QE reduces interest rates, by increasing the demand for bonds and driving down yields, which may have stimulated demand for equities, but have not pushed total spending beyond resource constraints.

But the commentators couldn’t get to parroting quantity theory of money quickly enough.

The QTM partners with the money multiplier to allow neoclassical/New Keynesian economists to claim that when bank reserves rise, broad money rises and inflation results from too much money chasing too few goods.

The causality is that broad money is driven via the money multiplier by the introduction of ‘high powered money’ or in this context bank reserves.

This is wrong on so many levels but the level of indoctrination that these comments reflected goes very deep.

First, when the central bank credits bank reserves in return for receiving bonds via the QE purchase, all that really happens is some numbers are shifted from one account at the central bank (public debt) to another (reserves).

The crediting of the reserve accounts do not involve any ‘money’ entering into the hands of the public (us).

It is fallacious to conclude that banks have greater capacity to make loans because their reserve accounts at the central bank have larger numbers in them.

Sure enough, greater reserve balances means the chances of being compromised on any particular day when the payments system resolves all the interbank transactions falls.

But that doesn’t increase the propensity or the capacity of banks to make loans.

That was the other point I was making.

Banks don’t loan out reserves.

They make loans when a credit worthy borrower seeks a loan. Loans create deposits and the liquidity is then available for spending.

Simple facts tell us that with the vast QE programs that the central banks have been running, broad money has not expanded anything like the expansion in reserves, and there is not a strong relationship between bank lending and reserve accumulation.

So the commentators can go on about ‘money printing’ for all they are worth, but they are just disclosing their own inadequate understanding of how the monetary system that they profess expertise in (which is why they make such assertive comments) actually works.

There was also commentary about housing price inflation.

I was writing about general inflation measures as captured by the standard CPI type measures published by the national statistician.

No-one is denying that in some nations housing has become unaffordable for many citizens because of the booms in prices.

That is definitely a problem but it is hard to directly relate this as a consequence for excessively expansionary monetary or fiscal policy.

More like the housing booms are being exacerbated by:

1. A lack of low income state housing being provided (definitely a problem in Australia) – this requires more public spending not less.

2. Tax structures that distort investment choices and bias savings allocations to speculative property market behaviour and away from productive asset accumulation.

3. Population pressures.

4. Poor urban planning frameworks adopted by nations, states and cities.

So the cure for an ‘inflated’ housing market is not to inflict austerity, which seems to be one of the suggestions that would satisfy the commentators, but to deal with the distortions and lack of public housing.

Anyway, there is a lot of work still to be done if the sentiments expressed by these commentators, who would seem to have a progressive bent (because they read the UK Guardian, notwithstanding the likely trolls), are expressive views and using analytical frameworks that are anything but progressive.

Music –

This is what I have been listening to while working this morning.

Lately, I have been digging deep into my archives – aka the boxes of records in the cupboard.

Today, we have the marvellous – Dave Brubeck Quartert – playing Koto Song.

The quartet is made up of:

1. Dave Brubeck – piano

2. Paul Desmond – saxophone

3. Eugene Wright – bass

4. Joe Morello – drums

The whole band has died now, but they left a fabulous legacy.

This note – Koto Song – provides background to what motivated Dave Brubeck to write the song.

It is essentially a 12-bar blues in C minor with lots of interesting deviations away from that “harmonic structure” that allows the improvisation to really fly.

The song appeared on the 1964 album – Jazz Impressions of Japan – which is one of my favourites.

It followed Dave Brubeck’s visit to Japan with his quartet and attempts to capture their impressions from that visit.

I don’t know if the album is still available but if you can get it then it is a treasure trove. This track was the most popular back in the US and elsewhere but other tracks on the album are worth absorbing.

That is enough for today!

## The Ritual of Capitalization

### Tags

There’s something mysterious about finance. The symbols are arcane. The math is complex. The practitioners are impressively educated. And the stakes are high. All of this gives finance the veneer of higher truth — as if quants are uncovering a reality not accessible to the rest of us. In a sense they are. But the ‘reality’ is not what you think.

When you look at stock-market numbers, they do point to a truth about the world. But it is a truth not about natural law or of human nature. It is a truth about human ideology. The reality is that finance is a quantitative belief system. At its center is a universal ritual — the ritual of capitalization. It is this ritual that underlies all stock-market numbers.

In this post, we’ll look at the regularities that stem from the ritual of capitalization. They are astonishing in scope — a breathtaking consistency to human behavior. They beg the mind to look for some material basis for their existence. But that is a mistake. The reality is that the regularities of capitalization are an artifact of ideas — a manifestation of capitalist ideology itself. A regularity from ritual.

### Giving property a number

The ritual of capitalization starts with the institutional act of exclusion — namely property.1 Property, of course, has a deep history that long predates capitalism. I won’t wade into this history here. Instead, I’ll defer to Jean-Jacques Rousseau’s succinct (but apocryphal) telling of property’s emergence. Property arose when

[t]he first person who, having enclosed a plot of land, took it into his head to say ‘this is mine’ and found people simple enough to believe him …

Putting a fence around something and calling it ‘property’ is step 1 of capitalization. But property alone is not enough. Romans had property. So did most feudal kingdoms. But these societies did not have capitalization. To capitalize property, there is a second step. You must mix property with finance.

The word ‘finance’ evokes a sense of awe — a sense of other-worldly complexity. But at its heart, finance is simple. It is the act of reducing property to a number — a price. Merge property and finance, and you have capitalization. How this merger happened historically is complicated. But let’s again reduce history to an apocryphal story. To paraphrase Rousseau:

Having enclosed a plot of land, the first capitalist took it into his head to put a number on his property and found people simple enough to believe him.

This act of giving property a number, political economists Jonathan Nitzan and Shimshon Bichler observe, is the central ritual of capitalism. It is the ritual of capitalization … and it comes with a problem.

Because ‘capitalization’ is literally just slapping numbers onto property, any number is as good as the next one. My property can be a 23. It could also be a 1023. In other words, property can have any conceivable price. But which price is ‘correct’? Ever since our apocryphal capitalist put a number on his property, capitalists have agonized over this question. ‘What is the true value of my property?’

Like so many human-created enigmas, the scientific answer is that the question has no meaning. Determining the ‘true’ value of property is like discovering the ‘true’ nature of the Holy Trinity. It cannot be done because there is no objective ‘truth’ to uncover — there are only subjective human beliefs. The ‘true nature’ of the Holy Trinity is whatever church clergy define it to be. The same holds for capitalization. The ‘true value’ of property is whatever capitalists define it to be.

This arbitrariness is why capitalists need a ritual.

If you’re going to answer unanswerable questions, there is no better way than through ritual. Think of a ritual as a mystified habit — a repetitive behavior that you reify with significance. As an example, take the ritual of gesturing the cross. It is a reified habit that Catholics use to symbolize both their faith in the Holy Trinity, and to remind them of how the Trinity has been defined (the Father, Son, and Holy Spirit).

Rituals are surprisingly powerful, especially when ingrained during youth. I’ll use myself as an example. During my childhood, my family went to a Catholic church, and I attended Catechism (Sunday school) weekly. I learned all the rituals that are part of Mass. After being ‘confirmed’ as a Catholic at age 13, however, I stopped going to church. The truth is, I’d always been an atheist … I just didn’t know it until adulthood.2 And yet, atheist that I am today, if I hear the words ‘in the name of the Father, Son, and Holy Spirit’, I have the near-irresistible urge to gesture a cross. That’s the power of ritual.

Capitalists have invented a similar ritual, but it is not physical. It is mathematical. Faced with the desire to know the ‘true value’ of their property, capitalists have invented a formula that defines it. A property’s capitalized value is the discounted value of its future income:

$\displaystyle \text{capitalized value} = \frac{\text{future earnings}}{\text{discount rate}}$

In textbooks, this equation is put more succinctly as:

$\displaystyle K = \frac{E}{r}$

Looking at this equation, Jonathan Nitzan and Shimshon Bichler note something interesting. The formula ostensibly capitalizes property — the stuff that capitalists own. And yet the capitalization equation makes no mention of this stuff. There are no symbols for factories, machines, or infrastructure. Instead, there is only income (E). And that, Nitzan and Bichler observe, is precisely the point. The capitalization ritual tells us how capitalists see the world. Capitalists care not for the things they own. They care about their property rights — their right to earn income by putting up an (institutional) fence.

