Vindicated 1 – Inflation

In 2020, I wrote several posts (A Global Weimar, Post Covid, Prices and Revenues, Covid Induced Inflation, Bank of England Doublespeak, US Inflation Spikes, US Inflation Surges, UK Inflation Rises Sharply Again, Retail Prices). These set out, as central banks and many economists were claiming that inflation was only transitory, why it was not. The central banks and pundits argued that much of the higher inflation figure was due to statistical flukes. In fact, as I pointed out, because the annual inflation number was based on looking backwards, rather than forwards, it understated what the inflation figure was likely to be. They argued that any economic weakness resulting from lockdowns, would inevitably cause inflation to fall, as demand fell, and that was an argument that was also to be found on the Left from people like Michael Roberts, who never tire of letting the potential for the next recession and catastrophe go to waste. Writing a few months later, Roberts saw US inflation rising to 3%, but, by the time he wrote that, it was already at 4.5%!

In fact, in my post UK Inflation Rises Sharply Again, written in November 2020, I predicted, on the basis of official CPI data, that a year ahead it was likely to be around 4.95%, which is pretty much spot on to what it turned out being. Indeed, I pointed out that this official data significantly understated the actual inflation, because the basket on which the data is collected was heavily weighted to those goods and services the demand for which had been stopped due to lockdowns, and, whilst under-weighting all those goods and services that people had actually turned to during that period. Moreover, such data, as recent studies have shown, under-weights the goods and services that working-class people buy, and those goods and services tend to rise more in price than the more expensive and luxury goods that the middle-class, and more affluent buy. Taking that into consideration, inflation in both the US and UK is already in double digits.

In 2021, I asked the question “How Will States Respond To Rapidly Rising Inflation?”, and answered it by saying that they would continue to print the money tokens that caused the inflation in the first place. They would do so, because, as the pandemic increasingly could not be used as an excuse for continued lockdowns to restrict demand, so as to prevent economic activity rising rapidly, which would cause interest rates to rise, as profits were squeezed, but firms needed to expand to grab market share, central banks would print more money tokens so that they could buy up government and other bonds, taking them off the hands of their private owners, before the prices of those bonds collapsed, much as they did with Greek and other bonds, in the period of the Eurozone debt crisis. But, in conditions in which economic activity rose sharply as restrictions were lifted, all of this additional liquidity, on top of the vast oceans of it already in circulation, would necessarily flow into the real economy too, causing commodity prices to rise. In certain sectors, as firms sought to expand to keep or capture market share, they would have to compete for available labour, pushing wages sharply higher, in those sectors (for example, wages in hospitality rose 18%, HGV wages rose by 30%), but this competition for labour, amidst sharply rising inflation, would work through into higher wages in general.

Because, the state is not going to sit back and allow higher wages to simply squeeze profits, because firms are unable to raise prices if currency is restricted, they would inevitably continue to increase liquidity to allow firms to try to recoup higher costs by raising prices, which sets in place an inevitable price-wage spiral. Only when that inflation gets out of hand, and workers continue to be able to increase wages to cover it, will central banks step in to curtail currency supply to an extent that it induces a sharp recession, so as to undermine the position of labour, and so slash wages, as happened with Volcker in the early 1980's. So, it was no surprise to me that throughout 2021, central banks continued to print money tokens, and to buy up worthless paper, taking it off the hands of its private owners, and justifying it with claims about protecting the economy, all the time with states undermining the economy with unnecessary lockdowns and lockouts!

In Inflation Is Barrelling Towards US, I set out why many pundits under 50 would not understand the reason that inflation was going to continue to rise, as all of the excess liquidity created by central banks now flooded into the real economy, just as over the last 30 years, it has caused an inflation in asset prices as it was deliberately channelled into those share, bond and property markets. In A Contribution To The Critique of Political Economy, Marx explained why this is. When you have a money commodity such as gold, the quantity of it put into circulation as currency is determined by the value of commodities to be circulated, and by the velocity of circulation (basically how many times a gold coin changes hands in transactions during the year). It is the universal equivalent form of the value of all these other commodities to be circulated, and is then a function of the value of those commodities, and of gold itself.  Price is the exchange-value, or under capitalism price of production, of any commodity measured against gold as the money commodity, 

