Inflationary thoughts

Yes, I do have thoughts about inflation.

Recently, my smart friends have finally started asking me what I think about inflation.

This isn’t exactly an answer to what they want to know, but here’s a good overview of how I’ve been seeing the issue.

Inflation, as a term, operates in an over-loaded context. This means that when you think “inflation” and someone else says “inflation”, often you may be talking about something that feels well defined but in fact is very nebulous. The ‘latent nubulousness’ is problematic because it makes it hard to evaluate the accuracy of the statements. It also makes it difficult to know if what someone else is saying about ‘inflation’ matches what you’ve observed about what you think are ‘inflation’.

As a solution, instead of talking about ‘inflation’, let’s define the three things that inflation describes.

The first is the Cost of Money. This is what bankers talk about when they talk about inflation.

The second is the Cost of Getting Things Done. This is an outcome based look on the use of money.

The third is the Cost of Goods. This is what consumers talk about when they talk about inflation.

The literal cost of money is interest rates. This is the explicit cost, over time, to get access to capital from someone else.

Investing news focuses on the cost of money, pretty much exclusively. This is because it’s all that matters in the world of finance. It’s a baseline predictor for what returns you can expect on stocks versus bonds.

You can see the “cost of money” changing when bonds start being issued for greater interest rates. Higher interest rates mean that you need more money to get access to money. The amount of return expected by someone giving you capital has gone up.

The cost of money is important for valuing assets, as it tells you what to expect the dollar value of that item to do over time. If that asset is an entity that is, in itself valuable, you can expect the value of it to increase when the cost of money rises.

If you’re holding a wad of cash and interest rates go up, suddenly that cash is worth more over time than it was previously. (Though we’ll talk a bit about how your access to higher interest rates may be restricted.) See also, real estate.

If you’re holding shares of stock in a company, a company who ostensibly has borrowed money and has to pay it back. All else being equal, your rate of return on that company is expected to go down.

In periods when the cost of money is rising, owning stocks is not as good as owning bonds. This is why a mixed portfolio (of stocks and bonds) is a good bet over the long term.

The ‘cost of money’ is separate yet related to the ‘cost of getting things done’.

In some senses, the ‘cost of money’ is much much easier to observe and measure than the cost of achieving things.

This is because the number of variables that goes into “accomplishing a thing” is very large.

Getting something done depends on culture. It depends on personality. It depends on access to information and capital. It depends on social capital. It depends on skill. It depends on the cost of money.

It depends on physical reality.

Let’s say a ship blocks the Suez Canal and prevents the movement of goods between Europe and Asia for three days. Suddenly it doesn’t matter what money costs. No change in the cost of money is going to unstick a ship.

The “cost” of getting that ship unstuck is suddenly a very important factor for international trade.

“Corruption” is a form of inflation where the cost of getting something done balloons immensely for inexplicable reasons.

How much money you have to exchange for a good is the one that you as a worker and consumer care about.

The cost of goods is affected by the total supply of money, the cost of that money, the total supply of the underlying good, the demand for that good, and the social desirability of that good.

Depending on the good, it also sometimes depends on the Cost of Getting Things Done. If this cost changes, then the cost of goods will change.

The cost of goods goes up when someone figures out that they can charge more money for something, and then does.

This is the kind of price increase that monopolies and cartels enact. Apple products and other luxury or high status goods are often “monopoly goods”.)

I’d also argue that most healthcare and education cost increases are a function of this. People keep paying for healthcare, they don’t really have a choice. An obvious example is the price of Epi-pens and insulin.

People keep paying for universities, they don’t think they have a choice. (And in a lot of cases, they’re right.)

We’re seeing shortages in graphics drivers for computers and car production. Both of these are effects of the global chip shortage, which happened in part because the pandemic disrupted the manufacturing output of the one or two large chip foundries that exist.

I don’t know. It sure looks like things are headed that way, but bank deposits are still edging towards negative rates. Which seems to mean that the access to providing your capital to capital markets has all but disappeared to the common depositor.

*If you could lend your savings to someone’s credit card account, and make back 25.99% annual interest, compounded daily, this would be access to a higher “cost of money” situation than putting it into a bank deposit. Consumer deposits don’t have access to this kind of opportunity. Your money is literally worth-less because of this.

If the cost of money is rising, it is sensible to own hard assets, things that you could lend out to others at the going rate of money. Hard asssets are things that don’t depend on “getting things done”, don’t use the capital markets to finance their operations, and don’t require ongoing inputs in the form of other goods. (Businesses e.g. equities, as an asset class, tend to require some form of these; highly dependent of course on what that business *is).

I don’t know. I think it depends on who you are and what you’re trying to do.

If you’re Elon, the answer is probably no.

Do you have access to money at the rates that central bank deposits pay? Or are you suddenly looking at paying capital market rates?

Are you trying to build or produce a thing? Does that depend on being able to ship things through the Suez Canal today? Does it require graphic cards?

Are you trying to do something that the infrastructure for has disappeared or degraded? For example, mailing out orders via the US Post Office last year.

Yes.