Why inflation is a terrible tax

[Hygro]

Inflation isn't really a mechanism for employment/production. The mechanism or cause of increased production is financing employment. An effect can be inflation.

The place where inflation becomes part of the mechanism is that it is part of the calculation of real interest rates, changing the viability of lending opportunities. More inflation decreases the cost of borrowing, increasing the amount of investment.

 

[Hehehe]

Yes, the rich have savings. Massive savings. But inflation isn't a tax on savings, it's a tax on cash. I am just guessing here, because my post is about the regressive nature of inflation, but I am going to outright say that the rich have a lower amount of their savings in cash than nearly anyone else. The only exception I can think of are people with no money in the bank, but a pension that's inflation-protected. Or someone who's a little bit into their mortgage repayment already. When I look around, I see lower middle-class people keeping a hedge in their bank account. But the truly poor have almost no appreciating assets, merely depreciating ones. A few hundred bucks in the bank plus their furniture and car.

Mortgages?!? You mean rent. And car payments. But no. You're looking at total debt/income, and saying that many owe more than they're loaning out over the course of the week. And sure. But every single dollar that they are taking in has already been spoken for.

You cannot prepay your rent and gain a financial benefit. So, a pay raise barely helps there. Car payments? Sure, but at 1% return. Student loans? Maybe 8%? Credit card is absolutely a great choice, obviously. 19% plus can be done nearly immediately and is why I used the credit card example in my numbers. But that's about it. Meanwhile, any bump in costs is going onto a credit card, or on deferred maintenance, or as a large (relative) pull on the savings. And remember the marginal utility of money, where the price increase is vastly more painful the poorer you are.

Neither. Higher taxes. Now, I like low inflation. I think it brings many (many!) social benefits compared to the counterfactual. But I also think it's a terrible tax. If you want something done in a country, you'll want an inflationary policy merely so that your economy is stronger. But if you want something done that requires additional investment, paying for it with inflation is a terrible idea.

Yes, everyone loses purchasing power. But the poorest worker loses the most (relative) purchasing power. And yes, in many ways inflation-through-spending helps a different segment of the poorest. The bridge-builder is quite happy to have gotten a better job.

But it's like the minimum wage, where it's a benefit gained through terrifically regressive means. It's better to recognize that it is. It's a tool in the toolkit, but that's politics and not economics.

I would have written a full scale reply, but I fear I would just be repeating the same points I made earlier. I suppose we can respectfully disagree about this. Based on a very surface level analysis, I don't see a correlation between inflation and income inequality, and the causal link seems somewhat ambiguous to me. You've also repeatedly brought up income inequality, and I definitely agree that income inequality is a problem. However, I believe that the causes for it run much deeper in the system, but that's another conversation.

 

[El_Machinae]

The economy has always worked in cycles, and while there is some disagreement as to what causes these cycles, the cyclical nature of the economy seems undeniable. For a short summary of the economic debt cycles, I would recommend this video. Ray Dalio's model wraps almost everything I know about economics into a neat little bow (there are, of course, other proposed reasons for the economic cycles, from Piketty's theory about the concentration of wealth to Marxist labor theories)

The Ray Dalio video was fun, thank you. I should have agreed with one of your comments, that one of our major issues is the wealth inequality ruining the economic game. It really is the underlying damage that can happen in an economy. This thread wasn't intended to be a thesis on reducing inequality, but was more intended to show the regressive effect of misusing one of the tools in our toolkit.

 

[El_Machinae]

@Mise @Cutlass @Hygro @Lexicus

Do you guys see any real errors in the video in the segment I quote above? It's really pretty good, and it's not like Dalio is disrespected. Is there something missed that really changes the entire theory?

 

[Hehehe]

Do you guys see any real errors in the video in the segment I quote above? It's really pretty good, and it's not like Dalio is disrespected. Is there something missed that really changes the entire theory?

If you're interested in more Youtube economics, may I interest you in this video? It's Keynesianism versus Austrian economics. Although it's presented as a rap battle, the economics side is fairly solid. The only thing I would disagree with is how Keynesianism is presented only as deficit spending, but that seems to be a common misconception these days. Also, you might want to check out Piketty's capital in the 21st century. To sum it up, Piketty's central thesis was that in a free market economy, wealth tends to concentrate more and more until time goes on, and that in his data, world wars were to only exception to this pattern. This would lead to a cycle where wealth concentration reaches unhealthy levels, which then manifest as political unrest, until the resulting conflicts equal the wealth distribution.

