A very common economic concern at the moment is whether there will be significant inflation as the result of large federal spending programs as well as the injection into the economy of vast sums of money as the result of the Federal Reserve increasing the money supply by buying government bonds. There are even concerns that the United States might experience hyperinflation. Opinions on this subject vary widely with experts of differing backgrounds providing contradictory predictions and analyses. In order to sort through these and try to establish a foundation so that reasonably intelligent people with common sense can make their own educated guesses, it might help to begin with some non-controversial observations.
I. The value of anything is ultimately a matter of opinion
The first is that inflation is a phenomenon that reflects the value of money in relation to the value of other things. When money is considered less valuable, for example with respect to a list of consumer items, it takes more money to exchange for those items and inflation results. This observation is a specific example of the more general observation that the value of anything is a matter of opinion. IT may consensus opinion, or expert opinion or popular opinion, but anything is only worth what someone thinks it is worth. This was demonstrated quite dramatically when the value of Bitcoin dropped when Elon Musk expressed opinions about it. His opinions affected the opinions of others, with the result that Bitcoin lost about 40% of its value over a period of a few days.
When pondering inflation, it is not only the opinion regarding the value of money with respect to something or class of things, but the anticipated future value of money with respect to those things. This point is a source of much of the disagreement and difference of opinion regarding inflation. To male this point more concise, inflation is affected by the opinion of what the value of money with respect to some reference will be in the near future. It should be noted that another source of disagreement is what that reference is: it is quite possible for example that there will be inflation in price of some things and deflation in the price of others. The value of anything is ultimately a matter or opinion. When sufficient popular opinion, or authoritative opinion regarding something (such as Bitcoin or Blackberry devices) changes, the value of those things change.
II. The supply of money interacts with other factors to produce inflation or deflation
The second point arises from limitations of the notion that increasing the money supply leads to inflation. This principle was not borne out by the experience of Japan in the 1990s, nor in the United States following quantitative easing associated with the 2008 financial crisis. Whether it will be true of recent injections of money into economy is the key inquiry at the base of contemporary inflation concerns. The explanation for the failure of quantitative easing to generate significant inflation is that the money that was being created was being injected into a liquidity trap. The money was not circulating in the economy because because people were hoarding it; that is inflation depends not only on the quantity of money, but also on people's willingness to spend it, i.e. liquidity. Liquidity, like value is as much a result of psychological factors as it is economic ones. This leads to the concern that "pent-up demand" will lead to a surge in liquidity and provide an inflationary stimulus that was lacking in 1990s Japan or subsequent to the 2008 financial crisis.
Liquidity depends on willingness of people to spend money and this willingness is very sensitive to their opinions about future economic conditions. As with the idea of the value of money, differences in inflation estimates that consider liquidity rely on accurate predictions of people's opinions, and there is no way to reliably do this; hence we have widely divergent predictions for inflation from "low" to "manageable" to "significant but transient" to "high and persistent" to "runaway hyperinflation." The key concept is that inflation is highly sensitive to people's opinions and perceptions about the future and this is very difficult to accurately model.
III. The key psychological determinant of inflation is confidence, and this has provides conflicting inflationary pressures.
Confidence is really just a particular type of opinion, but it is actually the type that will determine whether there is significant inflation, and what type it will be. Confidence applies to different things and what those things are determine if confidence produces or inhibits inflation.
One can look at the experience of Bitcoin and consider that its price in U.S. dollars reflects confidence that 1.) it will hold its value, 2.) that it will remain liquid, i.e. that it will be easily convertible into other things of value, 3.) that it will be a secure and largely anonymous medium of exchange. Loss of confidence in any of these things will affect its price, as happened when Elon Musk implied that environmental concerns might influence it acceptability as currency. The disturbance of confidence affected the opinion of what the future value of Bitcoin would be; no one wants to hold an asset that is likely to plummet in value (which is highly sensitive to opinion) and be worth much less in the near future. The day-to-day value of Bitcoin as reflected in its market price is largely a measure of confidence.
The same principle applies to the U.S. dollar. Its present value is affected by opinions of its future value in terms of liquidity, stability, etc. and these in turn depend on confidence in government policies. Loss of confidence in government, particularly perceptions that governments are corrupt or ineffective is a common feature of countries afflicted with hyperinflation, such as Weimar Germany, and more recently Argentina, Zimbabwe and Venezuela. As with Bitcoin, the value of the dollar is a reflection of the confidence that people have that it will hold its value particularly against other currencies. One may note that the United States has a bit of a buffer in this regard given the dollar's status as the recognized reserve currency.
All money is essentially backed by the value of something, and in the case of fiat money, that something is confidence. Money backed by confidence is worth more as confidence increases; i.e. the value of money with respect to other goods and services goes up as confidence increases and this is a deflationary effect. When confidence goes down, the value of money goes down and this is an inflationary effect. Economists can measure confidence at a point in time, but not in the future, even the near future. Even such metrics as bond prices and associated interest rates can give no more than an estimate of current opinion rather than future opinion. This results in a significant limitation on their ability to model inflation and explains the lack of consensus regarding what will happen in the setting of huge injections of cash into the U.S. economy.
Confidence in the government and its policies increases the value of money and is a deflationary influence, but lack of confidence in individual economic circumstances leads to hoarding money, lack of liquidity and is also a deflationary influence. Confidence is both deflationary, when applied to future government credibility, and inflationary when applied to an individual concerns regarding his own economic prospects. This is a complex interaction that cannot be easily modeled.
Technological innovation tends to increase efficiency and therefore increases the supply of goods and services, resulting in a deflationary variable. It may also make a worker more anxious for the future of his job and also produce a deflationary effect. However technological innovation may create a sense of reassurance that considerations of scarcity are not thought of as existential threats, to the point that politicians might talk openly of universal basic income based on adding no value to the economy whatsoever. This encourages spending and would be expected to have inflationary tendencies. The amount of money per unit of work is conceivably infinite, which is definitely an inflationary state.
IV. Other factors that influence inflation are ultimately dependent on opinions regarding value.
The remainder if this post is published on the LibertyZ.substack.com site.
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