Because it reflects an ideology, the capitalization formula is delightfully circular. It defines one monetary sum in terms of another. Nothing in science says that the equation should hold. It holds only because we’ve convinced ourselves that it should.

As Nitzan and Bichler see it, the spread of capitalism boils down to the spread of the capitalization ritual. It allows anything and everything to have a capitalized value. Take music. In 2020, Bob Dylan sold his entire song catalogue to Universal for some $300 million. The truth, though, is that Universal didn’t buy songs. It bought income. The copyright on Dylan’s songs ensured a sizable annual income — by some accounts about$4 million per year. Assuming this sum is accurate, Universal capitalized Dylan’s royalties by assuming a discount rate of 1%:

$\displaystyle K = \frac{E}{r} = \frac{\4~\text{million}}{0.01} = \300~\text{million}$

Bob Dylan traded future income (from his property rights) for a lump sum. And Universal traded a lump sum for future income. That’s capitalization in action.

### Regularity from ritual

Unsurprisingly, rituals give rise to astonishing regularity. Every Sunday, Catholics gesture the cross. Five times a day, Muslims bow towards Mecca. Regularity from ritual. Like these religious rituals, the secular ritual of capitalization gives rise to astonishing regularities. Let’s have a look at them.

We’ll start by noting that capitalization is defined only when property changes hands. Put another way, capitalized value is contested until property is sold. Take, as an example, Donald Trump. He proclaims daily that his property is worth billions. Critics counter that Trump’s empire is worth far less. Neither side is correct. Capitalized value is undefined until the property is sold. If tomorrow, Trump sold his business for 1 billion, that would be its capitalized value. In the past, capitalization was poorly defined because property changed hands rarely. An aristocratic family, for instance, might run a merchant business for many generations without ever knowing its capitalized value. Today things are different. That’s because in modern capitalism, partial ownership has become the norm. Portions of firms are bought and sold every second, which means we know capitalized value with exquisite detail. Take Amazon as an example. The business is preposterously large, employing about 1.2 million people. And yet the unit of ownership — the Amazon share — is minuscule. One Amazon share buys you about 2 billionths of the company. Because the unit of ownership is tiny, it is trivial to buy and sell. The result is that unlike aristocratic businesses that changed hands once a century, Amazon shares change hands every second. As such, Amazon’s capitalized value is known exactly. As of May 28, 2021, it was: \displaystyle \begin{aligned} \text{Amazon market cap} &= \text{share price} \times \text{number of shares} \\ \\ &= \3223~\text{per share} \times 0.51 ~\text{billion shares} \\ \\ &= \1.6~\text{trillion} \end{aligned} That’s nice. But why is Amazon capitalized at1.6 trillion? The answer is that the company has a massive income stream — its profits in 2020 were $21 billion. Discount that income at 1.3% and you get Amazon’s capitalized value: $\displaystyle K = \frac{E}{r} = \frac{\21.3~\text{billion}}{0.013} = \1.6~\text{trillion}$ Next question. Where did the discount rate of 1.3% come from? The answer: out of thin air. Like the capitalization ritual itself, the discount rate is whatever we define it to be. Capitalists employ the capitalization ritual by ritualistic choosing a discount rate that they deem ‘proper’. Ritual within ritual. Yes, the whole endeavour smacks of arbitrariness. But that is the nature of ritual. What is important is the regularity to which the ritual gives rise. This regularity is not visible when looking at a single firm. It’s only by looking at thousands of firms that you can see it. On that front, let’s turn to Figure 1. I’ve plotted here data for the profit and capitalization of US public firms dating back to 1950. Each point is a firm in a given year. (There are about 200,000 observations in total.) From this sea of firms, the regularity of capitalization is unmistakable. Capitalization is proportional to profit discounted at a rate of 7%. Regularity from ritual. Figure 1: Profit and capitalization of US firms, 1950 – 2017. Each point represents a US firm. Color indicates the year of observation. The black line shows how capitalization relates to profits for a discount rate of 6.8% — the average found in the data. [Sources and methods]. ### The discount rate Is there something special about the discount rate of 7%? The answer is yes and no. That rate is special in the sense that it’s what US capitalists have deemed to be ‘proper’. But this rate is banal in the sense that it has no deeper meaning. US capitalists discount at 7% because that is the norm they have accepted. Gesture the cross. Discount at 7%. Regularity from ritual. How does this regularity come to exist? In the past, it was by decree. Much like how church clergy decreed the nature of the Holy Trinity, they decreed the ‘proper’ rate of discount: Until the emergence of capitalization in the fourteenth century, [the ‘proper’ discount rate was] seen as a matter of state decree, sanctioned by religion and tradition, and modified by necessity. The nobility and clergy set the just lending rates as well as the tolerated zone of private divergence, and they often kept them fixed for very long periods of time. Today, the ‘proper’ discount rate still has an element of decree. Governments (via central banks) set the benchmark interest rate, which in turn affects the benchmark discount rate on equity. If you’re a finance outsider, you may be wondering what the interest rate has to do with discounting. The two rates are related because the principle of capitalization is the reverse of the principle of interest. Here’s an example. Suppose you put$100 in your savings account at 5% interest. In a year, you’d have $105. Now ask yourself — how much would you pay now to receive$105 in a year? The answer, if you’re a ‘rational’ capitalist, is $100. That’s the sum that would earn$5 when put in a savings account for a year. So by thinking about interest, you’ve capitalized a $5 future income at$100.

Although the principle of discounting stems from the principle of interest, the two rates (benchmark discount and interest) are not the same. This we can see from history. But before we get to the data, let’s think a bit more about the discount rate. Here’s some simple math. Start with the capitalization equation:

$\displaystyle K = \frac{E}{r}$

Now rearrange for the discount rate r:

$\displaystyle r = \frac{E}{K}$

The second equation defines the ‘effective’ discount rate at which investors capitalize income. I call it the ‘effective’ rate because the capitalization ritual is technically about future income, which is unknown. In practice, capitalists pin down earnings E by looking at the recent past (i.e. the last quarterly income report). Assuming this habit, the effective discount rate is the ratio of present income and present capitalization.

For an example calculation, let’s return to Amazon. Last year, the company raked in $21 billion in profits. And today, its market cap is about$1.6 trillion. So Amazon is currently capitalized at an effective discount rate of 1.3%:

$\displaystyle r = \frac{E}{K} = \frac{\21.3~\text{billion}}{\1600~\text{billion}} = 0.013$

This effective discount rate varies between firms. And it varies within firms over time. Let’s have a look at this variation.

### The benchmark discount rate

We’ll start with the benchmark discount rate. I define this benchmark as the average of the effective discount rate across all firms.

The math: to calculate the benchmark discount rate, we first take every public firm (with available data) and divide income by capitalization. That gives the effective discount rate for each firm in a given year. The benchmark rate is then the average across all firms in that year. (Because we’re dealing with growth rates, I calculate the average using the geometric mean.)

Figure 2 shows how the US benchmark discount rate varied over the last 70 years. It oscillated around the average rate of 7%. But there are conspicuous departures from this average. In the mid 1970s, for instance, the benchmark rate soared to a high of 20%. What happened then?

Figure 2: The US benchmark discount rate. I’ve plotted here the trend in the average discount rate across all US firms in the Compustat databases. The dashed horizontal line is the average benchmark since 1950 (geometric mean, weighted equally across years). [Sources and methods].

Given that the principle of capitalization works by reversing the principle of interest, one might think that the benchmark discount rate is a simple reflection of the rate of interest. If so, the discount-rate spike in the 1970s should correspond with an interest-rate hike.

While reasonable, it turns out that this expectation is wrong. Figure 3 tells the story. Here I compare the benchmark discount rate to US interest rates. (I’ve used the US Federal Reserve interest rate — the so-called ‘effective federal funds rate’. This is the interest rate at which banks trade money with the Federal government. It sets the benchmark for all other interest rates.)

