I read a very thoughtful post over at Bondsquawk, so I want to build on what Rom wrote over there with some thoughts of my own I’ve cobbled together over the past few months. Hopefully it will make sense to at least one person that isn’t me having an inner dialogue with myself. No, I don’t fancy myself as an econometric Raymond Babbitt. His social skills are far better than mine.
But let me pick up on Rom’s post. Here’s a juicy tidbit I particularly liked:
In order to have inflation and to drive prices higher, resources need to be relatively scarce in the face of rising demand. Capacity Utilization, which measures the actual output produced as a percentage of potential output given current resources, continues to hover in the low 70’s, citing idle and slack resources in the manufacturing sector. Typically, during periods of growth, the Capacity Utilization percentage should exceed 80 percent.
Rom started it, I’m going to finish it. Let’s look at the chart:
You should notice two things: first, the chart has tended to see lower highs and lower lows with each cycle. A deflationary force for sure. But let’s look at why this is the case. The peaks and valleys I highlighted in purple are from the 60s & 70s. Vietnam-era stuff. Also a stagflationary period, if you recall. What would’ve set that off? Massive increases in government spending that were a reaction to Eisenhower’s drive for balanced budgets and the maintenance of an adequate military. Ike was Ron Paul before Ron Paul was even Ron Paul. The Cold War loomed large, but LBJ also signed into law the Great Society that saw the biggest expansion of government since the New Deal.
But this was also the same point in time when we started seeing the decline of American manufacturing. Sure it was only in dribs and drabs, but it was there. You could see it. Feel it. Kiss it. Well, maybe not kiss it. But you get the idea.
So why the huge spike upward in capacity utilization in the 80s? Two reasons. One, we started seeing the benefits of Volcker’s policy to manage money supply versus interest rates. Second, personal computing and the transition of the American economy. Little did people know it, but by then we made our transition to an information/knowledge-based economy. Manufacturing wasn’t going to lead the country anymore, it was going to be services and information. So anything that helped expand the amount of information/services available in the economy were going to expand. At least up until now. I pointed this out in a nuanced manner in an earlier post:
We haven’t had a truly Earth-shattering breakthrough since some students at the NCSA started using something called HTML to design these things called web pages and Marc Andreessen ran with the idea and developed this company called Netscape. Yes, we have Twitter. Yes, we have Facebook and yes, dear God, we even have MySpace. But we still point and click our way around a two-dimensional GUI, most likely running on a 32-bit (although 64 bit is gaining) Intel-based chipset that has been essentially unchanged for decades. Yes folks, I’m saying we have plateaued in terms of innovation.
Capacity Utilization is headed downward again because our information-based economy has matured. Also, there’s this factor called demographics. So while there’s more slack, there’s also fewer able-bodied people to power the economy. Indeed, as I pointed out:
A flat-lining labor force will happen in most of the developed world given its demographic characteristics, it’s just a matter of time. The question is do we measure it in years or decades. My guess is years. Eventually the confluence of declining birth rates, rising average median ages and declining population growth rates (in total, including immigration) will take its toll.
But I also want to touch on debt for a second. I don’t see debt as the same driving force of inflation as many others do – far from it. And there’s one very simple reason: debt has to be serviced. Interest is owed. So if you can’t pay the interest and get the principal rolled, you either default or restructure it. Either way, you’ll need to change your spending patterns. Money printing – i.e. boosting the amount of currency in circulation is definitely inflationary in the long run. I realize many people will see debt expansion as inflationary, and I’ll buy into the idea that over the short-run it can be. But over the long run, debt is deflationary in my mind.
Of course, there’s these charts to go with the whole debt servicing argument: the collapse in the velocity of money, collapse in commercial paper borrowings and consumer credit. All courtesy of the St. Louis Fed publication “Monetary Trends:”
So let’s put things together: an economy that needs to transition into a new type of economy to better utilize the resources it has, meanwhile that same economy borrows money – which will require repayment; plus interest – at the same time the country is undergoing a demographic shift which will leave it with a smaller labor force than before? So debt-per-capita expands?
Someone is going to have to explain how we get inflation or hyperinflation from this because I frankly don’t see it.