By Daniel Lacalle, Chief Economist at Tressis
For more than ten years, ECB monetary policy has been ultra-expansionary, whether there was crisis, a recovery, economic growth or stabilization. The worst excuse of all that was used to justify endless quantitative easing has been the often-repeated mantra that “there is no inflation.”
Defenders of aggressive monetary policy have always used the same arguments really.
First, they say there is no inflation – as if an average 2% increase in prices during a crisis whereby many salaries fell up to 20% does not constitute “inflation”.
After, they say it is temporary, so to justify maintaining aggressive easing policies.
Next up, the “inflationistas” seek to blame businesses or some kind of external enemy for the rise in prices, whereby they ask governments to impose price controls.
Important to understand here is that money creation is never neutral. It disproportionately benefits the first recipients of newly created money – governments -, and negatively affects real wages and savings of those that are not able to buy financial assets: the poorest.
There clearly is massive inflation when it comes to financial asset prices. Negative-yielding sovereign bonds of nations with weak solvency ratios amount to massive inflation. Continuous price increases of both quoted and private assets amount to high inflation, and all of this is caused by monetary policy.
Furthermore, anyone can understand that the official headline consumer price index (CPI) is masking the increase in the price of goods and services that we really purchase on a daily basis, relative to the ones we only purchase occasionally, or for leisure. Any European citizen understands that tourism and technology may become cheaper, as a result of competition and innovation, but that the things we purchase every day have increased more in price than reflected by the headline CPI.
There also is high inflation when it comes to housing and non-replicable goods and services. According to Eurostat, the average house price and rent index has risen significantly above headline CPI, real wages and real disposable income. This amounts to massive inflation, which is being underestimated by official CPI statistics. Those underestimate rent and housing inflation as a result of the use of nationwide averages, which causes the price increases in in cities and highly crowded areas to be artificially reduced..
There is no infl… Ooops pic.twitter.com/Hn0wCtMV2W
— Daniel Lacalle (@dlacalle_IA) March 31, 2021
High inflation can furthermore be witnessed when it comes to the cost of education and healthcare., The prices of this have all increased more than the official CPI. The same is true for fresh food.
Moreover, there’s the fact that taxation and surcharges are not fully incorporated in vital components such as energy is, to say the least, misleading.
In sum, the official calculation of CPI and the basket used fail to properly reflect the real increase in the cost of living.
Reality shows that prices are not rising due to some external factor, but because of currency debasement which erodes purchasing power. The fact that inflation in Europe is lower than what it was when Eurozone member states still had their own national currency only shows that the euro still is a harder currency than the extremely weak currencies some Eurozone member states used to have. Importantly, this is due to the Eurozone’s massive trade surplus, not because of a lack of ECB policies to erode purchasing power. The euro is simply less damaging for real wages and savers than some of its purchasing-power destructing predecessors.
It is not by chance that there were protests in Eurozone against the increase in cost of living – think of the “yellow jackets” – while we were at the same time told that “there is no inflation”. It is however quite imprudent to say that there is no inflation without considering the increase in the prices of non-replicable goods and services – rent, fresh food, healthcare, education, etc – and financial assets, which have skyrocketed as a result of the ECB’s policies.
In the U.S., which witnessed similar expansive monetary policies, increased prices for non-replicable goods and services, amount in many cases to three times the official inflation rate, according to a recent study by Bloomberg Economics shows. It notes that it ise especially worrying when monetary policy encourages unproductive spending and when it perpetuates overcapacity. This causes real wages to fall in the future, as a result of lower productivity growth. Bjorn van Roye and Tom Orlik at Bloomberg Economics conclude hereby that real inflation isn’t only higher than official CPI statistics indicate, but that that is is also much higher for the poorest citizens.
A recent study by Alberto Cavallo of Harvard Business School and Bloomberg Economics equally warns of precisely this differential between real inflation suffered by consumers, especially the poorest, and official CPI statistics.
Now it is not just a matter of detailed study and basket weights. Inflation expectations have risen to a five-year high and inflation data in both Germany and the United States for January are particularly concerning for two reasons: inflation is rising faster than central banks and governments had estimated, and it is only kept at a low level by an energy component which will likely soar in the following months, after oil recovered 22% in the first two months of 2021 and most commodities are up between 6 to 15% during the same period.
In fact, if we analyze the cost of living with the goods and services that we really use frequently, we realize that during the unprecedented crisis in 2020, prices for the poorest layers increased almost three times the level shown by the CPI. Combined with the distorting factor of the enormous inflation in financial asset prices, this generates grave social rifts. This destruction of wealth has been even more evident during the first month of 2021.
The German wholesale price index increased +0.7% in February versus +1.4% before that. That is the highest increase in 10 years.
Looking at the details is even more concerning: Prices of intermediate goods increased by 3.8% compared with February 2020. This was the highest year-on-year price increase since November 2017. Secondary raw material prices surged by 46.6% year-on-year in February, with prices of non-ferrous metals up 11%. Energy prices increased by 3.7% year-on-year and by 1.3% month-on-month. The increase in energy prices resulted from a 6.8% jump in electricity prices and the introduction of CO2 pricing in January 2021. Prices of durable consumer goods increased by 1.4%, year-on-year, with prices for capital goods up 0.8%.
In the United States, the situation is similar. Inflation expectations are at a seven-year high. Deutsche Bank has pointed out that there is less to worry about the prices of education, healthcare, and housing, but since 2000, these prices have already risen a lot, between 2 and 2.5 times faster than the official CPI. Shadowstats has pointed out that “in general terms, methodological shifts in government reporting have depressed reported inflation, moving the concept of the CPI away from being a measure of the cost of living needed to maintain a constant standard of living”.
Many analysts think that this increase in inflation will be temporary and is due to the re-opening of most developed economies and the fast recovery in commodity prices. This is correct, and we will likely see a slowdown in official inflation during the second half of 2021. However, this is not likely to be the case with the goods and services we actually buy, and the increase in the prices of non-replicable and essential goods and services will remain significantly above both real wages and the official consumer price index.
This pricing pressure creates even more inequality, as it affects mostly the poor, as it is also turning into a real burden for most middle-class families, which have seen real wages stagnate amid an increase in the prices of the goods and services they cannot substitute. Furthermore, the poor and lower middle-classes do not benefit from the asset price inflation caused by monetary policy.
Former Fed chief Ben Bernanke used to say that central banks are not in charge of fiscal policy and that this is a matter of fiscal policy. This is wrong. Massive money supply growth and its negative consequences are not solved by raising taxes and increasing subsidies. This only perpetuates the problem and creates a zombie underclass, which is not able to recover when there are these constant boom-and-bust periods.
What is the biggest risk? This is for inflation to overshoot, while central banks aren’t able to stop the easing machine, because only a few percentage points yield increase would cause a massive debt crisis for insolvent governments. Faced with the choice of helping consumers or governments, most central banks will choose the latter.
To conclude: the ECB and central banks should stop ignoring the effect fiat currency debasement has on the cost-of-living, because if current policies continue, things will only get worse, which may lead to significant social unrest and discontent. Everything could be mitigated if the ECB and central banks would simply respect the so-called “Taylor-rule”, which is technical guidance central bankers can use in order to determine the level of money creation, avoiding the need for discretionary and random policy choices.
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