Looked at properly, inflation is the money getting less valuable, which shows up as rising prices. It’s opposite, deflation, is the money getting more valuable, leading to falling prices. Something that used to be very obvious, but has perhaps become less so, is that inflation sucks if you have money, whereas deflation sucks if you owe money.

TL;DR version: You can reverse inflation, as long as you’re willing to grind into the dust everyone who owes money, making them work more and more, to earn less and less, to pay back debts that get higher and higher (because the dollars it takes to pay them off are getting more and more valuable). Society has done that many times in the past. Sometimes it works out okay; other times it produces terrible impoverishment of ordinary people, leading to social unrest.

The rest of this post looks at this in a bit more detail. I was prompted to write it because recent polls have suggested that young folks—Millennials and Gen-Z—continue to be unhappy about inflation, even though the inflation rate is down a lot. When you talk to these people, it turns out what they’re unhappy about is not inflation but rather prices: They remember what things used to cost, and they cost more than that now, which they find annoying, even if the price has largely quit going up. (And of course prices change all the time, so some prices are always going up.)

Older folk—people who lived through the inflation of the late 1970s and early 1980s—have a different perspective on that, partially because their parents and grandparents lived through the Great Depression.

Basically, they remember what happens when you try to push prices back down to what they were before a period of inflation.

There’s a sense among the “hard money” types that inflation is impossible when the currency is backed by gold, but this is false. There is often inflation under a gold standard, but it (often) ended up getting undone, meaning that looked at from the perspective of a century, it looks like there wasn’t much inflation. And indeed there wasn’t much inflation on average.

This was especially true during the heyday of the gold standard, roughly the 18th and 19th centuries. In 1816 the pound sterling was defined as 113 grains of pure gold, where it remained until 1931. (Before that it was defined as 5,400 grains of silver—about a pound of silver, hence the name a pound sterling—but in terms of value it was a similar amount of purchasing power.)

A big part of the reason that people remember the gold standard fondly is that it worked pretty well, especially for people who had money. With stable prices, it was even possible to value land not at a market price (because who would sell land?) but at the income that land would produce—an income that would remain stable for generations at a time.

However, as I said, there was still inflation. Inflation came from many sources, but two important ones: new discoveries of gold, and war. When the quantity of gold increased—as during the 1840s and 1850s when large amounts of gold were found in California and Australia—the rising quantity of gold (i.e. money) would produce inflation just like rising quantities of money produce inflation now. The other common source of inflation was war, because paying for a big war without inflation is almost impossible.

For example, there was a big inflation in the U.S. during the Civil War, when the Federal Government printed “greenbacks” to pay for the costs of the war. (The Confederates did the same, but as they lost the war their Confederate dollars ended up being worthless.) Dollars, on the other hand, were gradually revalued, with greenbacks gradually being withdrawn from circulation producing a grinding deflation that went on for more than a decade.

Like always in economics, there were other things going on at the same time. Industrialization was going on at the same time, meaning that things produced by industrial firms were getting cheaper, leading to deflation, while gold discoveries were leading to an increase in the supply of gold (= money) leading to inflation.

On balance there was deflation, meaning that people who had money were getting richer, while people who owed money were getting poorer. As long as that happens only in a small way, and as long as people sense that it’s “fair”—that nobody is cheating the system to take unfair advantage—it’s kinda nice. If you don’t owe money (and most people didn’t, because there were no credit cards, and virtually no student loans), then whatever meager savings you had got gradually more and more valuable. At the same time, wages tended not to drop (for the same reasons that wages tend not to drop these days as well), so somebody with a job ended up gradually better and better off.

Of course rich people got vastly more well off, so they loved it. The main people who hated it were farmers and small businessmen, because they generally needed to borrow money (to buy seed or raw materials), so they were constantly screwed by the fact that the money they had to pay back was worth more than the money they’d borrowed.

