Hi, I'm the author.

> Money isn't created primarily because governments print it; whenever a bank creates a loan money is created, and when they call in loans money disappears.

Yes this is right, and I am in fact aware of this mechanism. As I say in the post: "[...] anticipated high levels of lending and consumer spending post-pandemic, seemed likely to fuel substantial USD inflation in real terms through the end of 2021."

Velocity-of-money and the M2 money supply weren't that relevant to the main story I wanted to tell, so I went into no more than superficial detail here.

Even if inflation were to occur at the levels you anticipated, I would find it hard to justify crypto being a safe hedge against the dollar. Dollar backed productive assets are largely much safer.

I recommend that you listen to this: https://www.coindesk.com/podcasts/the-breakdown-with-nlw/bre...

Thanks for a great article. Wondering what would be the best way to follow your writings, given that you're currently anonymous.

CPI is a very distorted view of actual living costs over time. House prices aren't included and we've seen prices balloon over the last decade. Sure, your apples cost the same but good luck trying to buy property.

Yes we have the usual supply constraints, etc.

>House prices aren't included and we've seen prices balloon over the last decade

Depending on exactly what you mean, this is not a great criticism of the CPI.

House prices are excluded on purpose. Housing costs are included (including for housing equivalent to what an owner owns).

CPI does include housing expenses: "The CPI represents all goods and services purchased for consumption by the reference population (U or W). BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups (food and beverages, *housing*, apparel, transportation, medical care, recreation, education and communication, and other goods and services)." [1]

Furthermore, it includes housing expenses for owner-occupied housing as follows: "The [owners' equivalent rent] index is designed to measure the change in the rental value of owner occupied housing change. In essence, OER measures the changes in the amount a homeowner would pay to rent, or would earn from renting, his or her home in a competitive market." [see p. 107 of [2]]

As the BLS notes, the primary service provided by houses is to shelter the inhabitants. The house itself may be held as an investment. See [3]

So the CPI explicitly captures the cost of providing shelter, though it excludes the investment value of the property.

[1] https://www.bls.gov/cpi/questions-and-answers.htm#:~:text=BL...).

[2] https://www.bls.gov/opub/hom/pdf/cpi-20180214.pdf

[3] https://www.bls.gov/cpi/factsheets/owners-equivalent-rent-an...

Thanks for the extra context - I should have been more clear. CPI does capture OER and rental costs as you show.

I get that mortgage costs and the like aren't considered as consumption ( rightly so ) but that makes the measure inaccurate when assessing prices people pay to live day to day. Rental prices are generally a more applicable indicator for most of the population as the BLS says but the rising costs of houses and mortgage costs by extension imo should be captures because it signals how money is flowing.

Is there another metric perhaps that captures both consumption costs and housing beyond rent/rent equivalents?

I think what you're missing is that many people are not paying market price for housing, because they bought their houses a long time ago. If they have mortgages, they were set by the home price when they bought.

CPI is an average. The people who have owned their own homes for years are dragging down the average for the cost of living. You can't get the cost of living that they have if you buy today.

Averages can mislead. It's like the old joke about average income in a room when Bill Gates is in the room.

By changing who is included in the average, it might be possible to construct a CPI that's more relevant to you?

If homebuyers are irrationally paying significantly more than it would cost to rent the same house, then that doesn't seem to me like a valid reason to inflate the indexes.

If homebuyers push prices of housing up and that does increase rents, then it is a valid reason to adjust CPI upward, and they do, AFAIK.

What I'm saying is that many home owners are paying significantly less than it would take to rent the same house, because they bought decades ago.

Though of course there are also those who bought at high prices too.

If you want to know about rents, it would make sense to just look at rents. I wonder how the housing component of CPI would look if there were a survey that was limited to renters?

My understanding is that the index relies on estimates of what homeowners would pay in rent for equivalent housing.

If you think longtime homeowners are paying less, then substituting equivalent rent should push the CPI rate of inflation to be higher than the genuine rate. An overestimate.

So you think correctly calculated inflation is less than the CPI says?

I thought everybody who thinks it is inaccurate thinks it is an underestimate, that the government is covering up inflation being rather high.

Also, if they just didn't survey non-renters, then the result would not include how much homeowners spend on, say, hamburgers or whatever.