This is why, the Keynesian view of inflation, also basically adopted by Michael Roberts, that inflation is caused by rising costs, is false. For costs, read value, i.e. the value of commodities rises, because productivity falls, more labour is required for their production/the cost of their production rises. Suppose, that the value of all commodities to be circulated is equal to 1,000 hours of labour. A gram of gold is equal to 1 hour of labour, and, in the form of a coin, this gram of gold has the name £1. If the velocity of circulation is 10, then 100 of these gold coins must be put into circulation, to circulate the commodities. Now, suppose, that productivity in the economy falls, so that to produce all of these commodities requires not 1,000 hours, but 1200 hours. However, gold is also a commodity, and we would have to assume that this fall in productivity affects it too, for example, the prices the gold miner pays for machines, tools, timber and so on would rise. In that case, a gram of gold now represents not 1 hour of labour, but 1.2 hours of labour, and a £1 coin also now represents 1.2 hours of social labour-time. Consequently, the same 100 coins would still be required in circulation, and prices would remain constant measured in £'s! Only if productivity in gold production was different to that in the rest of the economy would this not be true. In effect the exchange-value of gold, relative to other commodities, would change. That is why, as Marx describes, inflation is a monetary phenomenon.

But, if too many gold coins are in circulation, they are either hoarded and withdrawn, or else the gold content of the coins is reduced accordingly, so that each represents less quantity of gold, less social labour-time. With coins or paper notes that merely represent gold – in reality represent a given quantity of social labour-time – this is not possible, because they have no real value themselves in terms of their physical composition. As Marx says,

“How many reams of paper cut into fragments can circulate as money? In this form the question is absurd. Worthless tokens become tokens of value only when they represent gold within the process of circulation, and they can represent it only to the amount of gold which would circulate as coin, an amount which depends on the value of gold if the exchange-value of the commodities and the velocity of their metamorphoses are given... If the value of gold decreased or increased because the labour-time required for its production had fallen or risen then the number of pound notes in circulation would increase or decrease in inverse ratio to the change in the value of gold, provided the exchange-value of the same mass of commodities remained unchanged. Supposing gold were superseded by silver as the standard of value and the relative value of silver to gold were 1:15, then 210 million pound notes would have to circulate henceforth instead of 14 million, if from now on each piece of paper was to represent the same amount of silver as it had previously represented of gold. The number of pieces of paper is thus determined by the quantity of gold currency which they represent in circulation, and as they are tokens of value only in so far as they take the place of gold currency, their value is simply determined by their quantity. Whereas, therefore, the quantity of gold in circulation depends on the prices of commodities, the value of the paper in circulation, on the other hand, depends solely on its own quantity.”

In the example, above if the value of gold rose in proportion to the value of other commodities, no additional gold is required for circulation, and similarly, no additional notes representing that gold is required. But, the gold itself is only a representative of a given amount of social labour-time, its proxy. Each note, like each gram of gold, represents, now, 1.2 hours of labour. So, that 100 £1 notes are required. If, instead, 120 £1 notes are put into circulation, these now claim to represent 1,440 hours of social labour-time, whereas the value of commodities to be circulated is equal only to 1200 hours. As the paper, unlike gold, cannot be automatically withdrawn – unless the central bank does so, deliberately - the consequence must be that the price of each commodity rises, by 20%, i.e. there is inflation, or put another way, each note is devalued by 20%, so that it represents only 1 hour, not 1.2 hours of social labour-time.

The only thing that prevented commodity price inflation surging in the period from 1990 to the present was that, firstly the technological revolution brought about by capital from the mid 1970's, hugely reduced the value of commodities, as social productivity surged, so that had currency supply remained constant, there would have been a large decrease in prices, but secondly, from 1987, and the stock market crash of that year, central banks, across the globe, printed money tokens and deliberately channelled them, directly, or via the banks and finance houses, into asset price speculation, in fact, diverting money and money-capital from the real economy into this casino economy. The lockdowns and lockouts that began in 2020, reversed that process, because, now, governments borrowed money on a vast scale, and the additional liquidity financed this borrowing, but the borrowing itself now went directly into funding consumption, as governments handed out replacement incomes to workers, and businesses. What is more they did so, stoking monetary demand, precisely at a time, when a) supply of goods and services was being artificially restricted by lockdowns and lockouts, and b) all of the various restrictions were themselves causing productivity to fall, and the value of commodities to rise. In Britain, Brexit put that process on steroids.