I started this post meaning to suggest that “kids these days” just didn’t understand the dynamics of deflation, But upon reflection, I think there’s another layer to it. Kids these days (as opposed to the Gen-X kids who trusted their parents and guidance counselors, and borrowed as much money as necessary to go to the best school they could get into) don’t owe so much money, so they’re not in the position of being utterly screwed by deflation. Many of them may be in the position of ordinary people in the great post-Civil War deflation, who ended up doing pretty well, with their wages or salary rising in value, while industrialization and globalization helps hold down prices.

The fact is, though, that deflation can absolutely destroy a generation of ordinary people. After WW I, for example, Britain, having funded the war through inflation, decided to return to the pre-war gold parity, which required a grinding deflation that lasted until 1929—great for people with money, bad for people without, devastating for people with debts. France decided instead to revalue, punishing people with money, coddling people with debts (which has its own downsides in terms of social disruption). German, the loser of WW I, saddled with debts denominated in gold, made a valiant effort to pay them back, giving up and starting WW II only when that proved utterly impossible.

The lesson of that period, understood by pretty much everybody from the 1940s through the 2000s, was that the best thing to do after a period of inflation was to bring the inflation rate back down near zero, but accept the price increases that had already happened. (If the inflation rate is brought back down to, let’s say, 2%, prices will be generally stable. The slight remaining inflation will be barely noticeable, hidden amidst the ordinary rise and fall of prices due to changes in fashions, technological improvements in the means of production, depletion of resources, etc.)

It’s very interesting to see young folks returning to the instincts of the 18th and 19th century, thinking the prices should go back to what they were before the inflation. It goes very much against what I learned as an economics student, but who can say that what I learned was right and that their instincts are wrong?

Seems like a situation of “time will tell.”

Sources:

The Winfield Village finance committee (everyone here interested enough in the budget to show up) met last night. The subject of interest rates came up, and I was surprised to find it a near-unanimous opinion that rates were going to stay high at least through 2024.

Thinking of myself as a contrarian, I always worry just a bit when I agree with everyone, but I think they’re right.

Apparently I was a lazy girl my whole life, and didn’t even know it.

The Wall Street Journal provided a fairly succinct summary of a lazy girl job in July: “one that can be done from home, comes with a chill boss, ends at 5 p.m. sharp and earns between $60,000 and $80,000 a year — enough to afford the basic comforts of young-adult life, yet not enough to feel compelled to work overtime.”

Source: The New York Times

Inflation and a declining standard of living are two different things. Inflation is when the money becomes less valuable, resulting in rising prices. But when a whole society becomes poorer, it can look like inflation, because prices may rise, but it’s not the same thing.

“Despite the Bank of England’s efforts so far, there is accumulating evidence that inflation will be harder to stamp out than previously expected. In the past week, data has shown that pay in Britain has increased faster than expected, inflation in the services sector has accelerated and food inflation is still near the highest level in more than 45 years.”

https://www.nytimes.com/2023/06/22/business/economy/bank-of-england-interest-rates-inflation.html?smid=url-share

To my eye, viewed from over here, that looks less like inflation and more like a falling standard of living—largely caused by Brexit. If you block immigration, of course wages are going to go up. If transporting stuff across the border takes longer and is more expensive and difficult, of course food is going to be more expensive. That’s not inflation. That’s reducing everyone’s standard of living by raising actual costs.

It looks similar, because the symptom tends to be rising prices, but they’re two different things. If the problem is inflation, then raising interest rates (by reducing the rate of growth in the money supply) will probably help. But if the problem is a declining standard of living, then it’s probably not going to help. Higher interest rates will just be yet another expense (like border controls) that flow through to making everything cost more.

All through the 1990s I was waiting for the labor market to punish employers for their (then new) strategy of laying people off as soon as there was 15 minutes with no work to do, intending to hire them back (or hire somebody else) as soon as they had work again.