We can in see in Figure 3 that interest rates did spike in the past. But the hike came about 7 years after the spike in the discount rate. Clearly, then, interest rates are not driving how US capitalists discount income. To understand capitalists’ herd behavior, we must look elsewhere.

Figure 3: The US benchmark discount rate vs. the FED interest rate. The blue line shows the trend in the average discount rate across all US firms in the Compustat databases. The red line shows the US FED interest rate. [Sources and methods].

While only loosely related to the rate of interest, it turns out that the benchmark discount rate is related to another rate: the rate of inflation (Fig. 4). The inflation rate is a measure of how rapidly prices tend to rise. Because price change varies by commodity, there is no such thing as ‘the’ rate of inflation. Instead, think of inflation like discounting: it has an average rate surrounded by a sea of deviation.

The most comprehensive measure of the average rate of inflation is called the ‘GDP deflator’. (It measures the average price change of all the commodities included in the calculation of GDP.) In Figure 4, I compare this inflation rate to the benchmark discount rate. The two rates are clearly connected. When the benchmark discount rate spiked in the 1970s, so did the rate of inflation.

Figure 4: The benchmark US discount rate vs. inflation. The blue line shows the trend in the average discount rate across all US firms in the Compustat databases. The red line shows the US GDP deflator, a measure of inflation. The inset plot shows the correlation between the two series. [Sources and methods].

Why is the discounting benchmark related to inflation? In a word, uncertainty. Remember that capitalization is the ritual of putting a price on (unknown) future income. Capitalists make this leap of faith by assuming that present income will continue in perpetuity. But that’s a risky assumption, especially when the social order is in turmoil.

Back to inflation. Milton Friedman proclaimed that inflation as ‘always and everywhere a monetary phenomenon’. His slogan is a nice tautology, since anything to do with prices automatically has to do with money. The actual science lies in what Friedman omitted. The reality is that inflation is always differential — some companies raise prices faster than others. That means inflation is always and everywhere a restructuring of the social order. It’s a boon for some firms, a bust for others. This is the inescapable conclusion reached by Jonathan Nitzan after an exhaustive look at the US data.

Far more than just a ‘monetary phenomenon’, then, the inflation rate signals instability in the social order. That instability, it seems, translates into capitalists’ fears about the future. When the price system is more unstable, capitalists discount present income more steeply.

### Discount deviation

Let’s back up now and look at the other component to discounting — deviation from the benchmark.

Over the last 70 years, the average (effective) discount rate for US public firms was about 7%. But although the aggregate data shouts this value to us, few individual firms were capitalized at exactly this rate. That’s because like all averages, the benchmark discount rate is a herd behavior that is visible only in aggregate. The effective discount rate for any single firm can vary widely. Let’s have a look at this variation.

Figure 5 plots the distribution of (effective) discount rates for every firm observation in my US dataset. The benchmark rate of 7% jumps out as big central lump in the histogram. But don’t be confused by the tidy bell curve. The horizontal axis here uses a logarithmic scale, which compresses variation. The reality is that some firms are discounted at rates up to 1000%. And other firms are discounted at rates below 0.1%. That’s variation over 4 orders of magnitude. Still, the vast majority of firms — about 90% — are discounted at rates between 1.3% and 25%.

Figure 5: The distribution of the effective discount rate among US firms. I’ve plotted here the distribution of the effective discount rate for every US firm observation in the Compustat database. I calculate the discount rate by dividing annual profit by annual (closing) capitalization. The red line shows the geometric mean. The shaded region represents the 90% interval of the data. [Sources and methods].

Whenever we have variation, the next step is to look for its source. Why do some firms have a high (effective) discount rate and others a low one? It’s here that things get interesting. Ostensibly, the capitalization ritual has a causal direction that flows from discounted earnings to capitalized value. Investors look at a revenue stream E, pick a discount rate r, divide the two, and poof … get a capitalized value:

$\displaystyle \frac{E}{r} \longrightarrow K$

There are instances where capitalization works in this simple way — but these instances are the exception, not the norm. The only time capitalization is so simple is when a firm is capitalized for the first time: during its initial public offering (IPO). Before an IPO, the firm opens up its books to let would-be investors see the income stream. Using the capitalization ritual, the firm picks a share price for the launch. From the IPO onward, the stock price floats on the market.

Other than during an IPO, then, the capitalization ritual has an element of circularity. The ritual is ostensibly about capitalizing an income stream. Yet the most known quantity in the ritual is not income, but capitalized value itself. You can know a company’s market cap down to the second. In contrast, the firm’s earnings get reported 4 times a year. So what happens in practice is that investors capitalize income by keeping one eye on capitalization itself. The result is that the discount rate is circularly related to capitalization.

Figure 6 shows the trend. Among US firms, the effective discount rate declines with capitalization. (Note that because I’m comparing capitalization across years, I’ve normalized the data within each year so that the median capitalization in my firm sample is 1.) Around the median market cap, the discount rate is the same as the global benchmark of 7%. But as relative capitalization gets smaller than the median, the discount rate grows. And as relative capitalization gets larger than the median, the discount rate declines.

Figure 6: The effective discount rate vs. capitalization among US firms. The horizontal axis plots relative capitalization, normalized so that the median of the US Compustat sample in each year is 1. The vertical axis shows the corresponding discount rate, binned by capitalization. (Each point is the center of a bin.) [Sources and methods].

The same pattern emerges when we look at different time periods separately. In Figure 7, I’ve animated 5-year snapshots of the discount-rate-vs-capitalization data. The trend shifts with time, but the overall pattern is consistent. The effective discount rate declines with capitalization. It seems that US capitalists agree that small-cap investments are riskier than large-cap investments. Hence they discount small-cap firms more heavily.

Figure 7: The effective discount rate vs. capitalization over time. Here’s the same analysis as in Figure 6, but now differentiated by year. Each snapshot shows data grouped over the preceding 5 years. [Sources and methods].

### Earnings risk

I’ve so far portrayed the discount rate as a number that capitalists pull out of thin air. But this portrayal is only partially true. The absolute value of the discount rate is arbitrary, just as is the absolute value of capitalization. I can capitalize my property at 23 or 1023. In isolation, the difference is meaningless. Capitalization, however, does not happen in isolation. And that, observe Nitzan and Bichler, is the whole point. The only reason to have prices is to compare them to other prices. Hence capitalization is meaningful only in relative terms. The same is true of the discount rate.

The relative value of the discount rate quantifies capitalists’ perception of risk. The rationale again has to do with the capitalization ritual itself. The ritual is ostensibly about quantifying the present value of future income. But the way capitalists calculate this value is to assume that present income continues indefinitely. That assumption is risky. And so capitalists try to bake future risk into their ritual. The more risk they perceive, the steeper they discount.

How, then, do capitalists assess future risk? Like all elements of the capitalization ritual, capitalists look to the past. They assess future risk by looking at past risk. On that front, we can see that the decline in the discount rate with capitalization is not arbitrary. It’s firmly grounded in the variability of past income.

Figure 8 shows the trend. It’s a bit complicated to interpret, so let me break down what I’ve done. I start with a firm — say General Motors. I then pick a year (say 1990) and observe GM’s market cap. Then I look at the preceding decade and measure the variability of GM’s profit over that period (1981-1990). I calculate the coefficient of variation of this profit (the standard deviation divided by the mean). Then I do the same operation in every year for which there is a preceding decade’s worth of data for GM. When that’s done, I repeat the whole process for every firm in the dataset. Finally, I analyze the aggregate trend by relative market cap.

Figure 8: Profit variability vs. capitalization among US firms. I’ve analyzed profit variability (using the coefficient of variation) over a trailing 10-year window among firms grouped by capitalization. Each point on the blue line represents a market-cap bin. Note that I’ve normalized capitalization so that the median in each year is 1. [Sources and methods].

Now that you (hopefully) understand the analysis, let’s interpret the results. According to Figure 8, the variability of past profit declines with relative capitalization. In other words, small-cap firms have more past risk than large-cap firms. If capitalists know this fact, then it is sensible to discount small firms more heavily than large firms.

It’s debatable, however, that individual capitalists know much about the aggregate trend plotted in Figure 8. Instead, it’s more likely that they rely on rules of thumb — something like ‘venture capital is more risky than blue-chip capital’. This rule then gets baked into the capitalization ritual as a sub-ritual: discount small firms more heavily than large firms.

