Reasons
need to be nuanced. Inflation is not only due to wars and pandemics, but even
more to the fact that over many years an
enormous increase in the money supply has been created. The high debts have
created a huge distortion.
When you follow the media reporting on the
sharply increasing inflation in the world and in Sweden, you get the impression
that it is a phenomenon that only occurs, such as natural disasters. Now they also call it Putin prices with reference
to the ongoing war in Ukraine. But the
explanation is not that simple.
There is a need for greater transparency and honesty when it comes to reporting on why
inflation and even deflation occur and what are the reasons behind it. These problems are largely of our own
making and the institutions we have created to manage the monetary system.
To
quote the Nobel laureate in economics, Milton Friedman: Inflation is always and
everywhere a monetary phenomenon, insofar as inflation is and can only be created
by a greater increase in the quantity of money relative to production.
In order to understand inflation, one must
understand how money is created. The majority of all money in existence is
created by the banking system and only a small portion is created by central
banks.
Money is created when someone takes out a
loan. Money is created out of debt. Banks are often described as money brokers, that
is, they take in savings and then lend them out. This is not true. Banks create
money through a multiplier effect. The explanation is that regular transaction
accounts are actually equivalent to money - they are fully money.
If at the same
time the bank created a loan for a borrower with the help of this money, that money is also immediately available to the borrower. That is to say, the amount of money, which today is mostly electronic
and not notes and coins, has increased. The bank has created new money that
previously did not exist. The central bank is responsible for the control
mechanism of this system.
You control how much loan and thus how much
money is created through your policy interest rate. If the central bank has a high policy rate, it becomes expensive to
borrow and fewer loans are issued, that is, less money is created.
Therefore, it is the central banks together with the banks that determine how
much money there is in circulation. You control, so to speak, the amount of
money in circulation, the money supply.
But not only the money supply affects what we
call inflation today. Inflation is measured in the consumer price index (CPI).
This measure is based on the changes in the prices of goods and services in a
preselected basket. In Sweden, Statistics Sweden (SCB) determines the contents
of the basket. Some things are not included in the CPI, for example real estate
prices or prices of securities.
If we return to Friedman's quote, inflation is affected by two things,
money supply and production. If the money supply increases or if production
decreases, inflation will occur. In the media, you usually only highlight
one side, i.e. decreasing production due to various reasons mentioned above,
but you very rarely highlight the other side - increase in the money supply,
i.e. what central banks and banks control.
Since 1971, when the gold standard was
dismantled, the money supply has been controlled via monetary policy according
to the mandates given by the political system to central banks. In Sweden,
the Riksbank must keep the CPI at 2 %. In recent years, we have had to
learn new concepts such as quantitative easing (QE) and negative interest
rates. These concepts have one thing
in common. There are active attempts by the institutions to increase the amount
of money in society.
The idea is that more money will fuel growth and
prevent recession from occurring. This thought is good because low growth and
recession bring with it undesirable things such as unemployment, exclusion and
poverty. The problem is that this
medicine can be overdosed and I would say that it has been severely overdosed.
Since the 2008 financial crisis, there has
been an explosive increase in the money supply via QE and negative interest
rates. As previously mentioned, money is created via debt, i.e. from loans. If
you want to create more money, debts must increase. That debts increase does not have to be a problem if the increase in
debts occurs at the same level as growth.
In recent years, this has not been the case. Debt
has increased much faster than growth. The problem then is that there is more
money chasing fewer goods. This is inflation.
One can ask why, since the financial crisis in
2008 until recently, we have not seen any inflation measured in CPI?
The reason is that new money is not only used
to buy goods and services according to Statistics Sweden's shopping basket. The new money is also used to buy real
estate and securities on the stock exchange and financial market. One
should ask who get the new money and for what purpose. To borrow, you must be
creditworthy. The more creditworthy you are, the easier you can borrow. When
you borrow, new money is created. It is
easy to see that it is the well-off who have access to new money and these use
the money to invest in real estate and shares, among other things. The new money has mainly gone to these
assets and has therefore driven up their value (inflated prices in thoose areas.).
Money has to a lesser extent found its way
into the shopping basket and wages, so despite the enormous amount of money
created, the CPI has not been significantly affected until 2022. On the
contrary, it has been difficult to have an effect on the CPI and difficult to
get good growth started. This is an
unfair process that favors the creditworthy who have gotten richer and richer
in real estate and stocks and that has clearly disadvantaged wage earners, senior citizens and
the poor.
This is also clearly seen in the measure of
inequality that exists, the so-called Gini coefficient. The recent inflation is due to two things. Partly the reduced
production due to war and pandemic, but even more so because for many years
there has been an enormous increase in the amount of money.
This money is available and when investors see risks
of falling real estate prices and bad upside in the stock market, a little more money will move from real estate and
the stock market to physical assets such as goods, productive land, etc.
This then drives up prices of goods in the CPI basket . It is enough for a small part of the money supply to be moved from
stocks and real estate to the physical market for the CPI to take off.
Central banks are now in a difficult
situation. If inflation is allowed to be, it can derail into a price and wage
spiral, and in the worst case, society
can end up in a hyperinflation - like in 1930s Germany.
But if you try to fight inflation through
sharply increased interest rates, it becomes problematic when the indebtedness
is so high. Interest costs would greatly
reduce the consumption space of people, which affects the companies that have
to reduce the workforce, leading to unemployment. A deflationary spiral can
occur which in the worst case can resemble the Great Depression.
To a large extent, inflation is a problem
caused by the politically appointed institutions which have certainly tried
with good intentions to prevent recessions, but instead built up a huge distortion in the monetary system
with high debts, large redistribution from poor to rich and which also now entails that we risk having to go through a
significantly deeper recession in the future.
We need to talk much more about this in the
future.