 

[Hygro]

All iterative trading games lead to increasing inequality.

 

[Cutlass]

@Mise @Cutlass @Hygro @Lexicus

Do you guys see any real errors in the video in the segment I quote above? It's really pretty good, and it's not like Dalio is disrespected. Is there something missed that really changes the entire theory?

OK, I took the time to watch that. For the most part I'm usually not willing to watch a half hour video for an internet argument. But oh well.

As a whole it's pretty good. A few points stand out. The short and long term debt cycle points I don't like. First of all, the Great Depression and the Great Recession were not the result of the long term debt cycle, not a situation where we were at a long term debt peak, and so had to deleverage. The Great Depression happened not because of excess leverage, but because of the gold standard, and the failure of the French and US central banks to understand the limitations of the gold standard, and because of that they took too much money out of circulation because they thought they had too much gold. The Great Recession was caused not because of too much debt, but because the quality of the debt was so poor, and so much of the collateral of the debt was fraudulently valued. So the long term debt cycle doesn't hold up. The short term debt cycle has a problem as well. And that you can see if you're familiar with an oscilloscope.

What happens when you have a wave. And then what happens when you have a second wave, which is not in phase with the first wave? And then what happens when you have a few more waves, which are not in phase with those waves? And then what happens when you add in millions more waves, none in phase with one another? Well, eventually you really don't have a wave anymore, you have white noise.

Now that said, in the general course of events, most recessions happen because inflation has gotten a little high, and the central bank puts on the brakes by pushing interest rates higher. But is that really a credit cycle? I don't think it's really like the vid explained.

Now if we were at the peak of a debt cycle in 2008, how do you explain the fact that instead of deleveraging, we've done a crapton more debt since then?

Now on what the debt is used for, that sort of hits the right way. Debt used for consumption in the long run is a bad idea. I've mentioned this in the past, that Republican debt is essentially debt to pay for coke and hookers. It is not used to create the productive capacity necessary to repay it, it is fully consumed at the time it is run up.

Another point to take note of is the idea of bubbles. Now bubbles do exist, but they are not understood as being a formalized regular thing the way that the video suggests.

 

[Lexicus]

how do you explain the fact that instead of deleveraging, we've done a crapton more debt since then?

????



We haven't gone down to pre-1990s levels, but we haven't added more debt. Private debt, by the way, is what's relevant to all these debt and credit cycles since public debt follows different rules.

edit:
Not saying that supports the argument that the debt cycle acts like a mechanical wave. The axiom that financial events have real causes (obviously they have real effects too) is pretty much always true. The problem we have now is that financial events are driven too much by corporate governance problems in the finance sector. I think Hyman Minsky's theory of financial instability is a better explanation of the business cycle than this thing. BTW, I didn't watch a video but found a pdf by the same guy that appears about the same thing.

He's more on track than the mainstream of neoclassical macro because they hardly even admit that the financial sector exists, let alone that from it might emanate seismic waves that can liquefy the real economy. But I don't think his theory is all that useful except as a sort of vague description of how the business cycle occurs. Minsky's theory actually gives a pretty strong causal mechanism that is linked to the human world we inhabit.

Here is a link to a 1992 paper by Minsky summarizing that theory.

Notice he uses the term 'debt deflation' which I think is probably more accurate than 'deleveraging.'

 

[Hygro]

I’ve seen it a few times and I rewatched
It per your call. I really like it. To answer your question there are no glaring errors.

Could it be better leading (as in the opposite of misleading)? Yes much but this video is to get people to stop thinking a boom or bust is anything other than temporary or special.

My biggest gripe is the graphical suggestio that a deleverage need equal the leveraging in both shape and size.

After all, like exercise giving upfront performance and needing rest, the process of the exercise and rest itself gives more power to the exercise over time and requires less rest with more conditioning.

In other words, the lending process itself is drives drives the slope of that straight productivity curve, as well as its effect itself shaped by changes in productivity.

 

[Hehehe]

OK, I took the time to watch that. For the most part I'm usually not willing to watch a half hour video for an internet argument. But oh well.

As a whole it's pretty good. A few points stand out. The short and long term debt cycle points I don't like. First of all, the Great Depression and the Great Recession were not the result of the long term debt cycle, not a situation where we were at a long term debt peak, and so had to deleverage. The Great Depression happened not because of excess leverage, but because of the gold standard, and the failure of the French and US central banks to understand the limitations of the gold standard, and because of that they took too much money out of circulation because they thought they had too much gold. The Great Recession was caused not because of too much debt, but because the quality of the debt was so poor, and so much of the collateral of the debt was fraudulently valued. So the long term debt cycle doesn't hold up.

