Inflation After 1971

[moda0306]

I have been thinking of a more mathematical reason for the inflation of the 1970's (deeper thanthe simple  ut obvious response of dropping the gold standard) and how Keynesians and even MMT'ers have, from what I can tell, glossed over the stagflation of thed decade following 1971, as well as pretty high inflation even throughout the 1980's during recovery.

I think, though, that the MMT'ers have probably mostly answered their own question.  If net financial assets only existed in the form of gold before 1971 (at least here... And that assumes silver doesn't count as a currency, and that since all private sector credit money has a liability associated with it, it doesn't have a net affect on our balance sheets), then can we describe the breaking of the gold standard to be an instantaneous creation of $?? Billion of net financial assets (the total of all the reserve notes and treasury bonds in circulation.

If we had all been savvy enough with post gold-standard economics at the time, maybe the inflation would have been much more instantaneous, but the long-standing fear of it would have died off much quicker.

During the gold standard, as tax-payers, we very well could have incorporated on our personal balance sheets the debt of our national gov't, and once that weight was lifted all at once, it was as of we enacted the largest fiscal stimulus in the history of the world.

This doesn't fully answer the stagflation question, but it helps explain almost 2 decades of relatively high inflation came after. 

[stone]

http://socialdemocracy21stcentury.blogs ... esian.html

moda, is that link any use?

It can be summed up with "the long-term solution was, and still is, an international system of commodity buffer stocks".

They claim that stagflation started before the US came off Bretton Woods and before the oil crisis. They blame it on the abandonment of the post war policy of having strategic stocks of commodities. They said that things were exascerbated  by fear around the end of Bretton Woods resulting in commodity hoarding as a store of value as people didn't trust the currency. The OPEC cartel issue then added an extra spin.

They don't explain why it ended. My guess was that it ended because the commodity exporters were successfully lured into ploughing money into US asset markets. That allowed commodities to be exchanged for account statements (ie essentially free commodities for the USA etc).

It is interesting to compare with the present situation. From what I can see, we now have the diametric opposit of "an international system of commodity buffer stocks". We now have immense amounts of financial derivatives tossing commodity prices around specifically inorder to create and harvest commodity price volatility even when real supply and demand are pretty much aligned.

[craigr]

The oil problems of the 1970s was not due to OPEC. IMO. It was due to price controls from Nixon and the bad inflation working through the economy. The US also had policies back then that made retrieving certain types of domestic oil very expensive so producers just left it in the ground. These rules were removed (IIRC) after Reagan came into power.

http://www.eia.gov/dnav/pet/hist/LeafHa ... RIMXX2&f=A



This chart shows a spike in OPEC imports during the 1970s. A direct result of not being able to get to good domestic supplies cheaply and price controls. It cratered by the early 1980s. If OPEC was not selling to the US during that time due to an embargo, then why the big spike in imports?

Additionally there are papers from the Fed during the 1970s that essentially confirmed my own findings. We caused our own oil inflation, not OPEC.

Cartels are overrated. They never work because there is too much incentive for the members to work behind each other's backs to sell more outside their quotas. OPEC is no different. That's why you hear them squabbling so much from time to time amongst each other.

[Gumby]

Here's what one MMT commenter wrote on 70s stagflation. I need to research it more, but maybe it will shed light on the MMT perspective:

...Automatic cost of living adjustments built into many employment contracts in the 70s – those created a self-propelling wage/price inflationary spiral without any increase in efficiency.

When your pay is specified in essence as a percentage of GDP, and if most of the pay in the country is negotiated that way then the government increasing GDP via spending money into existence won’t increase production.

So basically this should be added to the MMT list of “don’t do it”? policy measures: don’t kill your currency by automatically coupling wages to price levels. This comes right next to the “don’t get indebted in another country’s currency”? rule....

I should add that the 70s had pretty much full employment as well – the unemployment rate was 4-6% and only went to 9% during the 73-74 oil shock which made the U.S. severely uncompetitive and came down quickly afterwards.

The 79 oil shock then pushed unemployment above 10%.