Capital markets forced employers to go that route. Any company that tried to resist—keeping on employees beyond the bare minimum—would see its stock price fall so much that it would be taken over in a leveraged buyout, and then the new owner would cut staff to the bone.

As I wrote for Wise Bread back in the day (in What’s an employee to do), it made me sad to watch. Surely, I thought, eventually the labor market would tighten up, and employers who had kept their employees on through a rough patch would have an advantage over employers who had to go out and recruit, hire, and train new employees.

But it never happened. Until, according to a recent article in the New York Times, now: Companies hording workers could be good news for the economy.

It’s a pretty good article.

Employers traumatized by not being able to hire enough people may not be quite so quick to lay them off:

“When the job market slows, employers will have recent, firsthand memories of how expensive it can be to recruit, and train, workers. Many employers may enter the slowdown still severely understaffed, particularly in industries like leisure and hospitality that have struggled to hire and retain workers since the start of the pandemic. Those factors may make them less likely to institute layoffs.”

Jeanna Smialek and Sydney Ember https://www.nytimes.com/2022/10/12/business/economy/companies-hoarding-workers.html

And, if employers do keep workers on as the economy slows, it will help the U.S. economy. As Federal Reserve Board Vice Chair Lael Brainard says:

“Slowing aggregate demand will lead to a smaller increase in unemployment than we have seen in previous recessions.”

https://www.federalreserve.gov/newsevents/speech/brainard20220907a.htm

Perhaps even more important than those things, it will make me happy.

After three decades in which the market was reinforcing exactly the wrong behavior, now maybe it will encourage the right behavior.

I’m generally unimpressed with Krysten Sinema, whose failure to support Democratic initiatives has generally been harmful. However, I kinda like the tax changes she’s forced into the climate package.

Fundamentally, I like dividends and I hate stock buybacks. So a tax on stock buybacks—even a small one—makes things better.

Now, most economists would have you believe that the two are equivalent. This is false.

Economists can gin up a model that suggests that owning a slightly larger share of a slightly smaller company is “equivalent” to getting paid a share of the company’s profits. Or that getting cashed out completely (by taking the buyback), and then finding a place to invest almost all of that cash in some new company is somehow equivalent. I don’t think either of those things is true even in an economic sense, but I think both are clearly false in a larger societal sense.

New York Stock Exchange

The way things used to work was that a company earned a profit, reinvested an appropriate amount of that profit in growing the business, and then paid out the balance to shareholders to do with as they pleased. (They could reinvest the money by buying more stock, they could spend it on luxuries—or necessities, they could invest it in some other company, they could donate it to charity—the possibilities are literally endless.)

This situation produces a sort of virtuous circle. A company that earns a reliable profit—and shares it with its stockholders—becomes more valuable, because people will pay more for a company that pays a reliable dividend. It’s good for the owners (their stock is worth more), it’s good for the employees (both line workers and managers), it’s good for the community (a profitable company pays taxes, their employees have money to spend, their shareholders have money to spend, etc.).

The non-dividend situation lacks all these dynamics. Instead of wanting to produce a profit, the company has all sorts of weird incentives—to maximize “growth” or “revenue” or “earnings” according to whatever weird metric appeals to Wall Street that week. Owners don’t get cash that they can spend. Instead they get the option to cash out at random intervals. The weird incentive structure encourages companies to make weird decisions regarding investing in growth (or dumping cash into buybacks). Shareholders who would otherwise be living on dividends are constantly having to make difficult decisions about selling small amounts of shares in this or that company for money to live on.

Maybe there’s some technical economic sense in which buybacks and dividends are equivalent, but they are very much not equivalent in a societal sense, producing very different results for ordinary investors and their communities.

The only reason any ordinary person would think a stock buyback was even close to equivalent is because capital gains have been tax-advantaged over dividends. So, something that reduces that tax advantage is all to the good.

Details: Krysten Sinema Agrees to Climate and Tax Deal – The New York Times