First of all, as far as Great Depression goes, if you want to go with a theory of monetary contraction, I don't think that central banks taking money out of circulation is a significant factor. In fact, even it happened, I that daresay it was absolutely dwarfed by the amount of money that was taken out of circulation by banks going under. We can argue as to what caused the Great Depression, but a lot of the proposed causes (from aggregate demand to financial bubbles) can arguably be tied back to market cycles.

The short term debt cycle has a problem as well. And that you can see if you're familiar with an oscilloscope.

What happens when you have a wave. And then what happens when you have a second wave, which is not in phase with the first wave? And then what happens when you have a few more waves, which are not in phase with those waves? And then what happens when you add in millions more waves, none in phase with one another? Well, eventually you really don't have a wave anymore, you have white noise.

If you sum up the macro-economics behind this theory, then you only get one wave. If you sum up all net debt, then it is either increasing or decreasing, not both at the same time. What are you even saying there? That short term debt cycles do not exist at all? Or that there are no identifiable waves in the markets?

Now that said, in the general course of events, most recessions happen because inflation has gotten a little high, and the central bank puts on the brakes by pushing interest rates higher. But is that really a credit cycle? I don't think it's really like the vid explained.

Well, I'm not sure what exactly you mean by this. But what is inflation, if not the supply of money growing faster than the supply of goods? Are not the central bank interest rates crucial to both the amount of debt in an economy, as well as the overall supply of money?

Now if we were at the peak of a debt cycle in 2008, how do you explain the fact that instead of deleveraging, we've done a crapton more debt since then?

That would be why it's called the Great Recession, rather than the Great Depression. I don't see how this is supposed to contradict the theory of debt cycles. Taking on more debt tends to boost the economy short term.

????



We haven't gone down to pre-1990s levels, but we haven't added more debt. Private debt, by the way, is what's relevant to all these debt and credit cycles since public debt follows different rules.

If you want to examine the theory of debt cycles, you'd need to sum up all debt, public and private. There is some debate to be had about how different public debt functions from private debt, but it definitely is not a factor that can simply be hand waved away. And total debt has been increasing.

edit:
Not saying that supports the argument that the debt cycle acts like a mechanical wave. The axiom that financial events have real causes (obviously they have real effects too) is pretty much always true. The problem we have now is that financial events are driven too much by corporate governance problems in the finance sector. I think Hyman Minsky's theory of financial instability is a better explanation of the business cycle than this thing. BTW, I didn't watch a video but found a pdf by the same guy that appears about the same thing.

He's more on track than the mainstream of neoclassical macro because they hardly even admit that the financial sector exists, let alone that from it might emanate seismic waves that can liquefy the real economy. But I don't think his theory is all that useful except as a sort of vague description of how the business cycle occurs. Minsky's theory actually gives a pretty strong causal mechanism that is linked to the human world we inhabit.

Here is a link to a 1992 paper by Minsky summarizing that theory.

Notice he uses the term 'debt deflation' which I think is probably more accurate than 'deleveraging.'

The impact that the finance sector has is debatable, but even if I were to accept it, I don't see Minsky's theory necessarily contradicting the theory debt cycles in any way. Events can have multiple causes leading up to them.

As far as Minsky's theory goes, I'm not sure what kind of evidence he has backing it, and it seems to me that he just kind of glosses over the macro-economic conditions that the finance sector operates in.

 

[Hygro]

First of all, as far as Great Depression goes, if you want to go with a theory of monetary contraction, I don't think that central banks taking money out of circulation is a significant factor. In fact, even it happened, I that daresay it was absolutely dwarfed by the amount of money that was taken out of circulation by banks going under.

The policy of the Federal Reserve was to defend the gold standard at all costs, which meant aggressively raising interest rates to keep gold in America. Raising interest rates drove bank failures.

 

[Hehehe]

The policy of the Federal Reserve was to defend the gold standard at all costs, which meant aggressively raising interest rates to keep gold in America. Raising interest rates drove bank failures.

They only started defending the gold standard after the trouble had already begun. There is a strong case to be made that gold standard worsened the effects of the depression, but there's no reason to think that the gold standard was the original cause. Unless of course, you're referring to the interest rate hike plan in 1928-1929, but that was specifically aimed at combating speculative behavior.

