SA: 'The world doesn't work like that'

THE HEISENBERG writes on Seeking Alpha:

“The world doesn’t work like that.”

So said Zoltan Pozsar recently, about the idea that containing inflation is as simple as central banks hiking rates and shrinking their balance sheets.

His remarks amounted to a recap of missives penned over the past eight months, and although I most assuredly don’t agree with Pozsar all, or even most, of the time, I’m glad he’s adamant about the risk of inflation becoming stochastic going forward.

“In a stochastic world — where the price of everything is thrown around randomly by a pandemic and an unrestricted economic war — inflation is impossible to forecast,” he wrote in early August.

We’re all reluctant to admit that. At the least, we all pretend that in an absolute worst-case scenario, central banks can still control inflation by destroying every last vestige of demand. But that simply isn’t true. There will always be some demand. But there needn’t always be some supply. Sometimes, there may be no supply at all. Just ask the Nord Stream. As such, there’s no guarantee that central banks, no matter how hawkish, can everywhere and always contain price growth.

The Fed and its many critics have at least one thing in common: They both believe monetary policy can be an effective check on inflation.

Critics rarely charge that central banks are incapable of reining in runaway price growth in developed economies. Rather, the derision over the last 18 months centered on the contention that policymakers were, at best, hopelessly behind the curve and, at worst, deliberately behind the curve by virtue of various “shadow mandates.” Either way, policy was derelict, not defenseless. Hapless not helpless.

By contrast, I’ve suggested that, in fact, there’s no guarantee central banks can “always and everywhere” (to hijack a portion of Milton Friedman’s famous axiom) bring inflation under control. If there’s not enough food to eat or oil to go around or if we lack the wherewithal to get the food where it needs to go or the refining capacity to process the oil, then we have problems central banks can’t solve.

Theoretically, central banks can solve such problems by engineering a drop in demand commensurate with constrained supply, thereby balancing the equation. In practice, that’s a questionable proposition in the presence of persistent and severe supply disruptions.

Central banks’ capacity to ameliorate inflation is contingent on two things: Some semblance of adequate supply (e.g., enough food to go around such that loaves of bread aren’t subject to bidding wars and enough labor such that employers aren’t compelled to offer C-suite compensation packages to every new hire, as nice as that’d be) and anchored consumer expectations. If supply is insufficient even in the face of severely curtailed demand and/or if the public adopts an inflationary mindset, central banks will do well just to keep the situation from spiraling totally out of control.

From my perspective, that’s the most damning critique of central banks there is. And yet, so wedded are the Fed’s critics to the notion that central bankers, when they’re not busy being devious, are hopelessly incompetent, that they (critics) miss the opportunity to prosecute the real case. So busy are critics lionizing the likes of Paul Volcker, that they never stop to consider if there’s an even more condemnatory line of criticism. Or maybe they do consider it, but are just too frightened of the implications.

Inflation, as a phenomenon, is independent of central banks and money. It can easily occur in a barter system, for example. In many (or most) hypothetical dystopian scenarios, hyperinflation is inevitable for food and energy. We may currently be living out a kind semi-apocalyptic scenario in which logistical challenges related to supply chain disruptions and war mean that some locales (Europe for energy, emerging markets for grain) are experiencing dystopian hyperinflation. The kind of inflation that’s unresponsive to central banks.

Have a look at the simple figure (below). It’s my contention that inflation in the eurozone is now totally independent of monetary policy. The two aren’t related…

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