### Capitalizing markup

Continuing the theme of rituals within rituals, let’s look at another aspect of capitalization: the markup. We start with the capitalization formula:

$\displaystyle K = \frac{E}{r}$

Here, E is the firm’s net earnings — what the non-corporate laity call ‘profit’. Now ask yourself, how can you earn a profit? To think about this question, consider the following equation:

\displaystyle \begin{aligned} \text{profit} &= \text{sales} \times \frac{\text{profit}}{\text{sales}} \\ \\ &= \text{sales} \times \text{markup} \end{aligned}

According to this equation, there are two routes to more profit:

1. increase sales (gross income)
2. increase profit as a portion of sales (the markup)

The two routes to profit are very different. When you increase sales alone, everyone gets more income in the same proportion. Wages and profits increase at the same rate, so their share of the pie remains constant. This is not true, however, when you increase profit using the markup. When you fatten the markup, a greater portion of gross income goes to the firm’s owners, leaving less for workers (and for other firms).

Looking at our basic capitalization equation, we can see that it says nothing about how profits are earned. All that matters is their size (net earnings, E). But when investors apply the capitalization ritual, it turns out that they do have a profit preference. Investors prefer to capitalize a high markup.

Figure 9 shows the trend. I’ve plotted here the markup as a function of relative capitalization among all US public firms (since 1950). Each point indicates the median markup when firms are grouped by relative market cap. (I’ve normalized capitalization so that the median cap in each year is 1). It’s easy to spot the trend. The markup grows reliably with capitalization.

Figure 9: Markup vs. capitalization among US firms. I’ve analyzed firms’ markup among firms grouped by capitalization. Each point on the blue line represents a market-cap bin. The vertical axis shows the markup. Note that I’ve normalized capitalization so that the median in each year is 1. [Sources and methods].

We can see the same pattern when we look at different time periods. In Figure 10, I’ve animated 5-year snapshots of the markup-vs-capitalization data. The trend shifts with time, but the overall pattern is consistent. The markup grows with relative capitalization. When US investors capitalize profit, it seems they prefer it be reaped on a fat margin.

Figure 10: Markup vs. capitalization by year. Here’s the same analysis as in Figure 9, but now differentiated by time. Each frame shows data grouped over the preceding 5 years. [Sources and methods].

Why do investors award greater capitalization to firms with a higher markup? Perhaps it again comes down to perceptions of risk. Consider two companies with similar-sized profits. One company has mammoth sales but a razor thin markup. The other company has smaller sales, but a fat markup. Which one do investors deem more ‘risky’, and so discount more steeply?

We need not leave this question hypothetical. It’s easy to find two real-world firms that match the criteria. Consider the difference between Walmart and Apple, summarized in Table 1. In order-of-magnitude terms, the two firms have similar-sized profits. But they take different routes to this windfall. Walmart has enormous sales and a thin markup. Apple has smaller sales and a fat markup.

Table 1: Walmart vs. Apple

table_here Source: Walmart 2020 Annual Report, Apple 2020 Annual Report

Investors, it seems, prefer the Apple route to profit. Even though Apple’s profit is of similar size to Walmart’s, investors reward Apple with far more capitalization. The difference? Walmart has a thin markup, Apple a fat one.

Framed in terms of the capitalization ritual, investors discount Walmart more steeply than Apple. They obviously have reasons for doing so, but these reasons need not be object. That’s because we’re dealing with an ideological Russian doll — rituals within rituals within rituals.

### The finance ethos

It’s time to wrap up our dive into the capitalization ritual. We’ll end where we started — with the mystique that surrounds high finance. This mystique is reinforced by textbooks, which make hefty use of complicated math, giving the appearance of profound ‘scientific truth’. Heck, you often need a PhD in physics to understand the equations. Does that mean that like physics, finance is a ‘hard science’?

The answer is a hard no.

Finance does not describe our social world. Finance defines it. Finance outlines the rituals whereby capitalists impose order onto society, turning the qualities of ownership into a single quantity. Finance, Jonathan Nitzan and Shimshon Bichler observe, is the ideology of our time:

The ‘science of finance’ is first and foremost a collective ethos. Its real achievement is not objective discovery but ethical articulation. Taken together, the models of finance constitute the architecture of the capitalist nomos. In a shifting world of nominal mirrors and pecuniary fiction, this nomos provides capitalists with a clear, moral anchor. It fixes the underlying terrain, it shows them the proper path to follow, and it compels them to stay on track. Without this anchor, all capitalists — whether they are small, anonymous day traders, legendary investors such as Warren Buffet, or professional fund managers like Bill Gross — would be utterly lost.

Finance theory establishes the elementary particles of capitalization and the boundaries of accumulation. It gives capitalists the basic building blocks of investment; it tells them how to quantify these entities as numerical ‘variables’; and it provides them with a universal algorithm that reduces these variables into the single magnitude of present value. Although individual capitalists differ in how they interpret and apply these principles, few if any can transcend their logic. And since they all end up obeying the same general rules, the rules themselves seem ‘objective’ and therefore amenable to ‘scientific discovery’.

Make no mistake, the regularities of corporate finance are majestic in scope. But these regularities stem not from any laws of nature. They are regularities from ritual. Gesture the cross. Discount present income.

Perhaps the most important question is where this ritual is headed. Does capitalization have a long-term future? Neoclassical economists like William Nordhaus think so. They’re happy to apply the capitalization ritual to existential crises like climate change. And the net present value of their calculations tells them (surprise surprise) that we should do essentially nothing. But of course, by applying a heavy discount rate to future income, that is what they assumed in the first place. It’s ritualized apathy.3

Back to the present. The ritual of capitalization is surrounded by a mystique of ‘higher truth’. Whenever you encounter such a mystique, it’s a good bet that you’re dealing with ideology. The point of the ‘mystique’ is to stop you from looking under the ideology’s hood. When you do, you see that the whole thing is a house of cards. The ‘higher truth’ of the Holy Trinity is that it is an ideological invention of church clergy. So too with finance. The only difference is that with finance, the clergy aren’t priests … they’re economists.

#### Support this blog

Economics from the Top Down is where I share my ideas for how to create a better economics. If you liked this post, consider becoming a patron. You’ll help me continue my research, and continue to share it with readers like you.

Keep me up to date

### Sources and methods

All firm financial data comes from Compustat. Data series are as follows:

• capitalization: number of shares outstanding (series CSHO) × annual closing share price (series PRCC_C)
• profit (net income): series NI
• sales: series SALE
• markup (profit as a portion of sales): NI / SALE

Interest rates (Fig. 3) are from FRED series DFF. The GDP deflator (Fig. 4) is from FRED series A191RI1Q225SBEA

#### The effective discount rate

For each firm $f$, I define the firm’s effective discount rate $r_f$ as

$\displaystyle r_f = \frac{E_f}{K_f}$

where $E_f$ is the firm’s profits and $K_f$ is the firm’s capitalization (in a given year). I define the average discount rate for all firms, $\overline{r}$, as the geometric mean of $r_f$ over all firms:

$\displaystyle \overline{r} = \left( r_1 r_2 \cdot \cdot \cdot r_n \right)^{1/n}$

When calculating the effective discount rate, I exclude firm observations with negative profit.

### Notes

1. Here’s how Nitzan and Bichler describe the exclusionary act of property:

The most important feature of private ownership is not that it enables those who own, but that it disables those who do not. Technically, anyone can get into someone else’s car and drive away, or give an order to sell all of Warren Buffet’s shares in Berkshire Hathaway. The sole purpose of private ownership is to prevent us from doing so. In this sense, private ownership is wholly and only an institution of exclusion, and institutional exclusion is a matter of organized power.

2. One of my only memories from Sunday school was my incredulity at hearing the story of Jonah and the whale. “You’ve got to be joking,” I remember saying to the church teacher. “This is a myth, right?” The teacher assured me it was not. This interaction cemented in my mind that I wanted nothing to do with religion.
3. If you’re interested in the economics of climate change, Steve Keen’s debunking of Nordhaus’ work is a must read. See his paper ‘The appallingly bad neoclassical economics of climate change’. For a discussion of how Nordhaus uses the capitalization ritual to discount future income, see Bichler and Nitzan’s research note ‘The Nordhaus Racket’.