Hmmm, it looks like they just ask people what they think it would rent for and use that number:

"If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” [1]

So, I was wrong about this. I'm wondering how people might be biased, though? They could over- or under-estimate what their property would go for.

[1] https://www.bls.gov/cpi/factsheets/owners-equivalent-rent-an...

Yep, the new money has flowed into capital assets rather than consumption goods. But inflated, prices have.

It would be like saying there’s no inflation because milk prices are steady, ignoring that cows cost three times as much.

> Yep, the new money has flowed into capital assets rather than consumption goods.

Yes, because the wealth has flowed to people who primarily relate to the economy as capitalists, rather than laborer/consumers.

> It would be like saying there’s no inflation because milk prices are steady, ignoring that cows cost three times as much.

So, it would be true, for the purpose for which we have and measure general inflation. It would not be true for certain other inflation measures which are also used, but which aren’t part of (and aren’t relevant to the purposes of) general inflation measures like the CPI

Depends on who the “we” is there. Certain agencies don’t care that new money is flowing into capital assets but probably should care.

> Depends on who the “we” is there.

I would argue the statement is true for any significant government or private use of general inflation measures.

But, sure, if you’ve got a case where the CPI is actually used for a purpose and you think a different measure of inflation that incorporated asset prices would be a better replacement for the CPI, please feel free to present (1) the existing use in question, (2) your proposed replacement measure, and (3) your argument for why your proposed replacement is better.

That was the purpose of comparing to cows and milk. For all the same reasons you should worry about cows being expensive (even if milk is still cheap), you should worry about real estate being expensive (even if rents are low).

In the case of a household, those mean that you can't take some of your production, and save it for the future in capital goods -- the same kind of thing that happens when more of your income has to go to the same necessities.

In the case of a central bank, those mean that the injections of money aren't (currently) effective for stimulating economic activity, but are simply causing a wealth transfer and rallies in whatever stores of value remain. That is the same signal it needs to get back as when consumer goods become more expensive: you are not relaxing a limiting factor on economic growth.

Edit: toned down

> For all the same reasons you should worry about cows being expensive (even if milk is still cheap), you should worry about real estate being expensive (even if rents are low).

I would argue that the only reason you should consider cows being an expensive an issue if milk is cheap is in regard to it making some other bovine product expensive; cows aren’t important in and of themselves, but as instrumentalities in the production of milk and other products.

> In the case of a household, those mean that you can’t take some of your production, and save it for the future in capital goods

No, asset inflation absolutely does not mean that. Increasing the minimum buy in for asset investments would do that, but we’ve got mature enough financial markets that a general increase in asset prices doesn’t increase the minimum needed to enter productive investments.

> In the case of a central bank, those mean that the injections of money aren’t (currently) effective for stimulating economic activity

No, it doesn’t; driving money into productive investments and out of cash (which, as an expected side effect, produces asset price inflation) is part of the mechanism by which loose monetary policy is expected to stimulate economic activity. Asset price inflation does not indicate that that is not working, it is what you expect if it is working.

What would indicate that it is not working is if output figures did not exceed what was expected without the policy.

>No, asset inflation absolutely does not mean that. Increasing the minimum buy in for asset investments would do that, but we’ve got mature enough financial markets that a general increase in asset prices doesn’t increase the minimum needed to enter productive investments.

Yes, "can't", taken literally (and uncharitably), is incorrect. I was exaggerating. The point is it becomes much more difficult with lower yields, just as it becomes so with cows. To produce the same X units of milk tomorrow, you have to save more milk now (to buy the cow) -- the same effect as if you had less to save due to your consumption goods being more expensive.

So, no, "mature financial markets" don't really solve this.

>No, it doesn’t; driving money into productive investments and out of cash (which, as an expected side effect, produces asset price inflation) is part of the mechanism by which loose monetary policy is expected to stimulate economic activity. Asset price inflation does not indicate that that is not working, it is what you expect if it is working.

Money going into productive investments is only good if it also translates into productive economic activity. You can't just say, "we gave it the old college try, so that's a win". We're seeing P/E ratios go up (earnings yields down), which means that the higher asset prices aren't translating into that productive use of assets. And even by your own standard, the flows into gold, bitcoin, and idle real estate indicate a failure.

>What would indicate that it is not working is if output figures did not exceed what was expected without the policy.

So, non-falsifiable, then.

House prices are absolutely included and are the single largest item in CPI. It's Owner's Equivalent Rent. Overall, shelter represents 33% of CPI.

