Egg prices are through the roof, more than at any time in the last five years. But this is the exception. Real-time inflation started settling down in late January, around the time of the inauguration, which allows the Trump administration to take some credit. This is not entirely incorrect but the causal relationship is rather circuitous.
Inflation, a general increase in prices, is a consequence of several factors: output, growth in the money stock, and the pace of spending which is known as velocity. Velocity is to monetary policy as the infection rate is to the flu, a measure of how fast it spreads. More spending causes higher velocity and more saving causes lower velocity.
Velocity has a huge effect on inflation, which is obvious if you consider the following scenario. Let’s say the government prints $10 trillion tomorrow and drops it into the bank accounts of every American. But instead of using it, everyone just sits on it and the bank lends no additional resources based on new cash balances. What happens to prices? Absolutely nothing. New money only matters for prices if it enters circulation.
Even without a change in the money stock, a higher velocity can cause higher inflation, while the opposite is true. People can also change their spending patterns based on expectations of future prices. If people expect things to cost much more in the future, they will buy now, whereas if people expect prices to be flat or barely rising in the future, they might save more, driving down velocity and thus inflation.
It’s speculation in part because we do not have real-time velocity numbers but there are hints in the data that velocity might have taken a fall in the last several months. Why might this be so? Because people and businesses might expect inflation to fall under Trump. The prophecy then becomes self-fulfilling.
A complicating variable in all of this is output itself. If production keeps pace with money stock increases while velocity is unchanged, prices will generally stay flat. The formula is: money x velocity = price x output. There are a thousand other variables that prevent this equation from smoothly operating in real-time, among which is a time lag, but you get the idea.
Right now, the money stock is rising even as velocity is falling. Very likely output has started to rise again in real terms. Here is the monetary picture that we have based on the latest data. The money stock is still down from its high in 2022, but it is also up from its lows and rising 3.8 percent annualized. That is far too high but the effects are mitigated by slowing velocity.
There is a profound difference between a rise in general prices and a change in the prices of particular goods or services. This is how it can be that eggs are up so much but general grocery prices have settled down in their rate of increase. Eggs are rising because of mandated slaughtering of chickens by federal and state regulators. Both New York State and Georgia have canceled poultry auctions by government decree.
This has had a profound effect on egg prices.
This insight pertains to the promised Trump tariffs, which are coming one way or another. They will most likely increase prices for affected goods. It is however incorrect that this will automatically translate into higher prices for all goods and services. It is inaccurate for media constantly to claim that tariffs will feed inflation.
The main hope of the attempt to control inflation is to avoid a second and third wave such as we saw in the 1970s. Before the election, it looked as if all the signs were pointing to just such a thing. The Fed was engaging in quantitative easing and lowering rates as a means of bettering the macroeconomic environment in advance of the election. It did not work and now the Fed has seemed to pause its rate reductions.
We seem better poised now to avoid such a second wave.
As for the broader economic outlook, we’ve been in an unadvertised quasi-recession now for nearly five years. All that Biden administration talk of higher sales and better jobs numbers was always highly questionable. The latest jobs data from the Department of Labor has already readjusted last year’s numbers to expose the fiction of some 600,000 jobs.
That said, even a slight bit of output growth combined with lower inflation will serve to bolster consumer and investor confidence. This means that we will likely experience the feeling of recovery even if it is not robust.
If the Trump administration ends up balancing the budget, it will put less pressure on the Treasury and Fed to engage in debt finance, which will free up private capital to flow into productive projects rather than forever fund a rising debt load. Such a move would also be bullish for capital markets. If Trump can also manage a tax cut on capital and income at the same time, we could end up ready for robust growth as we approach the midterm elections.
Still, many things could go wrong. A wide-ranging trade war with the world cannot be good for prosperity, and there are any number of contingencies that could distract the Trump administration from its agenda. For that matter, there are growing signs of another pandemic panic, this time involving Bird flu, that could make a huge mess out of the Trump agenda.
One can also hope that the Trump administration will not pressure the Fed for lower rates. That would fire up inflation again and do nothing to repair the deep damage to the economy that has been inflicted over five years. The road to genuine recovery is a long one and requires discipline and patience. Fortunately, the second Trump term seems smarter and more focused than the first, and less likely to be diverted by plots and schemes. One can hope, in any case.
Finally, I was asked the other day about the possibility of deflation. My own assessment of that is that there is zero risk for the whole country, though we could see some big corrections in commercial real estate and possibly housing prices in the DC/Virginia area depending on how the effort to clean up the public sector labor market goes.
In any case, as much as a real increase in purchasing power of money would be welcome, I seriously doubt that this is likely anytime soon.