Nitzan, J. (1992). Inflation as restructuring. a theoretical and empirical account of the US experience (PhD thesis). McGill University.

Nitzan, J., & Bichler, S. (2009). Capital as power: A study of order and creorder. New York: Routledge.

### Tags

I was asked about the commentary in a report "Inflation, Do You Feel it Yet?" by the Interprime Newsletter. I think it follows standard market research conventions, which is aimed to be fairly sensitive to changes in direction. The problem with this sensitivity is that underlying inflation in recent decades in the developed world is quite sluggish. However, as seen in the chart above, standard economic time series have been mangled by the economic disruptions associated with the pandemic.
I will let the reader go through that newsletter. The focus is mainly on various goods and commodity prices, many of which have jumped in the past couple of years.
The advantage of looking at commodity prices is that they are available in real time (or close to real time), and there are no statistical adjustment issues to worry about. The problem with them is that they are now highly sensitive to the global cycle, in particular China. Although we cannot ignore the global cycle, the Chinese economy has been quite perky over the past couple of decades, yet that has not spilled into core inflation in the services-dominated developed economies.
Another issue with some goods prices is that they are tied to investment activity -- in particular, lumber (North American housing) and computer chips (cryptocurrency mining). We know that animal spirits have bounced back in speculative markets -- but we have had ongoing bubbles for a long time without there being much feed through into wages.
It is clear that it is probably a mistake to keep explaining away rising prices as being due to special factors, since supply chain disruptions always show up in particular areas. There is no doubt that there has been at least a one-time upward shock to a variety of prices due to various disruptions, the only question is whether price hikes can be sustained.
In order for goods prices to enter a sustainable uptrend, wages need to also rise to keep the volume of demand stable. The lack of follow-through into wages in the past decades explains why previous price jumps (such as oil price spikes) have not resulted in sustained inflation. Unfortunately, standard wage data has been disrupted by a change in mix (figure at the top of the article). Lower-wage employment was shut down more as a result of the lockdowns, and so there was a mix change that raised wages. (There are various data sources that were supposed to allow us to control for that mix change; I have not dug into them on the basis that I am not attempting to be a forecaster.) At present, there are plenty of anecdotes about labour shortages. At the same time, I dealt with economists who were pounding the table about similar anecdotes in 2010. Various programme changes as well as an unwillingness to take now-risky jobs for a low wage have tightened the labour market, but vaccinations have kicked in the United States (and with a lag, Canada), and the fiscal programmes are rolling off.React to Markets or the Economy?Turning back to the Interprime newsletter, one is faced with an interesting problem: what matters for inflation -- actual inflation, or what market participants think? If you are trading inflation breakevens, except for very short maturity instruments, most of your profit and loss is driven by the changes in the breakeven rate, which can be viewed as market expectations for inflation. (Some commentators object to that phrasing, but I think they are on very weak ground. At the minimum, if we use the mathematical definition of expectation, then breakeven inflation are definitely the expected value -- albeit an approximation.)
We are back to Keynes' beauty contest. Market participants react to fast-moving commodity data, and so it is somewhat suicidal to fight that trend. The problem is that if realised inflation does not track commodities, you need to be ready for revisions of expectations when commodity prices turn around. As such, one needs to keep in mind that there are very different audiences for inflation analysis.You've Been Cancelled!Finally, my Twitter timeline has been filled with moping by senior "centrist" mainstream economists (Larry Summers being one of them) about being "cancelled" for criticising Biden's fiscal package and/or worrying about inflation.
First of all, it is fairly clear that Democrat-leaning economists are closing ranks around the President. That is not exactly surprising behaviour in the current environment. To a certain extent, some dinosaurs in the Democratic party think it is still the 1990s. American politics is hopelessly partisan, so pretending to be a technocratic centrist is not going to work.
That said, it is clear that Larry Summers is being dunked on because his analysis was downright terrible. He swung from "oh noes, secular stagnation" to his now famous 33%/33%/33% probability distribution. The analysis was undisciplined, and so the response was predictable.
(c) Brian Romanchuk 2021

## I Want It And I Don’t Want To Pay – A Brief Guide To Something For Nothing Economics

### Tags

An anonymous hospital porter makes the case for modern monetary theory.

The post I Want It And I Don’t Want To Pay – A Brief Guide To Something For Nothing Economics appeared first on Renegade Inc.

## Criticism of failed economists is not cancel culture

### Tags

Everybody is concerned with ‘herd immunity’ at present as the pandemic continues on ravaging our social and economic lives. But I have been studying the concept of ‘herd mentality’ for some years, aka – Groupthink. Mainstream macroeconomics is sustained, not by any internal logical consistency (on which it fails), by close congruency with the empirical data (on which it fails), which are the usual qualities of a dominant system of ideas, but, rather, by (using modern terminology) its long-standing and on-going cancel culture. So it is rather amusing to read one of the leading voices in that paradigm, Kenneth ‘Spreadsheet’ Rogoff, whinging on the Internet that ‘cancel culture’ is being used to undermine the reputations of one of his mates (Larry Summers). Both continue to get platforms in the world media without trouble to push their vapid ideas into the narrative. The antithesis of cancel culture it would seem. What is going on is that more people are realising that the prognostications of mainstream macroeconomics are deeply flawed, and, while many may not know the technicalities and the theoretical complexities, they can see the empirical dissonance, and that means they know a – lemon – when they see one. And social media has given more people a voice and they are using that to call these characters out for what they are. And the sense of invulnerability that pervades all disciplines riddled with Groupthink is being questioned.

I wrote about my view on ‘cancel culture’ in this blog post – Be careful of what parades as academic research (Uber) (January 29, 2020).

In general, I do not like the social media phenomenon which is typically a sign of intolerance.

I consider that education is the path to a more enlightened, tolerant and inclusive society.

I particularly dislike progressive commentators publicly shaming others for being racist, sexist, mysoginist, anti-semitic, transphobic and more when the evidence is to the contrary.

I think there are valid criticisms of the Israeli government, for example and the illegal occupations that they Zionist settlers have imposed on the Palestinean people.

I don’t think that makes the person who makes those critical arguments anti-semitic.

I don’t think a person is always intrinsically transphobic, if they question the ‘fairness’ in sporting events, where biological males, who identify as females seek to make reputations by competing in those sporting events, where success is considerably influenced by physical strength and the fields are typically limited to biological females

Such a person might transphobic but the meagre point of raising the issue doesn’t immediately qualify for them status and disqualify their opinion or evaluation.

I understand the complexity of these issues and the need for respect for everyone and I think the ‘cancel culture’ tendency is the anathema of that.

My view is that education should be our guiding light and the cancel culture is bound to reveal its hypocritical tendency because at times we are assuredly better off being forgiving and adopting pragmatic strategies.

Rogoff and Summer – poor little darlings

But, of course, there is a clear difference between healthy criticism and debate and ‘cancelling’ a person outright for their views.

I too often see on social media that difference being blurred with vilification becoming the way of defending a position under attack, because it becomes easier to be abusive than to construct knowledge-driven arguments as riposte.

And it is clear that mainstream economists are being subjected to healthy criticism from more and more commentators, who, as I noted in the introduction, are becoming more erudite on economic matters, and are increasingly seeing that the predictions of mainstream macroeconomists bear little congruence with the real world events.

They are becoming sick of mainstream economists claiming that fiscal deficits, which clearly help people protect jobs and incomes etc, are dangerous and drive up interest rates and cause inflation.

They are becoming sick of mainstream economists claiming that when central banks buy government debt and thus control bond market yields (taking away any influence of the private bond investors, who have motives not usually linked to advancing general well-being), accelerating inflation will result and morph, at some point into hyperinflation.

The data doesn’t show that. People see the data and put two and two together.

They are becoming sick of mainstream economists claiming that bond market investors will stop funding governments and render them insolvent when it is clear the queues to get access to public debt (as corporate welfare) are long and showing no signs of drying up.

