In an unexpected twist of economic fate, inflation and unemployment escalated simultaneously around the time when Elvis Presley met his untimely end. This perplexing scenario left economists scratching their heads.
The Philips curve had long suggested a fundamental inverse relationship between inflation and unemployment: rising unemployment typically leads to declining inflation, and vice versa. Yet, how could both metrics rise concurrently? The answer reveals itself through years of government interventions aimed at manipulating the economy.
During the 1970s, as unemployment began to climb, the U.S. Treasury employed Keynesian principles, increasing deficits and spending to create job opportunities. However, instead of reducing unemployment, this tactic inadvertently spurred inflation. Subsequent attempts yielded the same disappointing results: jobs remained elusive, but inflation persisted. By the end of Jimmy Carter’s presidency, the misery index—which adds the unemployment and inflation rates—soared towards an alarming 20 percent.
It was during this turbulent period that Franz Pick famously claimed, “bonds are certificates of guaranteed confiscation.” It wasn’t until Federal Reserve Chairman Paul Volcker raised 10-Year Treasury yields above 15 percent in 1981 that inflation began to abate. Following decades of rising yields, the trend sharply reversed.
Something Has Gone Amiss
By 1982, with inflation under control, it turned out that investors in income-generating assets were entering a fruitful era. At the time, few would have predicted that locking in a 10-Year Treasury at 15 percent returns in 1981 would prove to be a savvy investment.
Over the subsequent decade, consumer price inflation hovered around 3 to 4 percent. Consequently, fixed-income investors enjoyed real returns of approximately 12 percent annually, without having to actively manage their investments. Moreover, those who anticipated the long-term trend of declining treasury yields could frequently trade bonds before maturity and benefit from rising prices.
However, the conditions that fostered a thirty-year descent in treasury yields have now mostly dissipated. Recently, 10-Year Treasury yields dropped back below 2 percent, with little indication they will fall further. Concurrently, credit markets appear increasingly disconnected from reality, signaling that something crucial has gone awry.
According to the most recent report from the Bureau of Labor Statistics, inflation over the past year rose by 2.9 percent. Consequently, a 10-Year Treasury currently offers a real return of minus 0.9 percent.
Considering the $2 trillion in Federal Reserve monetary expansion since 2008, it seems likely that inflation will escalate over the coming decade. Investors in fixed income may be nearly assured of negative real returns during this period. What is the underlying issue?
Similar to the perplexing scenario of simultaneous inflation and unemployment, treasury yields falling below inflation levels represent another economic anomaly. This situation has also arisen due to the central bank’s heavy-handed approach to financial markets.
Sowing the Seeds of Mass Inflation
Just as one expects a bountiful harvest from the land, a society can also demand a sufficient supply of money. However, much like agriculture, one reaps what one sows. Not all money holds the same value.
True wealth stems from productive endeavors, whereas excessive amounts of money can arise through the artificial inflation of digital monetary credits, a consequence of central bank price-fixing of interest rates. In this context, humans lack the ability to accurately price money, just as we cannot determine the boiling point of water or make pi a rational number.
While it is possible to measure water’s boiling point or approximate pi to two decimal places, these numbers are fixed and immutable. Even if legislation were passed to stipulate that water boils at 200 degrees Fahrenheit or that pi is rational, such rules would hold no power against the fundamental truths of nature.
As Ralph Waldo Emerson noted, “Cause and effect are two sides of one fact… [like the] seed and fruit they can never be severed.” He further elaborated that the effect already blooms in the cause, with the end pre-existing in the means, and the fruit residing in the seed.
The price of money—its real interest rate—is ultimately governed by market forces. When a government arbitrarily sets this price below the inflation rate, extraordinary and unforeseen consequences unfold, resulting in economic distortions that ultimately crash.
The seeds of mass inflation have undoubtedly been sown, and one can only predict that the resulting fruits will rot while still unripe.
Sincerely,
MN Gordon
for Economic Prism
Return from Sowing the Seeds of Mass Inflation to Economic Prism
