Inflation: Secrets and Lies

Why the stories we're told about inflation don't quite add up

Lately, I've become quite skeptical of the narrative we're being told about inflation—why it happens, what causes it, why it matters, and what to do about it.

In my opinion, the story we've been told by orthodox economists simply doesn't add up. Today, I'm going to start a series of posts explaining exactly why I'm skeptical. These posts are going to be more about asking questions than providing answers.

The Narrative

In brief: we're told that inflation is caused by too much money chasing too few goods. When the amount of money in circulation goes up, prices rise. It follows then, that if you reduce the amount of money, prices will go down again, or at least stop rising,

It's just as simple as that according to today's economists. Add too much money to economy and it will "overheat" causing inflation. To cure this, you withdraw money from the economy, causing it to contract. Then, when it contracts, prices come back down, or at least stop rising, and inflation "cools."

Another word for an economy contracting is "recession." That is, you induce a recession. If enough people are losing their jobs, or are afraid of losing their jobs, they will spend less, and inflation will get under control.

This leads to the conclusion that there is a tradeoff between inflation and unemployment. If too many people have jobs, the thinking goes, it will be inflationary, and therefore raising the unemployment rate will bring inflation down again. Economists call this relationship the Phillips Curve. In economic jargon, the level of employment that does not lead to rising prices is known as NAIRU (the non-accelerating inflation rate of unemployment—economists love their jargon).

The way the government contracts the money supply is by controlling interest rates, or put another way, they raise the price of money. The government does this by raising the interbank lending rate—the rate of interest charged on short-term loans made between U.S. banks. This is reflected in the loan amounts banks charge to borrowers. Because paying back loans becomes more burdensome, businesses take out fewer loans, and there is less economic activity overall. At the same time, government cuts back spending to restrict the amount of money flowing into the economy (another word for this is austerity).

Basically, you bring inflation down by punishing workers and throttling the economy.

I hope that this is a fair—if oversimplified—description of the popular narrative. This is the religion of the modern world. This story is told everywhere, from the pages of economic textbooks, to classes attended by millions of students every year, to the columns of every financial news publication across the entire world. It guides the thinking over every leader and central banker on the planet. I doesn't matter your politics—left, right, or center—this is simply treated as a fact. Anything else is "unscientific."

But there are reasons to doubt this narrative.

What we'll see is that, there is overheating all right, and it is causing inflation. But it's not the overheating economists like to talk about.

Problem 1 - the Climate

I've been reading a lot of stories in the media over the past year about why the cost of various commodities are rising. There have been quite a number of them, and I always click on them whenever I encounter them because I always expect to find one cause in particular, and I always expect to not find another. And so far, I've never been disappointed.

Let's start with this article from the BBC on the rising price of wine in the US: The major factors driving up the prices of US wine (BBC News)

This is one is interesting because its not monocausal—there are a number of factors going into the increasing price of wine. To a varying degree, many of these factors play a role in the rising costs of other things as well.

The first factor is the cost of glass bottles. The glass bottles U.S. winemakers rely on are made mostly in Europe. Natural gas is a key component in glassmaking, and the cost of natural gas in Europe has risen precipitously due to the war in Ukraine, therefore, the cost of glass bottles has shot up by as much as 20 percent. And it's not just the bottles—the cost of just about every component in the packaging of wine has gone up too, including labels, printing, corks, capsules, and so forth. Winemakers face a short window of time in which to bottle their product, so they have no choice but to pay these higher spot costs.

Labor costs have also risen. That means that picking and processing the grapes costs a great deal more than it used to as well. These costs must be paid, and so are passed along to the consumer.

During the pandemic, we all self medicated with alcohol (not me, of course, heh). People were willing to pay higher prices to get their hands on things like wine, and the producers and suppliers pocketed the extra. But now consumers have gotten used to paying higher prices for wine, so there is little incentive to lower them. Add to the fact that people see the price of wine as indicative of its quality—rightly or wrongly—so there is little motivation to lower your prices which may actually run the risk of your product being seen as inferior, hurting sales.