 

[Lexicus]

If you want to examine the theory of debt cycles, you'd need to sum up all debt, public and private. There is some debate to be had about how different public debt functions from private debt, but it definitely is not a factor that can simply be hand waved away. And total debt has been increasing.

No, this is false. Public debt is not subject to the same rules as private debt. Under the gold standard, or in the Euro, it is more correct, because under those conditions national governments are not really currency issuers. In the US the federal government is the issuer of the dollar. It isn't a "hand wave" because private debtors do not issue the currency. The US government cannot be forced to default on its debts - private debtors can. This makes an enormous difference.

The impact that the finance sector has is debatable,

No, it isn't. Ignoring the finance sector means you're never going to have a predictive model of a capitalist economy, period. That's why the neoclassicals not only failed to see the crisis coming, many then ignorantly/dishonestly claimed that no one could have predicted it.

but even if I were to accept it, I don't see Minsky's theory necessarily contradicting the theory debt cycles in any way. Events can have multiple causes leading up to them.

Yes, but Dalio appears to believe the business cycle is driven entirely by the central bank's interest rate policy. That is certainly false in the case of the Great Depression and the recent Great Recession, as you seem to grasp:

They only started defending the gold standard after the trouble had already begun.

In the Depression the commitment of national governments to remain on gold - another of way of putting this is their commitment to the self-regulating market economy - worsened and deepened the crisis, which eventually forced every country, one by one, off gold (and to abandon even the ideal of self-regulating market). But the federal reserve's interest rate isn't what drove the crisis in the first place. Per Minsky's scheme it was the prolonged boom of the 20s that led more and more investors to engage in speculative and ponzi finance rather than hedge finance. This is the origin of the phrase "stability creates instability." And implies that private financial markets inherently trend toward crisis because good times create the conditions for bad times.

IIRC Minsky believed this was unavoidable, at least if you weren't going to run a Soviet-style command economy. He believed that it was the government's job to offset the business cycle with countercyclical spending.

Now on what the debt is used for, that sort of hits the right way. Debt used for consumption in the long run is a bad idea. I've mentioned this in the past, that Republican debt is essentially debt to pay for coke and hookers. It is not used to create the productive capacity necessary to repay it, it is fully consumed at the time it is run up.

I want to say that I actually disagree with this. Per my posts about consumption driving the economy today, debt that is used for consumption can/does drive the creation of productive capacity. The issues with using debt to fund consumption are more distributional, ie, that creditors will begin to claim a larger and larger share of national income should debt for consumption be allowed to get out of control. (again talking private debt, public debt is a different creature)

 

[Hehehe]

No, this is false. Public debt is not subject to the same rules as private debt. Under the gold standard, or in the Euro, it is more correct, because under those conditions national governments are not really currency issuers. In the US the federal government is the issuer of the dollar. It isn't a "hand wave" because private debtors do not issue the currency. The US government cannot be forced to default on its debts - private debtors can. This makes an enormous difference.

Even if you want to ignore any complications caused by over-indebtedness, such as resulting inflation and/or liquidity traps, just mere fact that government is spending so much money is crucial when it comes to macroeconomic models.

No, it isn't. Ignoring the finance sector means you're never going to have a predictive model of a capitalist economy, period. That's why the neoclassicals not only failed to see the crisis coming, many then ignorantly/dishonestly claimed that no one could have predicted it.

"Ignoring finance sector"? No-one is claiming that it doesn't exist, it's only a matter of how much do the decisions made in the finance sector impact the economy compared to other things.

Yes, but Dalio appears to believe the business cycle is driven entirely by the central bank's interest rate policy. That is certainly false in the case of the Great Depression and the recent Great Recession, as you seem to grasp:

Please, take a moment to reflect on what you read. Not only did you construct a strawman, that strawman doesn't even work on its own merits. In Dalio's model, central banks use interest rate policy as a tool to influence markets. Central banks are responding to market cycles, and in doing so driving the markets. But even if your strawman were correct, your accusations would not be. As I said earlier in my previous post, the central bank did in fact raise the interest rate to combat speculation, which was a factor in the resulting stock market collapse.

In the Depression the commitment of national governments to remain on gold - another of way of putting this is their commitment to the self-regulating market economy - worsened and deepened the crisis, which eventually forced every country, one by one, off gold (and to abandon even the ideal of self-regulating market). But the federal reserve's interest rate isn't what drove the crisis in the first place. Per Minsky's scheme it was the prolonged boom of the 20s that led more and more investors to engage in speculative and ponzi finance rather than hedge finance. This is the origin of the phrase "stability creates instability." And implies that private financial markets inherently trend toward crisis because good times create the conditions for bad times.

