by Franklin J. Parker, CFA
The Summary
- This week’s data is all about inflation. Consumer inflation expectations post today, headline inflation figures post on Wednesday, and producer prices post on Thursday (producer prices are another way to gauge inflation). Each inflation data point is growing more important as the Fed considers when/how much to begin ending their ongoing support. Other important data this week are figures on productivity (Tuesday) and initial jobless claims (Thursday).
- Last week’s unemployment report was quite strong. Total jobs added in July came in at 943,000 and the headline unemployment rate dropped from 5.9% to 5.4%. It is important to remember that these figures are always posted with seasonal adjustments. Seasonal adjustments are a statistical technique to remove the predictable fluctuations from the numbers. In July, seasonal adjustments added over 1 million jobs to the figure, so the actual number of jobs in the economy fell by 133,000. Seasonal adjustments have been a source of contention among analysts during the Covid recovery—how much weight should we give them over the actual figure is an open question. In any event, the market appreciated the report.
- The debt ceiling is yet again in the news. For investors, the debt ceiling is largely a non-event. While the first government shutdown pushed prices around, the second and third one trained markets to shrug off the political brinksmanship, so it is mostly a non-event. The danger to investors is the very small (but nonzero) chance of the US Treasury missing an interest payment on their bonds. A default on US Treasury securities—considered by most the safest securities in the world—would be catastrophic. Therefore, a government shutdown should be on the radar of investors, but it is not worth worrying about… yet.
The Details
“He who does not take into consideration the scarcity of capital goods available is not an economist, but a fabulist.“
—Ludwig von Mises, Human Action
Economics is all about tradeoffs. Dedicating resources to one thing necessarily means you cannot dedicate those resources to something else. It is this scarcity of resources that drives any economic system. Whether socialist, capitalist, feudalist, or agrarian, any economic system must deal with the plain fact that resources are scarce. The economists’ crux, then, lies in answering the simple question: how should scarce resources be allocated?
Capitalism has the advantage of private markets which are marvelously efficient allocation machines. Private markets will naturally put resources where they can be of highest use to society. When resources are distributed efficiently and toward their highest use, economic growth is at its peak for that society.
Now, reasonable people can (and often do) disagree about the human ethic of an allocation driven entirely by efficiency. When that is the case a political process can be used to reallocate resources in a way that the populace deems more acceptable. It is not my objective here to argue for or against any particular allocation of resources. This is our system. My job as a professional investor is to play the game on the field, not the game I wish was on the field.
However, just like everything in economics, this reallocation of resources comes with a cost. When we move resources from their highest use toward another use, we necessarily sacrifice peak economic growth. Again, that may be an acceptable tradeoff given other, more human, considerations, but it is a tradeoff, nonetheless.
There are two basic ways politicians can reallocate resources. The first, and most familiar, is taxes. Taxes move resources from one area of the economy to another. Taxes are the most transparent method as it requires a debate about the merits and demerits of a particular allocation.
The second, and less familiar, is money-printing. This method is less transparent, so bear with me a moment while we explore how taxes and money-printing are basically the same thing.
You can think of a dollar like a share in the US economy. When you print more dollars, you simply divide the economy into smaller and smaller pieces, but you don’t actually make the economy bigger. By dividing the economy into smaller pieces, politicians are able to take those newly-created pieces and move them to different areas of the economy. The real advantage is that this can be done without having to go through the politically challenging process of raising taxes. But it is functionally the same thing. Pulling 3% of someone’s net worth in taxes or depreciating the currency by 3% still leaves you with 3% less wealth than you had before.
Printing money is more complicated, however, because a currency is always valued in relation to another currency. If most other economies are also printing money at about the same rate, then there is a dampener on inflationary effects, which is largely what we’ve seen over the past decade.
And all of this brings me to my point. The primary cost to excessive money-printing may not be inflation. The primary cost may be economic growth. By moving resources from their highest use toward another use, we necessarily sacrifice economic growth (because resources are inefficiently allocated). If inflation comes along as a secondary cost (which is possible but not certain), then we have a stagflationary environment until private markets can again allocate resources efficiently.
Japan is my favorite example of this. From 2012 to 2021, Japan’s central bank has expanded their money supply by 529%. Just as a comparison, the US Federal Reserve expanded the US money supply by 266% over the same period—almost half of the Japanese figure. Rather than spark inflation and economic growth as would be traditionally expected, Japan’s economy is only 2.5% bigger today than it was at the beginning of 2012, and Japanese inflation has yet to hit 2% in any year. By comparison, the US economy is almost 20% larger over the same period, and US inflation has just now started to break above the 2% level.
Exactly how the cost of ongoing money-printing will bear out is, I must admit, an open question. As I have said before, the most important value an investor can have in this environment is flexibility. We must take the data as it comes and update our views—being dogmatic about an idea is a sure way to get hurt. More than anything, my point here is to simply open our minds to possibilities other than “printing money = inflation.” As investors, there are alternate costs we must consider.
Because, in the end, economics is all about tradeoffs.
Chart of the Week
In support of my thesis above, I’ve plotted the cumulative change of Japanese Central Bank assets with US Central Bank assets (a good proxy for the change in money supply) along with the cumulative change in Japan’s GDP and the US’s GDP since 2012. US figures are in red, Japanese figures are in blue.
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