Because alcohol sales are heavily regulated, wine cannot be sold directly to the consumer. It has to go through a series of middlemen, known as distributors or wholesalers. In the United States, only three wholesalers control basically the entire market (a recurring theme, as we will see). As Forbes notes, "Of the top 10 distributors...the top three startlingly account for nearly $30 billion in wholesale wine movements; that’s big, and it clearly reflects the move toward consolidation in the distribution industry over the past two decades."

Because of power the wholesalers wield over producers to get their product to the retailers (also heavily regulated players who are allowed to sell alcohol to the general public), winemakers have less flexibility to adjust their prices and still maintain those key relationships.

As winemakers are squeezed by wholesalers, they shift focus to making high and mid-range wines with higher profit margins. The shift in consumer tastes from wine to seltzer pays a role, too. The most stalwart wine drinkers are more likely to purchase high-end bottles, whereas low-end wines tend to be drunk by dilettantes with more fickle tastes, making low-end wines less attractive to produce for winemakers being squeezed by costs.

All of these factors add up to a perfect storm of rising prices for the public. And then, finally, we come to the elephant in the room: climate change.

Now, in the grape-growing regions of the US, as in many places, climate change is causing erratic weather patterns that are keeping winemakers from predicting how their harvests will turn out – a ripple effect that extends to price and beyond. As extreme weather events become more common in winemaking regions – like 2020 and 2021's wildfires, 2022's record temperatures and 2023's unceasing rain – those days of consistency, say many vintners, may be over.

Now you can probably guess by now what I expect to see in every single article on rising prices. Yup, you've guessed it, It's climate change! And so far, I have never been disappointed, not even once.

Let's take a quick tour of some of the staple commodities that climate change has affected around the world. If you think you can get around high price of wine by switching to beer, well, I'm afraid I have some bad news for you—climate change is hurting that, too:

"What's happening with hops with climate change is that it is getting hotter, and there's more droughts," Stefan Schnitzer, an ecology professor at Marquette University, said. "What's happening is that when temperatures go up, those flowers develop too fast, and they're not developing all of what are called the alpha acids that are necessary to produce really tasty beer."

Climate change hurting hops, could lead to pricier pints of beer (WISN)

Well, maybe you want to self-medicate with chocolate instead. Not a bad idea. But, once again, there's some bad news. Here we don't just have temperature fluctuations but disease outbreaks as well:

Agriculture in West Africa is vulnerable to the El Niño (warm) phase of the ENSO cycle. It often leads to drier and warmer conditions. It has suffered intense heatwaves and drought in recent months. While this is expected during El Niño years, climate change could be making these conditions more intense.

The biggest impact on cocoa hasn’t been the temperature itself but the impacts of rainfall extremes on disease outbreaks. West Africa experienced extreme wet conditions late last year, driving an outbreak of “Black pod disease”. This is a fungal disease which tends to spike just after the wet season. If it’s not treated, it can destroy an entire harvest.

The chocolate price spike: what’s happening to global cocoa production? (Sustainability by Numbers)

Okay, so maybe we ditch the chocolate and cope with ongoing societal decay with candy instead? Maybe some cake? Unfortunately, the price of sugar has also risen dramatically. And since sugar is a fundamental ingredient put into just about every single food item we eat here in the United States (leading to an obesity epidemic, but that's a topic for another post), it follows that this will lead to rising food costs across the board:

Rising global temperatures – 2023 is expected to be widely confirmed as the hottest year ever recorded – are fueling droughts and other extreme weather that affect food yields, including that of sugar. The price hike has already started to filter down to chocolate, sweets and other desserts...

“Extreme weather is affecting food – a year ago it was avocados, now it’s sugar,” Wagner said. “Climate-flation is a thing and it’s getting worse. It’s convenient for the owner of Oreos to point to climate change for a price increase but it’s also understandable.” US consumers saw prices for sugar and sweets rise by 8.9% in 2023 and a 5.6% increase is expected this year, according to the US Department of Agriculture, which is well above historical averages.

In November, Mondelēz, a sprawling business that includes Cadbury, Oreos and Toblerone among its brands, warned of price increases for its products. There will have to be a “straightforward price increase” for consumers due to the high cost of sugar and cocoa, Dirk Van de Put, the chief executive of Mondelēz, told Bloomberg.