Inflation spiked during these shocks too. When your economy is so dependent on oil then you have in essence borrowed in another country’s currency: oil. You are forced to ‘pay back’ that currency (consume it) going forward, regardless of the true capacity of your country.

In that sense oil was an externally imposed gold standard – but there was no debt crisis associated with it in the U.S. So as the U.S. printed money to restore capacity utilization and employment, it necessarily inflated – made worse by cost of living adjustments.

I think economically speaking the 70s weren’t all that bad: GDP grew and the U.S. weathered a pretty significant external crisis that devastated many other countries. The 70s were perceived as “bad”? mostly due to the unprecedented spike in unemployment (which was still half of that of the Great Depression’s) and the loss of trust in politicians – the adoration of U.S. Presidents of the 50s and early 60s has turned into cynical distrust by the late 70s.

...and on Warren Mosler's blog, a commenter wrote the following about stagflation:

1970s stagflation was accompanied by wage indexation clauses, and strong union power which ensured that when certain producers pushed up prices in a bid to increase their gross operating surplus as a % of NGDP, this increase was passed back around again in a wage spiral feedback loop.

...which was followed up by a comment from Mosler that said:

More like business had pricing power so the path of least resistance was to compensate well and pass it on to consumers

But more important was the Saudi price hiking that ended after the 1978 deregulation of nat gas resulted in the positive supply shock that massively dropped the demand for crude

[stone]

There is also a wikipedia piece agreeing with Craigr's point about the phenomenon of price controls ironically CAUSING inflation as a result of supply shortages:
http://en.wikipedia.org/wiki/Incomes_policy
"Some economists agree that a credible incomes policy would help prevent inflation. However, this would have other effects. By arbitrarily interfering with price signals, they provide an additional bar to achieving economic efficiency, potentially leading to shortages and declines in the quality of goods on the market, while requiring large government bureaucracies for their enforcement. This is what happened in the United States during the early 1970s.[3] When the price of a good is lowered artificially, it creates less supply and more demand for the product, thereby creating shortages.[5]"

Moda, what you are putting foward as a rationale for the inflation sounds to me like a very sophisticated "Ricardian eqivalence" type of behaviour by the US people. I just don't think people put that level of consideration into deciding what form their money is in and so whether or not to spend it. People tend to have more immediate concerns IMO. Perhaps some hoarding of commodities occured in response to distrust of the USD after Bretton Woods broke down but I suspect that that effect was only a small part of it. Its a bit like my skeptcism of Lone Wolf's assertion that the hypothetical platinum coin seignorage by the US Treasury would be inflationary. People respond to having or not having money with little regard to how the money was constructed IMO.

[moda0306]

I guess it does sound a bit Ricardian, and I agree people tend to have more immediate concerns.  The BW system, being a bit hobbled, is hard to compare to pure gold standard or pure fiat, but once the break was made, it seems to me that it fundamentally changed the nature of the debts our nation held, bringing in a quasi-Ricardian relief, even though people probably didn't realize it at the time in that form.

Is going from BW to a fiat system the equivalent of creating (??,) billions of net financial assets?

[MediumTex]

Is going from BW to a fiat system the equivalent of creating (??,) billions of net financial assets?

It definitely seems to have created a more or less one time opportunity for the world to lever up in a dramatic way.

The 40 years period since the end of the BW system has seen an explosion of leverage at all levels of society, which seems to have led to increasing concentrations of wealth in the hands of fewer and fewer people and an increased probability of financial crises, which we saw in Japan in the early 1990s, the rest of Asia in the late 1990s, and the whole world in 2008.

Maybe what we really need is not a return to the gold standard, but merely stronger limits on the amount of leverage any economic entity can use.

[stone]

Medium Tex, moving the tax burden to an asset tax on GROSS assets would make people think twice about leverage IMO or even if it didn't it would recycle that money back around. I think the terrible bind we are in is that (as has always been the case) profits must get spent if output is to be sold unless government deficits or increasing private indebtedness conjure up money to account for any increase in saving. Net saving across the whole economy seems to me to be one of those things that at its heart is impossible. We have tried to use an expanding monetary system to make the impossible possible but I fear we have just stored up trouble. I elicited a lot of wrath on billyblog a couple of years ago when I said it was like having a dam at the head of a densely populated valley and each day adding an extra layer of bricks to the top of the dam to hold the water back .

