The Unique Property
Inflation, Yes, but How High?
I have been asked what has happened to my weekly blogs. The
thing is, although I enjoy writing, I only do so when I have
something to say, and this is, after all, a site devoted to
things relating to real estate, although I don't mind going off
at a tangent now and again. But it so happens that one of the
arguments I have looked at and digested over the past week has
been an interesting article about the coming inflation by a guy
I always find interesting; Nick Hubble. Maybe you should check
him out. He is definitely worth a read.
In this blog I will attempt to paraphrase his argument on
inflation. Like most articles on the future, the best anyone can
do is put forward a hypothesis. But the article I want to
discuss at least gives us a few ground rules from which to base
any thoughts about where we are headed.
He starts by reminding us of the basic equation that governs the
way we look at the financial aspects of an economy. When I was
studying this stuff at university I was much taken by the
methodology of one of my fellow students. He invariably started
his essays with the phrase "Take the product of an economy to be
a can of baked beans..." I am assuming MV=PY is arguably a more
useful point of departure, but what the heck is this equation?
M stands for the money supply, V is the velocity of that money.
P stands for Prices, while Y is real GDP.
The problem with all of this is that we can define the amount of
money in the system in many ways. Does it include reserves,
credit, the unused amount on your credit card, or something else
There are also some strange implications when talking about the
velocity of money, which basically refers to the speed at which
money is used in the system. If the same five pound note goes
from being used once a day to being used twice a day, it feels
as if there is twice as much money sloshing around the system.
Let's use another example. Quantitive Easing (QE) has
undoubtedly increased the money supply, but it was used as
reserves instead of being used in daily transactions, so its
velocity was low.
P is simply a way of representing inflation (rising prices), or
deflation (falling prices). This also is a difficult figure to
asses as some prices go up and some prices go down, but the
current indices take an average of a whole basket of items.
There are also some tricks of the trade such as hedonics, but I
dont want to get too technical here. Let's just accept that we
are talking about the price of a basket of basic items used by
most people in their daily life.
There are even problems with defining GDP. If instead of mowing
my lawn I pay someone else to do it, how has that increased the
country's GDP? The state is no more well off the day after my
lawn has been mowed, but money has changed hands.
Quite. Economics is a very inexact science. And we are supposed
to be using this stuff to try and chart a way into the future.
No wonder this subject is difficult, and prone to disastrous
assumptions. But let's struggle on.
Okay, we've defined our terms as best we can, but what does the
equation really mean?
Let's do a translation. "In an economy, the amount of money (M)
times the speed with which it is spent (V) is equal to the price
of stuff (P) times the amount of stuff (Y)."
I always maintain that the most important indicator in maths is
the equals sign, and the whole point of this equation is that if
you double the money supply, the other side of the equation has
to double as well.
The real problem with that assumption is that if you double the
money supply (QE), but the velocity of that money halves,
nothing changes on the other side of the equation. In other
words, there is no inflation.
There is a nasty corollary to that observation. If the
government introduces a digital currency, that currency can be
programmed to expire if not used. Expiring money encourages
people to spend it faster, which increases V (velocity). This
would have a stimulus effect on prices or a stimulus effect on
spending to spur on GDP. That's precisely what the governments
of the world want in order to get inflation to eat away at their
During the pandemic the lockdowns meant that the economy (Y)
crashed. Apparently it was the biggest drop in GDP in the UK for
300 years. On the other side of the equation, the velocity of
money (V) plunged too. People saved instead of spending. In fact
they were prevented from doing quite a lot of spending. Central
bankers responded to this drop in V by creating insane amounts
of money (M) to try and pump up the economy (Y) and keep prices
I hope you are all on top of this, or do you need a rest and a
Okay, it's Consequences time. As economies around the world come
back to some semblance of normality, spending is going to
return. All that increase in M is going to circulate faster,
triggering a spike in inflation.
This is starting to happen right now. But how much higher is
inflation likely to rise?
Sadly, there are too many variables in the equation to work that
out. But Nick has a try. "If V returns to its pre-pandemic
level, that would equal a rise of 27%. The Federal Reserve is
anticipating economic growth of 6.5% in 2021 in the USA." If you
assume no more QE, which is probably an unrealistic assumption,
but let's do the sums, then the left-hand side of the equation
has increased by 27% so the other side must equal that, which
means that 27 - 6.5 (GDP) = 20.5% worth of inflation. That's
If M increases with more QE, and V increases because in an
inflationary environment people spend money faster before it
loses more value, then the figures are going to show inflation
far higher than 20%.
What likelihoods are there? Inflation rises, so interest rates
rise to help damp down the problem. Rates ought to rise to
compensate for holding debt, but governments want inflation to
eat away at their debts, so that is going to be resisted as much
as possible. The only way I can see they can do that is by
cutting down on their spending, or by refraining from borrowing
to finance their obligations. There is, I believe, something
like eight trillion dollars that will need refinancing at the
end of this year in the USA alone. The only way out of that
problem is to print the money to pay off the debt. If they dont
have to borrow, that will take the pressure off a rate rise.
An interest rate rise would trigger a deflationary debt crisis
like the one in 2008-9, but with far higher levels of debt today
any crash would have more far reaching consequences.
Then there is the risk of stagflation. In the USA there is a
disappointing jobs number, and there are rather a lot of supply
In short, it looks as though there is more money printing to
come. Expect the dollar to fall against other currencies.
On this side of the pond an inflation spike might force the ECB
into raising interest rates on heavily indebted South European
countries, and inflation has already risen above the ECB's
mandate. Not that that little inconvenience will bother
The bottom line is that no-one knows where this mess is headed,
but the signs are not good. For the moment I am tentatively
suspecting inflation to rise at least to the levels last seen in
the seventies. 25% - 30% is perfectly feasible on the current
figures. Let's hope it doesn't get that bad, but it would be
sensible to be prepared. And those inflation figures will screw
the housing market, as price rises in that range would seriously
impact on disposable income.