Combine all of that with the fact that, the global economy has been wanting to grow at a faster pace, as a consequence of the operation of the long wave cycle, for the last 14 year, since 2008, but has been artificially restricted by policies of fiscal austerity, and QE used to channel money into gambling, and the stage was set for monetary demand to rise sharply, as soon as restrictions were lifted, for firms to seek to secure their share of that growing market, and to have to compete fiercely for inputs to do so, so pushing up the prices of those inputs, be they raw materials such as oil, gas, copper, steel, microchips, or labour-power.

By the Spring of 2021, despite governments having introduced new lockdowns over Christmas, this was becoming clear, as the global economy surged forward, again. In my post, The Global Economy Is Surging, I described that, and why the catastrophism of those like Michael Roberts, and Paul Mason had again been proved wrong. But, as economies did surge, and across the globe, shortages of raw materials, supply chain blockages, and shortages of labour emerged, causing prices to rise again, along with wages in all those sectors facing particularly skills shortages, governments again imposed restrictions, this time using the new Delta variant as their excuse for doing so, whilst central banks claimed again that inflation was going to be just transitory, and was now simply a reflection of these supply bottlenecks that would disappear as soon as economies properly opened.

I described this line pursued by the central banks that saw them continue to pump liquidity into the system, even as inflation was clearly becoming entrenched, in my post, The Fed & Inflation. One of its manifestations was again the rise in global raw material prices, and in Dr. Copper And Inflation, I again described that relation, based upon Marx's analysis in Capital, and in Theories of Surplus Value, as well as in his analysis of money and inflation in A Contribution To The Critique of Political Economy. I also recorded the rises that were taking place in these various materials prices, as the Spring and Summer progressed (Oil Price Goes Above $70, Corn & Wheat Prices Rise By More Than 4% In A Day, Global Food Prices Highest Since 2011, China's Producer Price Index Surges 9%, Eurozone Producer Prices Rocket, US Producer Prices Surge By Most On Record).

In the Spring, Michael Roberts had argued that Covid had blown a hole in mainstream theories of inflation, but it also blew a hole in his own analysis of it, as I set out in Michael Roberts and Inflation. As I pointed out in that post, his model predicted that US inflation could rise to over 3%, by the end of 2021, which, even in May was already wrong, as it was already at 4.5%! In fact, US inflation ended the year at over 7%, pretty much where I had said it was headed, a year earlier. Necessarily, the inflation in material prices, along with inflation of producer goods prices, and now combined with rising wages, particularly in spheres where labour shortages were manifest, itself, now, began to find its way through into consumer goods prices and services. I set that out in US Inflation Soars, UK Inflation Doubles In A Month, US June Economic Data, US Jobs, Wages and Inflation, US Consumer Price Inflation Surges To 5%, UK Inflation Trebles In Just Two Months, Philly Fed Manufacturing Survey Shows More Signs of Inflation, Inflation Bursts Through Even Raised Estimates.

And, I also set out the consequences of this for other aspects of the economy, in particular government spending, borrowing, and interest rates. Rising inflation, not only means that the prices of all those things that firms and government buy increase, but that their demand for the money they borrow to pay for them also increases. If machines, and so on increase in price, then these things that are normally paid for by borrowing involve firms and government borrowing more. For circulating capital, firms can normally avoid that, because they buy inputs using commercial credit, and they pay wages in arrears. Government pays for some of its spending out of taxes, but it too pays for long-term capital projects by borrowing, and also funds a large part of its current spending by borrowing too. As a result of locking down the economy, and locking workers out of the workplace, it not only cratered the amount of new value being created, which is the source of the governments tax revenues, it also increased the amount it spent, because it now found itself needing to pay workers wages, via furlough, as well as compensating firms for their loss of sales. Reduced tax income, at the same time as massively increased spending could only mean that the government, as well as business needed to increase borrowing on a huge scale.