They are becoming sick of mainstream economists claiming that saying that governments cannot afford to provide provide proper health care or proper employment support or addressing climate change or anything else that helps the most of us, when the same economists are silent or supportive when government bails out corrupt banks or hands massive tax breaks to the top-end of the income distribution.

And more.

That dissonance is now manifesting as widespread criticism of economists who have rarely been questioned such is the position they have created in the public debate for themselves.

But now those economists, who more recently have been railing against the size of fiscal support being given by the US government – when there are something like 8.2 million jobs short of where they were in February 2020 (see my latest US labour market assessment – US labour market goes backwards with mixed signals – but significant slack remains) – are being criticised for their ‘conservative’ views.

I wrote a bit about that issue in this blog post – The inflation mania is growing – but manias are manias.

More specifically, I addressed the sort of claims that Lawrence Summers and Kenneth Rogoff have been making about inflation fears in this two-part series:

1. Is the $US900 billion stimulus in the US likely to overheat the economy – Part 1? (December 30, 2020). 2. Is the$US900 billion stimulus in the US likely to overheat the economy – Part 2? (December 31, 2020).

It seems that Rogoff and Summers are feeling the heat as a result of the mounting criticisms of them, particularly from commentators who might identify as being progressive and Democrat, which excludes many of those who identify as being Democrat supporters in the US.

Rogoff, retains a global platform in the media, despite his role in the Reinhardt-Rogoff spreadsheet scandal during the GFC.

During the GFC they produced ‘analysis’ that suggested that there was an 80 per cent threshold for “safe” public debt ratios and once the ratios went above that level, growth suffered and insolvency threatened.

They received massive press coverage for their ‘threshold’, given that mainstream macroeconomists can always command a widespread platform in the media and political process.

Journalists kept repeating their stupid mantra ‘this time is different’ (title of their book) without critical scrutiny, which is another aspect of the platform these economists enjoy.

Rogoff and Reinhardt claimed during the GFC that “austerity is necessary” because the rise in deficits and government debt would create dangerous insolvency and inflationary consequences.

They said that “the overall debt problem facing advanced economies today is difficult to overstate”.

Nine or so years later their predictions have been revealed to be plain wrong.

And, eventually, their ‘analysis’ was exposed as being either incompetent or fraudulent (who knows) because the spreadsheet they had based their claims had been wrongly manipulated (presumably by a research assistant).

When the available data was used correctly, their threshold results lapsed.

Further, the causality between debt ratios and growth could run either way but the evidence suggests that it runs from real GDP changes to changes in public debt ratios.

The furore over the Rogoff and Reinhardt work was not really about their spreadsheet incompetence but the direction of causality.

Any reasonable person came to understand that the meltdown in 2008 was not a public debt event.

It was a collapse in confidence that led to a spending withdrawal that cause real GDP to decline sharply.

This was followed by the imposition of fiscal austerity in most nations which further dented growth. The rise in the deficits and, under the current institutional arrangements, the rise in debt issuance, saw public debt ratios grow rapidly.

I wrote about his work with Reinhardt in this blog post – More worn out ideological prattle from R&R (November 21, 2013).

Given the massive failure of their predictions, one wonders why characters like Kenneth Rogoff still commands a public platform.

But they consider they are largely invulnerable to scrutiny.

Think about Summers and his role, with Robert Rubin and Alan Greenspan during the period before the GFC and the demonisation of Brooksley Born, who became the head of the US federal Commodity Futures Trading Commission and tried to warn the US government of the increasing dangers of unregulated financial markets.

I wrote about that in this blog post – Being shamed and disgraced is not enough (December 18, 2009).

Now, as their views are being increasingly scrutinised in the public arena, they don’t like it.

Rogoff told Politico’s West Wing Playbook that (Source):

… it’s very courageous of him to make … [his arguments] … in this world where there’s this, basically, cancel culture, and there are plenty of people who probably want to do that to Larry.

The West Wing Playbook suggests that Summers is used to criticism but now his world is difference because:

… he’s enduring it while outside the circles of power and not within them is a sign of how far economic policy-making has shifted since the Obama administration.

They also suggest that the Biden Administration “is also chock-full of Summers critics—economists who believe that decades of Democratic economic policy that failed to address wage stagnation, outsourcing and rising inequality led to the rise of DONALD TRUMP.”

The response of Rogoff is possibly because neither he nor Summers are part of the Biden Administration, but their presence in the official policy making arena would probably not alter policies much, given how weak the Biden camp has been on fiscal policy to date – reneging on key promises etc.

This is just another dimension of Groupthink

The real issue is the complete denial from the mainstream macroeconomists of the reality they operate within.

They have created such a fictional world that they believe they are insulated from criticism.

I have written several blog posts (and articles/books) about the phenomenon identified by social psychologists called – Groupthink.

The original article – Groupthink – was published in 1972 by Psychology Today (Vol 5(6), pp. 43-46) and was written by American social psychologist – Irving Janis.

He refined the term that US sociologist – William H. Whyte – coined in 1952.

Irving Janis extended a lot of the ideas from his 1972 paper in his 1982 book – Groupthink : psychological studies of policy decisions and fiascoes – published by Houghton Mifflin, Boston.

The concept is very applicable to the economics discipline and the way the academy operates in this area of study.

Cancel culture is the norm within this discipline.

The dominant professors control the evolution of the ideas in many ways.

Examination processes militate against any critical views by students.

Scholarships to graduate studies are then highly biased towards those who have ‘done well’ in the undergraduate examination.

Then appointments to the lower jobs in the academy are highly controlled and a certain type of graduate typically gets a job.

Then promotion is tightly controlled according to the type of publications one produces and the rankings of the journals they are published in. These rankings are highly controlled and vet out heterodox publications from the higher (and more valuable) ranks.

The professorial appointments are tightly controlled.

The competitive research grant process is tightly controlled to restrict money flowing to research projects that might be too ‘challenging’ for the mainstream viewpoint.

Then access into influential policy jobs in central banks and treasury departments become highly biased towards perpetuating the mainstream viewpoint.

This is really ‘cancel culture’.

There were very few people with my views who made it through graduate school and then went on to reach the top of the hierarchy.

I was only able to get through because I was technically competent (maths, mathematical stats, econometrics) which meant I could do technical work that attracted a lot of research funds without having to actually ever publish anything remotely mainstream.

It also meant as an undergraduate and postgraduate I could solve their ‘meaningless’ puzzles easy to get top examination grades.

But that path is an anomaly.

Further, access to the media is highly constrained and journalists typically just rehearse the views of the top end of the mainstream academy giving them global voices on a daily basis.

The platform they enjoy is amazing and journalists rarely subject them to critical scrutiny.

Has any journalist ever asked Rogoff whether he checked the spreadsheet that led to the scandalous and incorrect claims about public debt thresholds?

Has any journalist ever asked them to account for the massive empirical dissonance between the main predictions of New Keynesian macroeconomists and the empirical history we all have experienced?

The norm is that despite major failures in prediction, these characters just retain their voice and are wheeled out as experts on the next issue that commands the public attention – at present inflation.

Have any of them been forced to explain why Japan has had no accelerating inflation despite the Bank of Japan purchasing most of the public debt issued over the last 20 years?

Have they been forced to explain why bond yields are negative around the world when their macroeconomic framework predicted rising yields?

And more.

The privilege these characters enjoy as public celebrities and the voice they can express without scrutiny is massive.

I am regularly told by journalists that they have to ‘ration’ my access to radio and TV because they get criticised for having me on by politicians and other economists.

The Groupthink that protects them has given them an ‘illusion of invulnerability’ where according to Irving Janus, group members deny basic facts that refute their views.

They create group rationalisations of any ‘failures’.

US Marxist economist David Gordon noted in his 1972 book Theories of poverty and underemployment; orthodox, radical, and dual labor market perspectives (Lexington Books) – how orthodoxy keeps reinventing itself when confronted with an anomaly that exposes the theoretical structure to rejection.

They vilify critics and call them ‘crazy’, ‘socialist’, etc.

This sense of invulnerability is what allows Rogoff to create a narrative that he and Summers are the victims rather than the millions of workers who have been forced into unemployment by the sort of austerity-biased policies that New Keynesian macroeconomists have promoted.

