Monthly Archives: January 2013

Money, Inflation, and Wile E. Coyote

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Before 2008, the bubble that some economists expected to pop was the value of the dollar. Paul Krugman used a colorful metaphor to describe this.

So it seems likely that there will be a Wile E. Coyote moment when investors realize that the dollar’s value doesn’t make sense, and that value plunges.

I found this in an old post from Mark Thoma. Feel free to use Google to find other citations.

Nowadays, when he looks at the prices of U.S. government bonds, Krugman sees rational expectations at work. He looks at the low long-term interest rates as a sign of the market’s wisdom in predicting low inflation for ten years.

But what I see is a market that could have a Wile E. Coyote moment. Once enough investors decide to dump our bonds, interest rates will rise. It will become clear that at those interest rates the government cannot afford to pay off the bonds, so more investors will dump bonds. etc.

Now the Fed can always buy our bonds. It is doing a lot of that, and I can see where an investor with a sufficiently short time horizon who believes that he won’t be the one still holding bonds when they start to lose value might say, “Don’t fight the Fed. Just ride the yield curve for a little while longer.”

But suppose that our Wile E. Coyote moment comes when inflation has been heating up. (Indeed, the Wile E. Coyote moment could come because inflation heats up, and at that point investors decide that the Fed may no longer be their friend.) Under this scenario, the Fed wants to be a bond seller, not a bond buyer, in order to keep inflation in check. If the Fed feels constrained not to sell too many bonds, then inflation could really take off.

How can I justify a fear of inflation, given recent behavior? In recent years, the Fed has created a lot of money, and we have not seen a lot of inflation. What is going on?

1. Perhaps money and inflation have no connection. We should go back to using the Phillips Curve. When unemployment is high, inflation is low, and conversely. After all, wages are 70 percent of costs, and it seems unlikely that wage inflation will get much traction with folks having a hard time finding jobs.

2. Perhaps we are suffering from tight money. This is the Scott Sumner argument. Money and inflation (he would prefer nominal GDP) are related, inflation is low, ergo we must have tight money.

For the short run, I believe something like (1). However, I am old enough to remember the 1970s. Based on that experience, I would say that inflation is subject to regime shifts. There is a regime in which inflation is low and relatively stable. There is another regime in which inflation is high and volatile. Finally, there is a regime of hyperinflation.

I think that with enough persistence, the Fed can move us between the low, stable regime and the high, volatile regime. The Fed spent the 1970’s getting us into the high, volatile regime, and it spent the 1980s getting us out of it.

Hyperinflation is a fiscal phenomenon. A government that can balance its budget is never going to have hyperinflation.

The scenario I have in mind is one in which the economy has begun to shift to the regime of high and volatile inflation. Then the Wile E. Coyote moment arrives, and the Fed feels pressed to keep the U.S. bond market “orderly” by not selling bonds. In fact, interest rates are rising so quickly that the Fed decides that it needs to buy bonds. This sets off a spiral of money-printing and price increases, threatening to bring on hyperinflation. In which case, the bond market will not be orderly. Nor will anything else.

Fake Chart?

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Many people have been commenting on a chart that shows annual per capital health care expenditures in the U.S. by age group. The chart seems to say that this figure is about $3500 until people reach their mid-50’s and then rises exponentially to about $30,000 in their 70’s and $45,000 in their 80’s.

Tyler Cowen is among those pointing to the striking chart, which is creating a frenzy in the health-care-wonkosphere.

At least two folks, Austin Frakt and Kevin Drum, are skeptical about these numbers. I am beyond skeptical. I call baloney sandwich.

Finding the most reliable data for 2010 takes two seconds. Just go to the trusty Medical Expenditure Panel Survey. The mean expenditure per person for people with expenses is $3866 for people under 65 and $10,274 for people 65 and over.

It takes another five minutes to generate your own table using MEPS. I wanted to break down the over 65 group into finer categories. So here are the means for each age group:

45-54: $4816
55-64: $6823
65-74: $9265
75-84: $10,175
85+: $11,233

Those are the facts, as best I can determine.

[Update: a number of bloggers have now backed away from the chart (see Tyler’s comment, posted below), on the grounds that it does not include private health care spending. But that makes it sound as though the problem is that the chart understates spending on the young, when in fact the problem is that it overstates spending on the old. The most charitable interpretation of how the chart emerged is that somewhere along the way somebody started with TOTAL spending on health care by people in a middle-age bracket (say, 45-54), multiplied this by the ratio of GOVERNMENT spending on people in a higher age bracket (say, 65-74) to GOVERNMENT spending on the middle-age bracket, and arrived at an alleged TOTAL spending figure for people in the higher age bracket. But really, trying to figure out how bogus numbers made it into a chart is a mug’s game. Regardless of how they got there, they are bogus.]

Fake Wealth

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Michael Munger writes,

If you measure from the peak of the bubble, we lost a lot of wealth. But that wealth was entirely fake, created by a revved up demand for houses as assets expected to appreciate rapidly.

Pointer from Mark Thoma. As Tyler Cowen would say, “We’re not as wealthy as we thought we were.”

If you are a Keynesian, fake wealth is a good thing. It is well known that deficit spending is pretty much useless if there is “Ricardian equivalence,” meaning that people realize that in the future their benefits have to go down and/or their taxes have to go up. However, I am a firm non-believer in Ricardian equivalence, as you might have noticed when you read Lenders and Spenders.

So if I thought that economic activity consisted of spending, then I would expect deficits to increase spending and economic activity. Instead, I think of economic activity as patterns of sustainable specialization and trade, and I do not think that deficit spending is helping, because it is so unsustainable.

To put this another way, I think that long-term government bonds are fake wealth these days. There has to be some kind of default on future government commitments. There is an off chance that the future commitments that get cut will be entitlements. There is an even more remote chance that the government will find tax revenue to cover all of its commitments. We can inflate away some of our past debt, but since our projected future deficits are even higher, inflation does not make the problem go away. So I think that it is likely that we will get some sort of default. The fake wealth will be marked down at some point in the future, either through inflation or default.

Once upon a time, we had an Internet bubble that gave us dishonest stock prices. Let us stipulate that it was caused by private sector shenanigans. When that collapsed, it was followed by a housing bubble. There were private sector shenanigans involved in that one, too, but I think that some of the fingerprints on the housing bubble belong to government officials. The fake wealth that is being created now? Pretty much entirely government-generated.

Happy New Year.