Disruption Plans Disrupted
“Government has three primary functions. It should provide for military defense of the nation. It should enforce contracts between individuals. It should protect citizens from crimes against themselves or their property. When government—in pursuit of good intentions—tries to rearrange the economy, legislate morality, or help special interests, the cost comes in inefficiency, lack of motivation, and loss of freedom. Government should be a referee, not an active player.”
“Don’t give me a low rate. Give me a true rate, and then I shall know how to keep my house in order.”
—Hjalmar Schacht, Reichsbank president, 1927
One reason today’s inflation has us all so concerned is we went a long time without any—or at least not much. That wasn’t normal. In the 1990s, a 3% annual Consumer Price Index reading was common and almost unremarkable. CPI approached 5% in 2005 and was briefly over 5% in 2008. But from 2012 until last year, 3% was a hard ceiling—to the point where Federal Reserve officials worried more about generating inflation than preventing it.
At the same time, many households faced constantly rising bills for healthcare, housing, and other essentials. The benchmarks certainly didn’t reflect common experience. But inflation was, if not actually low, at least lower than in the past. This is one reason the prospect of extended 5%, 8%, or higher inflation feels so dreadful. We’ve forgotten what it was like.
Post-2008 monetary policy unleashed deflationary forces no one anticipated. As often happens, well-intentioned plans had unintended side effects. Years of near-zero interest rates didn’t just produce stock and real estate booms. They also changed how businesses operate in ways that are now adding to our inflationary pain. The Fed and other central banks financialized markets and business to an extent that we are just now recognizing, distorting the economy in ways that will haunt us for years.
As you’ll see today, interest rates aren’t simply the price of borrowing money. They are also information, providing signals telling economic players what to do. Interest rates are in fact the price of time. Low interest rates don’t value time very much. Bad signals produce bad outcomes… and that’s where we are now.
This letter is actually in two parts. I’m going to describe a set of circumstances which are odd in and of themselves, and then we’ll begin to look at the reasons.