Irving Janus writes (p.84):

The symptoms of groupthink arise when the members of decision-making groups become motivated to avoid being too harsh in their judgements of their leaders’ or their colleagues’ ideas.

This is the problem of “concurrence-seeking” which:

… tends to override realistic appraisal of alternative courses of action.

Those captured by Groupthink also take on a sort of moral superiority.

Irving Janus noted that:

Victims of groupthink believe unquestionably in the inherent morality of their ingroup: this belief inclines the members to ignore the ethical and moral consequences of their decisions.

Go back to my comments above on mass unemployment.

It is also behind Rogoff trying to deflect criticism by claiming that ‘cancel culture’ is attacking a “courageous” Lawrence Summers and these critics are hiding behind social media anonymity etc – these ‘cowards’ are attacking courage.

Rogoff is also serving a role identified by Irving Janus as a “mindguard”.

Accordingly:

Victims of groupthink sometimes appoint themselves as mindguards to protect the leader and fellow members from adverse information that might break the complacency they shared about the effectiveness and morality of past decisions.

Mindguards are there to enforce conformity and disabuse anyone of questioning viewpoints.

Conclusion

Given that the dominance of mainstream macroeconomics is maintained in part by a sort of cancel culture, it is quite amusing that Rogoff would resist the mounting criticism by appealing to the same concept.

His sense of being victimised is ludicrous.

He is just displaying all the characterisations of being caught in a groupthink bubble and that usually means the group has become dysfunctional and dangerous.

That is enough for today!

## Inflation is not what we should be worried about right now

### Tags

Image by Manuel Alvarez from Pixabay

“The purpose of government is to ensure that everyone has what they need to live a good life. That means giving every child the very best start in life, caring for people when they need it throughout their lives and ensuring needs are met through a combination of universal public services, a secure living income and the basic human right to a home. A society that meets those basic needs of its citizens provides a foundation on which to build opportunities for individuals and our whole society to flourish.”

Social Justice and Fairness Commission

Wherever you look, the media is flashing its inflation warnings. ‘UK recovery overshadowed by inflation’ says the Guardian. ‘Serious inflation is coming and the time to start addressing it is now’, intones The Telegraph. Shock, horror says the Times, ‘Sirens over inflation are going off’ and ‘if it doesn’t get on with [unwinding QE] the Bank will end up like a fire brigade with no engines, no hoses and no water.’

We are all going to hell in a handcart, is the impression that readers might gain from these pronouncements. And yet, even as the headlines aim to create fear in the same way as they do when journalists sound the alarm about the rise in public debt, they often fail to tell the real story and lead people along with flawed narratives, which in some cases lay the blame on too much government spending, rather than examining the wider context of inflationary pressures. In this case, the evidence shows that it can be attributed to the ongoing reopening up of the economy (which may not be sustainable), price pressures on raw materials like oil, and rising commodity and freight prices. However, with the CPI standing at 1.6% last quarter and still under the Bank of England’s 2% target, inflation should hardly be a cause for concern. As Professor Mitchell noted in the conclusion of his blog on May 17th.

“Clearly, some areas of our economies will experience price pressures in the coming period given the disruptions in supply and various administrative pricing decisions by governments (reversing pandemic assistance in areas like rents, energy, childcare etc).

But these pressures in some segments of the economy are unlikely to instigate a major shift to high generalised inflation rates because the capacity of workers to defend their real wages is diminished now.

Fiscal policy has a long way to go yet in reducing unemployment and underemployment from their elevated levels before that capacity becomes functional again.”

Indeed, this week, Jan Vlieghe who is a member of the Monetary Policy Committee of the Bank of England, was clear in a speech to the University of Bath that the UK was ‘not yet out of the woods’, and that whilst there was a temptation to call the increased economic activity a boom, it was, he said, ‘more accurate to call it a prospective return towards normal’. He reminded his audience that the global situation will continue to affect the economy, not to mention the prospect of the risk of higher unemployment as the furlough scheme ends. He said that since the prospects for the labour market would remain uncertain, even when the economy reopens totally (if it does) there still could be the prospect of a rise in unemployment which would be of ‘macroeconomic significance’. He rejected the suggestion that increases to the money supply, commodity prices or wages were likely to increase the inflation rate permanently above the government’s 2% target.

However, even as Vlieghe refers to normal, we should remind ourselves in this context that prior to the pandemic life for many was not ‘normal’. The impact of government policies and spending decisions, originating with George Osborne’s austerity programme which began in 2010, has devastated many people’s lives, whilst at the same time the rich have gone on getting ever richer. Indeed, the Sunday Times reported that during the pandemic, the UK created a record number of billionaires, bringing the total to 171, 24 more than a year ago.

Austerity stripped out our public and social infrastructure, leaving it struggling to function even before the pandemic arrived. It has added to the woes of a society already disintegrating under the weight of huge wealth inequalities that have built up over decades. The pursuit of neoliberal dogma which has lowered living standards and led to the degraded infrastructure has been cruelly exposed over the last year.

As a Guardian editorial noted this week:

The reopening of our economy will reveal much weakness and high unemployment. This is a time for stimulus and repairing a broken social contract. Get people into work, especially the young, who have lost many opportunities in the past 15 months, and ensure key workers are better paid and protected. First things first.”

In short, neither Zimbabwe nor the Weimar Republic are on their way, and inflation is the last thing we should be worried about. We should instead be looking at the context at a time when there is substantial unemployment and underemployment, a phenomenon that actually precedes the pandemic and reflects the government’s misplaced obsession with cuts to public spending. It also reflects their use of unemployment as a mechanism to control inflationary pressures, by determining full employment to be anything but! Governments have, for decades, condemned too many people to a life of poverty and insecurity, whilst at the same time favouring businesses through legislation which allows wages to be kept low and employment insecure.

It is regrettable to note that according to an IPSOS Mori poll carried out for Kings College London earlier this year, many people still view poverty as a personal choice and believe that success is determined by hard work and determination. Meritocracy still rules as a guiding force in British life. The poll also revealed that even despite the exceptional circumstances of the pandemic, Britons were likely to think that job loss was the result of personal failure, rather than chance. It apparently does not seem to matter that prestigious institutions, thinktanks and charities recount week in week out the deleterious effects of poverty on people’s lives, and indeed on the economic health of the country, alerting the nation to the involuntary nature of unemployment and poverty. A divided society works for no one but the elites who push meritocracy.

Over the decades the concept of neoliberal meritocracy has held sway, the role of government appears to have become a secondary consideration. However, it has had no alternative over the past year but to prop up the economy with vast spending; clearly showing the capacity of currency-issuing governments to step up to avoid economic collapse. Such a capacity must then put into question the 10 years of austerity led policies and their consequences, which were presented as vital to the health of the public finances. The pandemic has shown without doubt that austerity was unnecessary; an imprudent policy that harmed the economy and people’s lives.

Even as the consequences of poverty and inequality become ever more apparent, our supposed freedom to be whatever we want to be has continued to be promoted as paramount, and led to a society divided by the notion of shirkers and hard-working people; lazy public sector workers against industrious private sector ones. This has enabled the government’s intent to divest itself of any responsibility for the well-being of citizens through its cuts to public spending, whilst at the same time pouring vast sums of public money into the ongoing scandal of government contracts; awarded without transparency or accountability to private companies or those with connections. No expense spared. The role of government has been subsumed into serving capital interests and endless growth, regardless of the impact on the environment and the lives of citizens.

Indeed, a case in point is the publication this week of the CBI report ‘Seize the Moment’, which focuses on addressing the long-term challenges facing the UK – ‘geographic inequalities, decarbonisation and innovation.’ No one would deny that we do indeed need to ‘seize the moment’, but how we seize it is the question we should be posing. Whilst the CBI sees partnerships, including with government, as an important part of this process and says that its members have an important role to play, it notes at the same time:

“Governments don’t create jobs. Governments don’t prepare people in the workplace for the skills of the future. Governments don’t suddenly invent new decarbonisation technologies. That’s what businesses do.”

The CBI seems to have misunderstood the primary role of government in creating an environment that is conducive to a successful economy. Governments can and should, through their policy and spending decisions, create the economic conditions for job creation, enable an educated workforce and ensure investment in research and development through universities. Investment that gives eventual life to new technologies and products that can be exploited by business.