The MMTers do seem to have a very clear understanding of how economy wide net saving works but they then say that although it makes no sense it needs to be accomodated . Like you say, if it wasn't for our current monetary set up, it simply wouldn't be possible.

http://moslereconomics.com/wp-content/p ... s/7DIF.pdf
Deadly Innocent Fraud #6:
We need savings to provide the funds for
investment.
Fact:
Investment adds to savings.
Second to last but not the least, this innocent fraud
undermines our entire economy, as it diverts real
resources away from the real sectors to the financial
sector, with results in real investment being directed
in a manner totally divorced from public purpose. In
fact, it’s my guess that this deadly innocent fraud might
be draining over 20% annually from useful output and
employment - a staggering statistic, unmatched in human
history. And it directly leads the type of financial crisis
we’ve been going through.
It begins with what’s called “the paradox of thrift”? in the
economics textbooks, which goes something like this: In our
economy, spending must equal all income, including profits,
for the output of the economy to get sold. (Think about that
for a moment to make sure you’ve got it before moving on.)
If anyone attempts to save by spending less than his income,
at least one other person must make up for that by spending
more than his own income, or else the output of the economy
won’t get sold.

[melveyr]

I have been thinking about this a lot lately, and I have come up with a probably overly simplified way of explaining it to myself.

Unemployment largely results from a failure of participants to interface with the medium of exchange. This can happen in both inflationary and deflationary environments.

In a deflationary environment, participants fail to interface with the medium of exchange because of its scarcity. In modern economies participants generally feel the need to acquire currency before exchanging goods and services. If two participants effectively want to barter with each other (that is that they both have something desirable that expands their efficient frontier), they try acquire currency first, and then transact. If neither participant has sufficient currency, the transactions do not take place, leading to the under-utilization of assets.

Now, this failure to interface with the medium of exchange can happen under an inflationary environment as well. However, there is plenty of currency with inflation. In fact there is so much that people are fearful of interfacing with it. Acquiring dollars and holding on to them, even for a month is a losing proposition. Thus, people just sit tight, holding onto their assets. This can create a similar under-utilization of assets as deflation.

This is how I reconcile unemployment with in an inflationary environment. Please pick holes in it because it is new way of thinking about it for me.

[moda0306]

I have been thinking about this a lot lately, and I have come up with a probably overly simplified way of explaining it to myself.

Unemployment largely results from a failure of participants to interface with the medium of exchange. This can happen in both inflationary and deflationary environments.

In a deflationary environment, participants fail to interface with the medium of exchange because of its scarcity. In modern economies participants generally feel the need to acquire currency before exchanging goods and services. If two participants effectively want to barter with each other (that is that they both have something desirable that expands their efficient frontier), they try acquire currency first, and then transact. If neither participant has sufficient currency, the transactions do not take place, leading to the under-utilization of assets.

Now, this failure to interface with the medium of exchange can happen under an inflationary environment as well. However, there is plenty of currency with inflation. In fact there is so much that people are fearful of interfacing with it. Acquiring dollars and holding on to them, even for a month is a losing proposition. Thus, people just sit tight, holding onto their assets. This can create a similar under-utilization of assets as deflation.

This is how I reconcile unemployment with in an inflationary environment. Please pick holes in it because it is new way of thinking about it for me.

I have to roll the inflation side of that around my head for a while but for the most part I totally agree.  I'd add, though, that it's not just "comfort" with bartering that we need to consider, but how difficult and inefficient it is.

[moda0306]

I think we can agree that uncertainty over future price levels can cause economic stagnation and/or inefficiency.  Of course, inflation, which can often be associated with a high velocity of money, would less-likely result in super high unemployment, as the economy is in a position to want to create real wealth to hold at the expense of money, even if it's inefficient as people play hot potato with the currency.

But when you get into very high inflation scenarios, I think you tend to get people, instead of playing hot potato with the currency, simply trying to quit playing the game, or use a different medium with more stability.  This improper management of a medium of exchange may not so quickly result in unemployment as deflation does, but it's easy to imagine it getting there.

