2022 Annual Letter
“The Highest Inflation in 40 Years” is easily one of the most written, and spoken, phrases of 2022, and the subject of almost anyone’s conversation at a dinner party. The cost of housing, cars, food, and everything in between seems to be going up, and the two “i”s (inflation and interest rates) seem to be all anyone can talk about.
The layman economist simply says it’s a matter of too many dollars chasing too few goods. The average citizen will offer that “the government flooded the economy with money and caused inflation.” Both sound answers, and undoubtedly true, yet inflation doesn’t happen overnight, and it certainly doesn’t happen in a perfectly mathematical way as many economists and accountants would like to believe.
Let’s look at a hypothetical.
Let’s say tomorrow at noon the money in everyone’s bank account will increase by 100%. Kids with $100 in savings will have $200, and hedge fund managers with $2 billion will have $4 billion.
How will the prices of goods and services react after everyone’s savings have doubled?
Will the cost of a super yacht that the fund manager is looking at increase at the same rate as the a pack of gum the kid is wanting to buy? And over what period will the price increases take place?
Thousands of PHDs at Ivy League schools, investment banks, and government agencies spend their lives trying to answer these questions, and at times have a truly unfortunate over-confidence in their ability to give precise answers.
The advent of computers and the increased usage of electronic payments has made the tracking of price increases much more accurate over time, but there is still a major problem as it relates to the perception of inflation, particularly when it comes to the all-important CPI (consumer price index) figures.
Starting in 1919, the government started to release the Consumer Price Index to give people an idea of average price movements, yet the figures seldom give an accurate representation of the inflationary pressures felt by the average consumer.
The average CPI for the year of 2022 was 7.7%, but that hardly means the price of milk and eggs at the grocery store went up by that amount. It’d hardly be worth talking about groceries going from $100 to $108. Indeed, the price of eggs went up 120% in 2022 and the price of milk roughly 30%.
Of course, the “Core CPI” is hardly worth mentioning as few things are as “core” as food and energy (which the number excludes), but the nonsensical figure provides delusional government officials with a number to pronounce to their constituents if the regular CPI number isn’t to their liking.
The price increases of goods on the shelves and services in the shop have received plenty of attention, but what has gotten the most attention (and rightfully so) is the increased price of money.
Interest Rate Interests
Alongside the overly reported phrase of “the highest inflation in 40 years” are plenty of other phrases regurgitated by the masses along the lines of “the fed increasing rates.” After 110 years of existence the population has seemed to grasp that The Federal Reserve, operating under the watchful eye of congress, sets the monetary policies that increase or decrease interest rates. What often goes unnoticed is the immense complexity involved with a central bank increasing rates.
Utter the phrases discount window, federal open market committee, prime rate, or quantitative easing to a stranger at a bar and you’re likely to be met with eyes that have glazed over, along with a facial expression that’s silently begging you to stop talking. But these tools that the Federal Reserve has in its toolbox has an immense impact on everyone in the country, and indeed outside of this country too, as the price of the world’s reserve currency today is as important as the conversion ratio to gold was in the 1920s.
Through increased interest rates, The Federal Reserve makes consumer spending scarcer. When rates were 0.5% one could borrow $10,000 from their local bank and only pay $50 in interest. Now, though, with rates around 5%, that same consumer has to pay $500 in interest, leaving less money available to purchase overpriced drinks at Starbucks and hardly fashionable shoes designed by Kanye West.
While increasing rates is what’s best for the country to keep inflation down, it’s a painful process to go through. To see proof, just look back at that period 40 years ago, when a 6-foot 7-inch Paul Volcker faced a tsunami of opposition as the Federal Reserve Chair and raised the prime rate to 21% and pushed rates on government bonds to 15%. The unemployment numbers during that period give a sense of the pain felt by the population, but a short vignette will give a better demonstration of the country’s anger.
In the early 1980s, after Volcker had vowed to do whatever it takes to bring down inflation, the country quickly started to see a decline in manufacturing and home building since few could afford the loans needed to complete such projects. Out of protest, construction workers en masse mailed lumber two-by-four pieces to Volcker’s office, representing the unused wood piling up as a result of his rate increases. In another protest, farmers blocked the entrance into the Federal Reserve by parking their tractors in front of the doors.
Not long after, a man broke into the Federal Reserve with a sawed-off shotgun, along with a knife and pistol, looking for Volcker. From that point on he was forced to have security with him wherever he went.
The instance clearly shows the nationwide shock his policies caused, and the agony felt by Americans. Volcker’s experience is accounted in further detail in his gripping autobiography Keeping At It.