Cookies and candy are latest victims of climate crisis as sugar prices surge (Guardian)

So no wine, beer, chocolate or candy? At least I can still self-medicate with caffeine, can't I?

Arabica coffee futures saw an upswing this month partially due to unusual weather patterns across Brazil's coffee-growing regions, according to Agriway Partners, a company that specializes in competitive grain marketing. Specifically, in Minas Gerais, which accounts for about 30 percent of Brazil's Arabica production, there was an excessive rainfall of 75.4 millimeters, over three times the historical average.

The excessive moisture is feared to have damaged crops at an important time for bean development...potentially diminishing the quality and size of this year's harvest. "An El Nino pattern typically brings heavy rains to Brazil and drought to India, negatively impacting coffee crop production," Agriway said in its report. "The El Nino event may bring drought to Vietnam's coffee areas."

Coffee Prices Are Spiking (Newsweek)

Oh crap. Maybe I'll just fix myself a nice Italian dish as part of my Mediterranean diet and wash it down with a bit of that expensive vino. But it looks like my Italian food is going to cost me a bit more as well.

This year, the International Olive Council expects that just under 2.3 million tonnes of olives will be produced – slightly down from last year’s yield of 2.5 million tonnes, and significantly lower than the 3.4 million tonnes produced in 2022. This significant decrease is largely thanks to climate change.

A few consecutive years of high temperatures and droughts in Spain, the country responsible for producing 40 per cent of the world’s olives, have drastically curtailed the quantity and the quality of the harvest. Unusually warm stretches of weather in winter are bad for olive trees: the higher temperatures can prompt them to start flowering and if the mercury subsequently drops to a more normal level, these premature blooms might die off.

Spring heatwaves, like the one Spain experienced last May, can be damaging too. “If the weather doesn’t change, olive oil prices will continue to rise,” Juan Vilar, the CEO of agricultural consultancy Vilcon, told industry bible Olive Oil Times in February.

Why olive oil is suddenly so expensive (Independent)

Wine, beer, soda, coffee—is there anything I can drink? How about a nice glass of orange juice. Surely that can't be much more expensive, can it?

Orange trees in Brazil have been suffering from a disease known as citrus greening. Once infected, citrus trees produce fruits that are partially green, small, misshapen and bitter. There is no cure, and trees typically die within a few years of infection.

The disease, along with severe heat waves and drought that occurred during the pivotal phases of flowering and early fruit formation, have put Brazil on track to register one of its worst orange harvests in more than three decades...In fact, the citrus growers organization forecast that the South American nation is set to produce...a marked 25% decline when compared with the previous cycle...

On top of that, Florida has been hit by a series of hurricanes as well as the greening disease, which is spread by a tiny insect called the Asian citrus psyllid. "This is a crisis," Kees Cools, president of the International Fruit and Vegetable Juice Association (IFU), told the Financial Times. "We’ve never seen anything like it, even during the big freezes and big hurricanes."

Orange juice makers consider using alternative fruit as prices skyrocket (Fox Business)

Oh well, maybe I'd better reach for a different fruit, How about a tasty banana:

...while banana supplies can cope with short-term weather events like this, experts are concerned about the growing threats from a warming world, and from the diseases that are spreading in its wake. "I think climate change is really an enormous threat to the banana sector," said Mr Liu of the World Banana Forum...As well as severe weather impacting production, bananas are sensitive to temperature rises which could wipe out crops in some locations. Perhaps the biggest immediate threat is the fact that rising temperatures are helping to spread disease...

Producers are also facing pressures from rising costs of fertilisers, energy and transport as well as problems in finding enough workers. Taken together with the impacts of climate change on supply, prices in the UK and elsewhere are likely to go up - and stay up.

Banana prices to go up as temperatures rise, says expert (BBC)

Have you gotten the picture yet???

Note how every expert above says that it's going to get continually worse going forward as the temperature of the planet ratchets up. Excessive rainfall also contributes to disease outbreaks. And cool, wet weather in some areas is accompanied by droughts and heat waves in others, exactly as climate scientists predicted. Clearly, this is going to affect prices for a long time. As the climate gets less and less predictable, it will have a ripple effect on prices. No one will know how to correctly price anything, and protectionism and speculation will abound.