[stone]

moda I think it is all a matter of degree. Zimbabwe had 80% unemployment at the hieght of their inflation. Unusable money throws a spanner in the works and that creates unemployment.

[moda0306]

I was basically trying to get to that very point, stone.

I am still skeptical of your system of taxing to eliminate private leverage.  There are a lot of people with wealth later in their life, and a lot of different people with time and skills early in their life.  It seems to me to be a mistake to punish those transactions with high gross asset tax.

I am not saying we're under leveraged by any means, but I don't know what the best way to prevent inefficient leverage truly is.

[MediumTex]

moda I think it is all a matter of degree. Zimbabwe had 80% unemployment at the hight of their inflation. Unusable money throws a spanner in the works and that creates unemployment.

IMHO, the problem in Zimbabwe was more about capital flight than inflation.

Inflation was simply a symptom of a much broader set of problems.

If an economy is experiencing capital flight as a result of incompetent and corrupt political leadership it would make sense that there would be very high unemployment whether or not the economy was also experiencing high levels of inflation.

Capital flight, by definition, means that there will be less economic activity and thus fewer jobs. 

[stone]

Medium Tex, Weimar also entailed a massive amount of selling of German currency to buy USD didn't it? Don't they call it curency slide hyperinflation?

[stone]

I am still skeptical of your system of taxing to eliminate private leverage.  There are a lot of people with wealth later in their life, and a lot of different people with time and skills early in their life.  It seems to me to be a mistake to punish those transactions with high gross asset tax.

moda, I don't think it amounts to punishing such transactions. You would have more money left to save early on in life (or to put yourself into your enterprises) because you would not have other taxes. During your working life you would be acumulating more money by saving but it wouldn't get a real return above tax. When you came to draw down your savings, then again you would have it all to spend as there would be no capital gains tax or income tax or sales tax etc.

It would be tax advantaged to invest (in the economic rather than financial sense of the word). If money was spent training people or building machines or developing new technologies then that would be money no longer there to be subject to the asset tax. I'd really recomend reading (or re-re-reading) http://moslereconomics.com/wp-content/p ... s/7DIF.pdf fraud number six.

[MachineGhost]

What we also need is term limits, capping government taxes/spending to 20% of GDP and stopping TOO BIG TO FAIL policies, etc..  A so-called "gold standard" will not (and has not) do any of this.  Gold bugs have have this naive belief that a so-called "gold standard" is a check on government power.

If these changes won't happen because of inside job cryonism and corruption, there is only one other way (short of insurrection): a constitutional convention.

MG

Maybe what we really need is not a return to the gold standard, but merely stronger limits on the amount of leverage any economic entity can use.

[MachineGhost]

I don't know if you guys are overthinking the inflation "problem" of the 70's as I haven't studied MMT yet, but it seems to me all the "solutions" so far were describing the effects and symptoms of inflation, not the root cause.  Conflating effects with causes is a common tactic of statists.

Under a so-called "gold standard", the currency in question does not have the ability to depreciate to offset unproductive (inflationary) government (fiscal) policies.  What inflationary policies where those?  It all started with the Korean War (1953-1955), the Vietnam War (1955-1975) and Johnson's Great Society programs (1965+), aka Guns & Butter (the Nazi's did this too).  By 1965, all precious metals was taken out of all currency coins, screwing domestic holders, and by 1973 the U.S. dollar was totally delinked from gold by Nixon, screwing foreign holders -- a subset that then went on to implement the OPEC Oil Embargo as they were being paid with a rapidly depreciating fiat currency in exchange for "hard assets".

Inflation will always creep into the system, in some way, shape or form as long as the money system is political ("keep your damn hands off my gold!").  We don't need complicated legal explanations or theories to describe actual human behavior.  When people suspect or know they're being economically raped in their medium of exchange or store of value, they will react. 

MG

[moda0306]

MG,

If you were king for a day, what kind of monetary system would you engage our country in?

You've said you're against a gold standard but also don't like a government run currency... does that mean simply allowing private currencies to develop?

What about tax collection?  What currencies would we be allowed to pay taxes in?