To the extent that purchase prices vary independently of rental prices in the same market, the CPI inclusion of equivalent rents will not reflect home purchase prices.

Then again, I don’t see why it should, unless it is some measure based on the lower of rents (actual or equivalent) or amortized purchase and ownership costs (as you need shelter one way or the other), but that could only drive the CPI down compared to just considering rents as is done now.

People often don't understand the implications of an elastic monetary system that is also decentralized because of the way that the Fed and member banks are structured.

There are things the Fed or the government could do to frogmarch devaluation (like, for example, encouraging banks to pay people to carry credit card balances through negative interest rate policy or encouraging no-doc/no-credit check loans of all kinds) but that is not their prerogative.

People also don’t realize that moderate inflation is a good thing. You want a gentle inbuilt mechanism to encourage consumption. And we have good tools to combat inflation whereas we don’t really have any tools to combat deflation.

There’s a reason nobody spends Bitcoin and it’s mostly not about fees or block size.

> People also don’t realize that moderate inflation is a good thing.

Price stability is a good thing, and moderate deflation (which discourages productive investment) is worse than moderate inflation, so policy targeting moderate inflation is a good thing. This isn’t because moderate inflation is a good thing in and of itself, its because you can’t perfectly target price level outcomes with policy, so you want to bias missing on the less harmful side.

> You want a gentle inbuilt mechanism to encourage consumption.

The utility of consumption encourages consumption. To the extent that inflation is good its more as gentle inbuilt mechanism to discourage nonproductive saving of cash in favor of productive investment.

> There’s a reason nobody spends Bitcoin

Right. You definitely don’t want deflation, which encourages hoarding currency that is surplus to immediate consumption desires and thereby sucks money out of productive investment.

> Price stability is a good thing, and moderate deflation (which discourages productive investment) is worse than moderate inflation, so policy targeting moderate inflation is a good thing.

That is one of the reasons. But arguably, even if a central bank could be 100% sure of hitting their inflation target exactly, they might still prefer moderate inflation to absolute price stability, because (a) it encourages productive investment and (b) it gives a simple mechanism for downward adjustment of sticky nominal prices/wages.

> You want a gentle inbuilt mechanism to encourage consumption.

This kills the planet.

This kills the environment, planet doesn't care, after we are gone, it starts over

Why do you want a gentle inbuilt mechanism to encourage consumption?

Because if you made a better return by hoarding cash then by investing -- holding bonds, buying apartment buildings-- investment would stop and people would stuff cash into mattresses.

Is that necessarily a bad thing? Growth at the cost of everything doesn't seem to bode well long term. What would the potential consequences of an economy not based on continuous growth? Genuine question, not trying to be inflammatory.

The proceeds from whatever growth there is should go to the people involved in growing it, not uninvolved previously-wealthy bystanders. With deflationary currencies, any growth in the total amount of stuff leads to one dollar corresponding to more stuff, which is like a tax on all of the people making stuff paid to the people holding mattress money. That's the most powerful argument against the gold standard, for example. People who spend gold to do actually useful things are punished and people who pile it up are rewarded.

Yes, that's a bad thing.

This is the primary mechanism that has stagnated Japan's economy since their asset bubble burst in the 80's.

If you want to start a business you need investment and customers. You will get neither if everyone is hoarding cash. Investors will not stomach your risk when they can just safely sit on their balance. Customers will hesitate to buy your product because they will always expect your prices to go down the longer they wait.

It depends on the type of growth. Growth through efficiency gains extends the productivity runway of economies reliant on finite resource consumption.

I think consequences of a no growth economy are pretty bad. It would mean much more of the world becoming zero sum. The pie would be fixed.

And in turn pollution might decrease, frivolous consumer waste might decrease, frivolous ad waste might decrease, people might turn to crafting and making their own home goods, and feel more pride and accomplishment, and the standard of return on investment to actually draw cash out of the mattresses would be higher, rather than building in a mechanism that stresses people into giving their cash over for hollow waste, and entrenching false “market demand” narratives around the whole destructive charade.

That’s a different argument from the GP, who was justifying it on the grounds of encouraging extra consumption, not investment.

To create employment and growth.

Distributed, not decentralized.

Deflation is a wonderful thing. It means more people can buy more stuff. It should be one of the primary goals of our civilization.