The government increased borrowing by issuing more government bonds. Again that reverses the condition that allowed QE to inflate asset prices over the last 30 years. During that period, fiscal austerity gradually reduced government deficits. Between 1997 and 2001, the Blair government actually ran budget surpluses, which meant that it actually paid down the government debt. But, reduced deficits mean that although the government continues to borrow, the amount of additional borrowing decreases, requiring fewer bonds to be issued. As the supply of bonds is reduced, but the demand for those bonds is increased, as a result of QE, so their price rises, encouraging speculators to also buy, in the expectation of further capital gains. Similarly, large companies sold commercial bonds, which central banks bought up, but companies then used the proceeds, as well as profits, to buy back shares, thereby, inflating share prices, and so encouraging further speculation in stock markets, also in the expectation of capital gains. A similar thing happened with property.

But, now, large companies have had to resort to actually issuing new shares, rather than buying them back, as well as issuing bonds to cover actual expenditure. Even with the continued artificial demand from QE, therefore, this increased supply of shares, and bonds, means that their prices are constrained. As soon as QE ends, let alone when central banks are led into QT, and rises in their official interest rates, these asset prices are set to crash. Even the hint of an end to QE, and of tentative rises in policy rates by the Federal Reserve, sent share prices tumbling, and the US NASDAQ index is already in correction territory, meaning it has fallen by more than 10% from its recent highs. Governments are going to be hit by a triple whammy. On the one hand, inflation is sending their costs soaring. In the UK, it has already meant that the interest charge has gone from £2 billion to £8 billion. That is going to rise much higher, but it is not yet facing the consequence of higher interest rates on that borrowing. Currently, the yield on the UK 10 Year Gilt is 1.31%. That is up hugely from what it was just a few months ago, when it was down at just 0.32%. But, it is set to rise much higher, as QE ends, and borrowing continues to rise.

Another aspect of inflation on government borrowing is the transfer payments that government makes in the form of pensions and benefits. These are linked to the CPI. The government switched from the link with RPI some time ago, because RPI nearly always comes in noticeably higher than CPI, so linking to the latter saves it money. But, last year, the government said that it was reneging on its commitment to the pensions triple lock. That ensures that pensions rise by CPI, 2.5%, or earnings, which ever comes in the highest. The figure for earnings came in at over 8%, reflecting the shortage of labour that had arisen, and that firms were having to pay much higher wages to recruit lorry drivers and so on, a factor that had been massively intensified by the damage caused by Brexit. I described that in Government Is Going To Renege On Triple Lock. But, that also indicates another important fact.

We are currently being told that although inflation continues to rise sharply, wages are failing to keep up. That 8% plus figure from last September, showed that it depends when in the year the comparison is being made. We know, as that post showed, that there have been huge wage rises in sectors where firms still cannot get enough labour, but this comes about by the wages they have to pay for these new workers, rather than being reflected in annual wage negotiations. The government itself, of course, has an incentive in downplaying the actual wage rises taking place in the economy, because it is itself a major employer of labour, and seeks to keep its own wage bill to a minimum. Indeed, it has continued to impose negligible pay rises, below the rate of inflation on its own employees. But, the big annual pay negotiations, between unions and companies start in the Spring. Union negotiators will have the data on inflation, and also what firms have been finding themselves having to pay to get workers. The energy price cap alone is going to be raised by a whopping 50%.  When those negotiations start, especially as workers know that further huge increases in the cost of living are coming, be it in higher energy bills, higher food prices, huge rises in mortgage payments as interest rates rise, or increases in National Insurance contributions, they are going to be demanding rises of at lest that amount. In practice, that means workers are going to be looking for pay rises well above 10%, and in conditions where labour is in short supply, and firms see rapidly expanding demand, requiring to employ those workers, they are likely to get it, without too much fuss.

Firms will pay expecting to be able to pass those costs on, as they see demand continuing to rise sharply, particularly monetary demand, which will get another kick higher as these various wage rises feed through into yet more monetary demand for wage goods. Central banks will inevitably enable them to do so, by increasing liquidity accordingly. Its noticeable that the Bank of England has already raised its policy rate from 0.1 to 0.25%, and now to 0.5% (with half the MPC wanting to raise it to 0.75%), whilst the Federal Reserve, which only months ago was predicted not to start raising rates until at least 2023, is now expected to raise its policy rates, probably by 0.5 basis points, at its next meeting, even before it starts QT, with up to another 7 hikes planned in coming months.