The pain the American people will have to go through to stomp on today’s inflation is unknown, but as in Volcker’s day, the pain is necessary. Yet, there are still countless factors that impact inflation that are far beyond the Federal Reserve’s control, such as trade tariffs, pandemics, supply chain disruptions, consumer behavior, or, as we’ve had to witness, war.
War, What Is It Good For?
Wars, by a historical account, almost always cost much more and last much longer than most expect them to. Just read the optimistic headlines and reports released in late 1914 after the assassination of Archduke Franz Ferdinand (the event that started The Great War) and you’ll see how few thought it would last more than a few months, much less 4 grueling years. Beyond the tragic death toll and devastation, the war has had a profound impact on the dynamics of the global economy, including wheat shortages, sanctions implemented by western nations, and a dramatic shift in the supply chain of energy resources to European countries. For the sake of long term peace, one can only hope that diplomacy and democracy will prevail as they have in the past.
While the tragedy of the war is nothing to understate, the impact that Russian sanctions have had on the United States are often overhyped, as many, particularly those who grew up during the cold war, still consider Moscow to be an economic power like it once was before the collapse of the Soviet Union. However, Russia’s power, from an economic standpoint, is a pale shadow of what it once was, due to the rapid rise of Asian economies, and a slowdown in Russian growth due to an immense amount of money and focus put towards weapons development rather than manufacturing capabilities and other means of economic growth.
Citizens uninformed of this global shift are likely the people suggesting similar sanctions on China, as they see Russia and China in the same limelight. This viewpoint, though, is an antiquated and delusional perception of global powers; all being fed by hatred of the word Communism. Such hatred blocks many from seeing that Russia is a dictatorship, while China is a socialist country that has thoroughly embraced the magnificence of capitalism.
Only through capitalism has China become the second largest economy in the world at $18 trillion dollars and is the only economy in the past century to have the potential to overtake the United States in GDP. While Russia, with its suppressive dictator, has just $1.7 trillion in GDP, giving it a smaller economy than the state of Texas.
Why Can’t We Be Friends?
There are many, though, that rightfully say that a decoupling of the United States from China is an irrational, and indeed very impractical, response to disagreements between the two economic giants. Even despite lockdowns in China, trade between the two countries reached a record $690 billion in 2022. Decoupling over $600 billion in trade is easier said than done.
The argument that overseas manufacturing will move from China to other countries is yet again another delusion. While many upcoming South Asian economies are providing more manufacturing capabilities, such as Vietnam, South Korea, and India, China still has far more capacity than any of its neighbors and has technological capabilities that are rivaling America’s.
Indeed, China’s immense industrial capacity is much of the reason why United States consumers were able to go the first two decades of the twenty-first century without having much inflationary worries.
As China emerged from isolation after the death of Mao Zedong in 1976, they marveled at the manufacturing ability of their close neighbors (namely Japan) and set out to build similar factories of their own country. Over the two decades leading up to the twenty first century China’s economy increased 528%, and in the years from 1980 to 2021 their exports grew from $11.3 billion to $3.5 trillion. With China’s cheap labor costs and bountiful human capital, companies in the United States were able to take advantage of low manufacturing costs and push those savings on to consumers, resulting in a lack of inflation.
Nonetheless, even with an immense amount of trade between the two countries, a confrontation between two economic superpowers is a very frightening thing to comprehend, especially in a world with slightly more than 13,000 nuclear warheads.
Just a few years before World War 1, Norman Angell published The Great Illusion which layed out reasons why war was to no one’s economic benefit, and therefore countries had to reason to engage in a global war. While the book was widely read, it failed to prevent the outbreak of the worst war the world had ever seen. For the sake of everyone on earth, we can only hope Angell’s rationality is better headed by today’s global powers, particularly with so much fear about the rise of China.
It's been easy over the past few years to many nations to try to impose economic restrictions on the People’s Republic, however, as China emerges from stringent lockdowns and attempts to get back on the economic growth train, it will be difficult for nations to turn their back on what may well become the largest economy in the world.
Confrontations between nations will forever provide eye-catching headlines for media sources to publish, negatively portraying the world and where it is going. Yet, through all the pessimism that spreads its way through society, the world continues to prosper and become more economically developed. Anyone who states that the world is getting worse is clearly oblivious to the advancement of the human race over the past two-hundred years, and anyone who looks at this advancement through a lens of rationality can only be awestruck by such incredible progress. Global disputes and economic headwinds will continue, but there can be no doubt that progress will continue.