We should not forget either the vital public infrastructure provided by government which keeps their businesses functioning, whether its education, health, or transport infrastructure. Government can also play a role in using regulation to ensure that business plays by the rules and does not overstep the mark in its search for profit. And, when trouble strikes it is only the government, not businesses, that can step in to support the economy.

Government puts in place the mechanisms to protect the economy in the event of external threats, such as disease or the cyclical downturns which afflict all economies from time to time. It does this through its spending capacity as the currency issuer, and we have seen those powers over the past year, as indeed we did in 2007 during the Global Financial Crash. When the chips are down, the government has no alternative but to act. It does not check the state of the public accounts, it just spends, even though the narrative of borrowing and taxation to fund it still sits at the forefront of both political and public understanding.

Wealth creation begins with the government, whose role is to lay the foundations for a successful economy. Not by serving profit-related interests through lobbying and the revolving door, but to serve the interests of the nation as a whole which includes those of working people. The function of businesses on the other hand is to make profits, and working people have often been the losers, given that in the current set up businesses are the beneficiaries of government policy, which may not always serve workers and their families.

The proof of failure to serve those interests is clear in the consequences of the policy and spending priorities of the current government. As reported by GIMMS last week, a damning report from End Poverty has shown that the number of children living in poverty, without sufficient nutrition, in unheated homes or facing the prospect of eviction, has shot up over the past few years in the North East. For all the promises made by Conservative politicians, levelling up still has to be translated into real action and reach those who need it.

The solution requires government action that starts with addressing poor wages and insecure work practices. As past figures have endlessly shown, many in poverty are in working families, existing on low wages and precarious employment. Marcus Rashford has done sterling work in raising money and awareness of the issues, but we should not need the charity industry or philanthropists to mitigate and pick up the pieces caused by a government that has abdicated its responsibility for those who elected them. Whether that’s rich individuals, food banks or housing charities. They are not a substitution. We need the government to do its job through spending and policy decisions that enable levelling up, through wage and employment legislation and by creating the public infrastructure which keeps the economy functioning and brings stability.

Instead, we have a government that has found how to loosen the purse strings for corporations, but is biding its time to tighten them yet again when it comes to public purpose. The revelations by Cummings told us what we already knew about the governing class, exposing an entire flawed economic system that is largely upheld by a media that has failed to hold it to account. This has had devastating consequences, not just this last year but for decades. As Aditya Chakrabortty noted in an article this week ‘it lies in a grotesque failure of the state.’ Not a mistake or an omission or a misjudgement. But the pursuit of self-interest and greed. The public purse has found its target while ordinary people have paid the price in unnecessary suffering and death, hunger, homelessness, and a degraded public infrastructure.

And consequently, daily, we are treated to media and political narratives which aim to prepare us either for further cuts to public sector spending and further hardship, or raising taxes to pay off public debt. Or at the other end of the political spectrum politicians who advocate collecting taxes from the wealthy to spend on public infrastructure. By creating connections between tax revenue and public spending, we hit a brick wall that stops us dead.

According to the first narrative, there will have to be an eventual reckoning given the ballooning public debt. This week the Treasury is alarmed as a result of its post-pandemic forecasts that claim that the value of future student loan write-offs and interest subsidies will eventually ‘hit the public finances’. Yes, the smoke and mirrors of public accounting will claim that they will, but the reality is the opposite for a sovereign currency-issuing country like the UK.

Our education system as a whole has paid a heavy price, not just in terms of cuts to funding across the board but also through its commercialisation. Universities have become fully-fledged businesses to make money and service the needs of capitalism, rather than the good functioning of society culturally, socially, and economically.

The plans to cut 50% of arts course funding because they are not ‘strategic priorities’ beggar belief. Aside from the cultural enrichment that the arts bring to people’s lives, they also make a huge economic contribution which runs into billions. In effect, the decision destroys the Treasury narrative that taxes are needed to fund government spending. Why would you in that case cut off your revenue streams? It seems that the Chancellor and his Education Secretary have lost their economic marbles. From an economic point of view, it is foolhardy and short-sighted. The future poses many challenges, and we will need to prepare for them.

In the second narrative, the Chancellor Rishi Sunak found himself under pressure from President Biden to back a global corporation tax, and the Shadow Chancellor Rachel Reeves, whilst supporting it as a mechanism to create a fairer playing field for UK businesses then spoiled it all by saying that it would bring in extra income to pay for public services.

Some on the left are like rabbits in the glare of an oncoming car – committed on one hand to creating a fairer society and addressing the climate emergency, but on the other, happy to be flattened through their adherence to a flawed economic model that suggests that affording everything a nation needs requires raising taxes at the top.

Yes, let us raise taxes on the excessively wealthy to remove some of their purchasing ability and the influence on the corridors of power that their wealth brings them, but let us stop saying it pays for government spending. Such narratives will in the end constrain public programmes, not to mention the capacity to address the climate emergency. The lack of money has nothing to do with revenue collection or the ability to borrow. The lack is a matter of political choice, and politicians pursuing an economic ideology that suits the interests of wealthy elites and their own personal gain. If that is not shocking, it should be.

This week, an article by the New Economics Foundation added to the confusion about how governments spend. On the one hand, it suggested that ‘Whenever new public finance statistics come out, what follows is: public debt fearmongering, false household analogies, and a flurry of commentary devoid of any semblance of literate macroeconomic analysis’. At first sight, a cause for a small celebration and thinking that on the ‘left’ there is a coming light at the end of the tunnel. But then it spoils it all by reinforcing the false household analogy, saying:

‘The fact that public borrowing has not been this high since the second world war is serious and should not be taken lightly. But equally, the fact that financing that debt has never been more affordable is also hugely reassuring. Yet despite having countless headlines on the former throughout the pandemic, there has been precious little attention given to the fact that the government’s debt servicing costs are at historic lows. […]

Next, they dig themselves ever deeper by suggesting that:

‘…for macro-economists, what actually counts is the cost (affordability) of servicing debt – whether the government can securely pay off debt interest payments. There are numerous tribal” battles across the schools of macro-economic thought. Yet, there is virtual agreement across the board that public finances are sustainable indefinitely when debt servicing costs are equal to or below the growth rate of the economy. The implication, drum roll please, is that increases in public debt may not require tax rises or public spending cuts in the future. If interest rates are lower than the increase in national income, the relative debt burden will shrink with it.

Blow me down with a feather! The NEF is right back down the rabbit hole of borrowing, debt servicing costs and all that nonsense and thus reinforcing the household budget analogy. It started so well!

If we thought that after a year and more of economic pain and suffering, which has been built on the backs of decades of neoliberally inspired public policy and spending decisions (which has infected all sides of the political spectrum), that the time has come to choose another path, then for the moment at least we might be disappointed.

But without doubt, the stakes are high. We must aim to create a fairer and sustainable planet, not based on the misplaced concept of green growth which implies maintaining our current consumption or growing it further, but on the understanding that there are real limits that relate not to money but finite resources. The CBI’s ‘Seizing the Moment’ report focusing on creating an extra £700bn of economic growth by 2030 is symptomatic of the problem we face. We have to consider that we cannot continue with life or business as usual. MMT as a lens on monetary reality offers us a perfect opportunity to view the world, not from a perspective of artificially created scarcity, but as Jason Hickel, author of ‘Less is more’ calls it ‘public abundance’.

Last year, GIMMS published an article by Carlos García Hernández. In his article, Carlos quoted Stuart Chase, an American economist who wrote in ‘The Road we are Travelling’ (1942) that all economic policy must meet five fundamental objectives:

• guaranteed and permanent full employment
• full and prudent use of natural resources
• a guarantee of food, shelter, clothing, health services and education to every citizen
• social security in the form of pensions and subsidies
• a guarantee of decent labour standards.

That should be our starting point for what comes next.

#### Support us

The Gower Initiative for Money Studies is run by volunteers and relies on donations to continue its work. If you would like to donate, please see our donations page here

Share

Tweet

Whatsapp

Messenger

Share

Email

reddit

Pinterest

tumblr

Viber icon
Viber

The post Inflation is not what we should be worried about right now appeared first on The Gower Initiative for Modern Money Studies.