So, price spikes seem to have occurred for just about every basic foodstuff across the planet for several years running. But it's not caused by an overheating economy. Rather, it's caused by an overheating planet. And we see a host of other factors in play as well as with the cost of wine, from the rising costs of labor to the rising costs of energy, fetilizers, packaging and transport. And we also see industry consolidation in sector after sector, squeezing producers and consumers.

Oh, and the one thing I've never yet seen, not even once, in any article about price hikes?

"Government money printing."

Yet we're told over and over again that inflation can ONLY be caused by "too much money." Why is that?

The Takeaway

Now, there are a couple of points to make here. Conventionally, it's thought that while, sure, some prices may be rising due to weather events and disease outbreaks, they can't all be rising at the same time. Inflation isn't a rise in the price of some things, it's a general rise in prices across the entire economy.

But that's not strictly true. As Blair Fix notes, inflation is measured as an average of price rises across a basket of goods. If enough things are rising in price, it will drag the average up even if other costs are constant.

Like much of economic theory, Friedman’s thinking appears plausible on first glance. Inflation is a general rise in prices. And since prices are nothing but the exchange of money, more circulating money means prices must increase. Hence, inflation is ‘always and everywhere a monetary phenomenon’. Unfortunately, this thinking falls apart on further inspection. The problem is that it treats inflation as a uniform rise in prices. That’s theoretically convenient, but empirically false. In the real world, inflation is wildly divergent. At the same time that the price of apples rises by 5%, the price of cars could grow by 50%, and the price of clothing might fall by 20%.

The Truth About Inflation (Economics From the Top Down)

The second is that, while normally we wouldn't expect bad harvests to decimate every single crop in the world at the same time, under climate change this becomes a realistic scenario. We could see bad harvests and diseases in so many different parts of the world simultaneously that it drives up the inflation rate across the board. Such price increases would affect every country on earth, which is, in fact, what we're seeing.

The second point is that there's something called "core" inflation which strips out "volatile" items like food, and the reason it does so is for exactly the reasons I described above. Food prices are affected by so many different variables, and they tend to seesaw up and down, so food prices may not give you an accurate picture of what prices are actually doing in the long-term, which is what the inflation index is theoretically supposed to measure.

The same goes for gas prices, as anyone who watches the kiosks at any gas station is familiar with. This is why food and fuel is often stripped out of "core" inflation. You need to look at the long term trend, not at the spot prices—the trend is what matters.

The same is done for housing costs. Most people don't buy a house every year. In fact, unless you are some kind of real estate tycoon, you're likely to buy only one or two houses in your lifetime and hold onto them for a long time, unlike, say, bananas or chocolate. So, housing costs may not reflect the current situation, they might reflect the cost at the time the house was bought, which tells you nothing about the inflation rate right now. Rent is theoretically captured, but the wide divergence in rental costs across the country often gives a distorted picture. That's why you constantly hear claims that inflation statistics are somehow being doctored or manipulated, or that they are "fake." But no single statistic is meant to capture the overall health of the economy, nor can it.

However, the fact is that housing, food and gas are most people's largest monthly expenses, and whether or not they are not part of "core" inflation doesn't matter. People are angry right now at the inflated prices they're paying at the supermarket and at the pump. And people may not be buying a house every year, but there a lot of people right now who can't afford a house due to the inflated prices for houses, and they are very, very angry.

Americans are spending the biggest share of their income on food in 3 decades (CBS Moneywatch)

Of course, none of this explains why food inflation was 79 percent in Turkey but 9 percent in Germany in 2023. It clearly can't be all climate. But that's the point! I have a hard time believing that it's all due to "government money printing," either. If that were the sole cause, inflation would be a trivial problem to solve—simply raise interest rates. But that's not the case. In fact, many of the places in the world with the highest inflation rates often have the highest interest rates as well. In 2023, Argentina experienced 100 percent year-on-year inflation with interest rates of 75 percent, up from 45 percent the year before. Despite this, inflation remains endemic. Clearly there's a lot more going on here than we're told.