>Deflation is a wonderful thing. It means more people can buy more stuff.

The problem is if you know your money is going up in value, why would you buy stuff with it? You'd hold on to it even harder... thus increasing the deflation, as people lose their jobs, homes, and society falls apart... but hey... your hoard is going up in value.

Deflationary spirals kill people.

Sure, if we're driving 100mph in one direction and suddenly place the car in reverse, there will be damage. But yes, if we weren't artificially spiking the system with inflation there will be an increase in savings, which is not a bad thing (yes! *gasp*).

It's pointless driving the economy in circles wasting fuel, which is akin to the 'spending is automatically good' mantra. We should be using the car efficiently to get to our destination faster. This means allowing the economy to be more geared towards essentials, which we all must spend on, making them immune from deflationary spirals. And essentials are not only toilet paper, they also include things like medicine and other vital technologies.

When spending power is more concentrated to these economic categories, the competition will increase to produce better versions. Companies will also be incentivised to get a bigger slice of a currency that increases in value over time. Through society's greater savings rates, the banks will have more capital to lend to producers. Innovation, including the move towards (hopefully human-values-aligned) AI and nanotech, will continue because companies without these technologies will eventually vanish.

Finally, if we accept that the environment is dying (or something like that), the real inconvenient truth is because ultimately there are too many consumers. Regardless of how carbon neutral we become, we can never get to zero and no (pre-superintelligent AI) strategy is a match for an exponentially growing population. Therefore, unbridled growth can become a destructive force of its own.

I believe the deflation virtue described above refers to the capacity to a business in democratising a product or service that used to be expensive. The growth here ( typical example is Uber) of the company called mes with a deflation of the price.

You’re talking about rising purchasing power, which is better achieved through rising income than deflating currency.

To verify, though: in fact, the M2 is skyrocketing in 2020, right?

Yes, but velocity of money is plummeting.

Is there reason to think that velocity will remain low in the long term, though? If it's just temporary economic effects caused by COVID (e.g. less physical commerce), then surely we will see higher inflation as those effects go away?

> Is there reason to think that velocity will remain low in the long term, though?

There's reason to believe that as velocity rebounds, ceteris paribus, monetary policy will tighten to avoid rapid inflation.

Congress may leave fiscal policy on autopilot all too often, but you aren't likely to find the Fed completely asleep at the monetary policy wheel.

Yes. See https://fred.stlouisfed.org/series/M2. In 2020 the M2 Money Supply increased with 25%.

>their goal is to keep things stable

But they've only got a few levers and there are a lot of things. The priority is to keep the real economy ticking along and retail inflation reasonable but if people are not spending much on things some of the easy money ends up going into financial assets which is one reason we have record stock and crypto prices. It's an unwanted side effect.

> In the real world, over the full year of 2020 inflation was 1.4% in the US (food costs went up a bit more, energy costs went down).

Are you sure about that? https://chapwoodindex.com

The Chapwood index looks a bit weird. It's based on only 500 items (compare to CPI which uses 94,000 according to [1]). And those 500 items[2] include things like "cat grooming", "horseback riding lessons" and "first class airfare" (but not economy class airfare?). Tennis is apparently very important because there's "tennis lessons", "tennis racquet" and "tennis ball" in there separately. Something similar is going on for golf: we find "golf shoe", "round of golf" and "golf lessons". I could not find information on how these items are weighted.

[1] https://www.bls.gov/opub/hom/cpi/pdf/cpi.pdf

[2] https://chapwoodindex.com/chapwood-index-items/

On the other hand, the billion prices project (http://www.thebillionpricesproject.com/) is generally well-correlated with the CPI.

CPI may not have gone up, but it sure seems like the prices of a lot of corporate stocks are pretty inflated...

I don't know if that is related to a change in money supply.

Those inflation figures, much like unemployment figures, are not really representative. If you take a basket of good that includes consumer discretion items like cheap tech gadgets, subscription music, staple foods, then these “balance out” the much worse inflation in housing, college costs and medical care, things which have a much higher quality of life impact.

I’n not making any claim on how this dichotomy relates to cryptocurrency speculation, but I do think in general nobody should be using CPI-based figures or traditional BLS figures at all, and anyone seriously talking about US inflation needs to be starting from the given baseline fact that “real” inflation (ie, excluding discretionary consumer toys, subscription services, staple foods) is much higher than 2%, and has been for a long time.