IIRC Minsky believed this was unavoidable, at least if you weren't going to run a Soviet-style command economy. He believed that it was the government's job to offset the business cycle with countercyclical spending.

I would agree with you here in that I do think that the gold standard did make things worse, and I also do not have that much confidence in the markets' ability to self-regulate. Where I would, however, disagree is with Minsky's theories. His theory is fairly obscure, and Minsky is not very well accepted among mainstream economists. And it would seem like that is for a good reason. At best it is something that may or may not expand upon more comprehensive models about debt cycles, but even that seems a bit strenuous. But I guess you and I can agree to respectfully disagree on that point.

 

[Lexicus]

Even if you want to ignore any complications caused by over-indebtedness, such as resulting inflation and/or liquidity traps, just mere fact that government is spending so much money is crucial when it comes to macroeconomic models.

Precisely - government spending is what breaks the private debt cycle and stops the debt deflation or "deleveraging" phase. Or at least, cushions the real economy from its effects.

No-one is claiming that it doesn't exist, it's only a matter of how much do the decisions made in the finance sector impact the economy compared to other things.

And Dalio grasps that they do effect the economy quite a lot. I suppose the question is, do you?

mainstream economists

My whole point is that mainstream (macro)economists tend not to know what they're talking about. Neoclassical macroeconomics is almost entirely worthless.

 

[El_Machinae]

Even with the ability to print currency, Federal governments can default on their debts . This is because, some of their debts are written in real terms. Social Security is written with a cola built into it. Federal pensions as well. Unlike other federal debt paper, when your purchase includes the risk of inflation eating away at your returns, pension debt is usually formulated in real terms, not merely in Fiat terms. I find this comes up most commonly when I am discussing pensions with conservative right-wing people, and the military pension.

 

[Hehehe]

Precisely - government spending is what breaks the private debt cycle and stops the debt deflation or "deleveraging" phase. Or at least, cushions the real economy from its effects.

I am glad that we agree. This is what I've been saying since the beginning.

And Dalio grasps that they do effect the economy quite a lot. I suppose the question is, do you?

Ah, does Dalio agree with Minsky? I must've missed that part

My whole point is that mainstream (macro)economists tend not to know what they're talking about. Neoclassical macroeconomics is almost entirely worthless.

Right, so mainstream economists don't understand economics, but you and Minsky do? Well, I guess that's the thing about economics. It's not an exact science, and you can believe fringe theories over mainstream ones if you want. I suppose in some sense economic theories are a matter of faith, as it can be somewhat difficult to show exact causal relationships in a system as complex as economics.

 

[Lexicus]

Ah, does Dalio agree with Minsky? I must've missed that part

It doesn't look like they disagree much on the descriptive aspect. They would probably disagree on "what it all means."

Right, so mainstream economists don't understand economics, but you and Minsky do?

The vast majority of macro modelling (including that produced by governments, e.g. Congressional Budget Office projections in the United States) does not maintain stock-flow consistency. This is like using a physics model that doesn't conserve energy. It just isn't going to be useful. I don't know about myself, but Minsky certainly understood macro better than most mainstream economists. Subsequent economists expanding his work have actually got a predictive framework and predicted both the Great Recession and the outlines of the Euro crisis. Folks like Wynne Godley (sadly also deceased), Randall Wray, Stephanie Kelton, Bill Mitchell, are who you want to pay attention to when it comes to macro - not the mainstream. The mainstream is still stuck on general-equilibrium nonsense for the most part.

 

[Hehehe]

The vast majority of macro modelling (including that produced by governments, e.g. Congressional Budget Office projections in the United States) does not maintain stock-flow consistency. This is like using a physics model that doesn't conserve energy. It just isn't going to be useful. I don't know about myself, but Minsky certainly understood macro better than most mainstream economists. Subsequent economists expanding his work have actually got a predictive framework and predicted both the Great Recession and the outlines of the Euro crisis. Folks like Wynne Godley (sadly also deceased), Randall Wray, Stephanie Kelton, Bill Mitchell, are who you want to pay attention to when it comes to macro - not the mainstream. The mainstream is still stuck on general-equilibrium nonsense for the most part.

Yes, and Nostradamus predicted everything from world wars to 9/11. But to each his own I guess.

 

[Lexicus]

Well, you're responding just the way the mainstream does.

"No one could have predicted this."
"Actually, someone did."
"Okay, let's make fun of them."