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Lender, Lender... Anywhere?
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Lender, Lender... Anywhere?
For the first 90-odd years of this century, inflation could be reasonably explained and occasionally predicted by measuring the degree of overheating in the labor market. Analysis by "Phillips curve", "NAIRU" (non-accelerating inflation rate of unemployment), and other eye-glazers worked pretty well.
Since 1995, a red-hot job market and falling inflation have combined to confound the world of economics and finance. There is no satisfactory explanation, let alone a predictive theory for where we might go from here.
In a theoretical vacuum, almost any gas should help. So, here's a grand theory to explain our current situation and to forecast how long it may last.
The key to the theory is a mistake made by somebody else.
In 1996, David Fischer, professor at Brandeis, wrote a wonderful history of inflation from 1200-present: "The Great Wave". He postulates a theory of inflation as a succession of multi-century waves: each long period of price equilibrium will give way to a price "revolution" (an ascending spiral of prices) followed by a culminating "crisis" (hyper-inflation) in turn followed by another long equilibrium. He argues further that these waves of inflation have been and will continue to be the cause of the deepest upsets in human society: war, revolution, famine....
Since medieval times, he found long periods of price equilibrium in the Renaissance (c.1400-1470), the Enlightenment (c.1650-1789), and the Victorian Era (c. 1815-1914). In between, and later in the Bloody 20th... horrors, all caused by inflationary instability descending into chaos.
His research is magnificent: the volume contains the most succinct yet comprehensive history of European and American prices (and data sources!) found anywhere.
However, Fischer's inflation-as-cause-of-chaos logic does not survive comparison to another historian's cart-and-horse, specifically Paul Kennedy's excellent 1987 compilation of human mayhem, "Rise and Fall of the Great Powers". Fischer's Renaissance equilibrium did not give way to a price spiral, but to a 1551-1650 stretch in which peace prevailed in Europe for one... one single year. The equilibrium of the Enlightenment was shattered by Napoleon, not inflation; and price stability was restored upon his exile. Fischer's "Victorian equilibrium" is better known as the Pax Brtitannica, which concluded in 1914 with World War I -- the beginning of an unparalleled interval of slaughter and inflation.
Fischer, brilliant researcher that he is, is wrong. Dead, flat wrong; but also precisely and usefully wrong. In the Western world since the last Millennium, war has been the primary -- overwhelming -- cause of great waves of inflation, not the other way around.
The precise mechanism of war-as-cause-of-"great-wave" is revealed by different outcomes in small-scale, short-term episodes. For example, big deficit spending and money-printing in the American Civil War triggered big inflation; as opposed to the 1991 Gulf War, fought with on-hand Cold War weapons and soldiers, the oil and gas bill paid in kind by allies.
A nation or continent driven by war or preparation for war to ruinous, inherently wasteful spending will inevitably suffer large-scale inflation.
It may be that our currently inexplicable situation -- hot economy and falling inflation and interest rates -- is traceable to one overriding change in our condition.
We are at peace.
Bosnia, Rwanada, and nuclear arsenals notwithstanding, the great powers are more thoroughly at peace -- free of armed conflict or its prospect -- than at any time in this century. Some might argue more thoroughly so than any time ever.
This peace broke out in 1989 with the fall of the Berlin Wall, and the outbreak coincided with the advent of our impossibly good economic fortune. America has de-mobilized to a degree not seen since the 1920's; and defense spending as a percent of our economy will soon be less than a third the level of 1989.
If you want an inflation and interest rate forecast, look to foreign policy. There will be short-term inflationary ups and downs having nothing to do with war, but so long as profound peace shall last, we will enjoy a price equilibrium.
Of course, there would be other rewards, beyond price.
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