Why Inflation Will be Hard to Contain
After staying at a pleasantly ignorable level for years, inflation is once again making headlines.
And so the pundits and talking heads are falling over each other trying to explain what’s going on.
And, of course, the Russian war in Ukraine, as well as lingering pandemic problems, are making their contributions.
But I believe there’s another, more serious, root cause at work.
Let’s look at a few charts.
The point is clear: when compared to the median income, the median home price in the US has grown from 2.2x in 1950 to 6.3x in 2020. Which means that home prices are growing much faster than wages.
Why might this be?
Let’s look at another chart.
This one comes from macrotrends.net.
This shows the growth of our US population over roughly the same timeframe, from 1950 to 2022. And if we look at the blue line, on the top of the chart, we can see that the number of people living in the US has more than doubled over that length of time.
Now let’s consider one more chart.
This one comes from footprintnetwork.org.
This shows the movement of the Earth overshoot day from 1971 - 2022. The overshoot day marks the date when humanity has used all the biological resources that Earth regenerates during the entire year. For 2022, the overshoot day for all of us on this planet falls on July 28.
For the United States, the overshoot day fell on March 13. That was the date on which people in the US consumed all of the renewable biological resources available over the course of the entire year.
Now let’s think about this data in terms of supply and demand. As we all know, when demand exceeds supply, prices tend to go up. And when supply exceeds demand, prices tend to go down.
When we see that the US population has more than doubled in the last seven decades, what does this imply? In general, with all other things being equal, it means the demand for goods and services has more than doubled. But it also means that the supply of labor has more than doubled. Meaning that there is an upward, inflationary pressure on prices, but nothing similar affecting wages.
If our supplies of goods and services were perfectly elastic, then suppliers would react to increased demand by increasing their production, and prices would reach a new equilibrium, without any excessive inflation levels.
But are supplies reasonably elastic? In the past, this was a fairly safe assumption, at least at a macro level, because the supply of natural resources was generally considered to be infinite.
But let’s look at home prices. To build a home, you need a plot of land. The number of people needing housing in the US has more than doubled in the last seventy years. So the demand for housing has more than doubled. But has the supply of land increased? No, of course not. The US doesn’t have any more land area today than it did seventy years ago.
But don’t we have lots of unused land? Well, based on the numbers of homes destroyed in the US every year by wildfires and floods, it would seem that we are already stretching the boundaries of our developed cities and towns beyond any safe limits. And judging by the rate at which existing single-family homes with yards and trees are being torn down by developers, and being replaced by larger homes and multi-family dwellings, it would seem not. And based on the recent rush of large investors to buy up farmland, it would seem not. All of these are indicators that land is a scarce resource.
And then there’s this pesky overshoot day business. If the US overshoot day is March 13, then this also is a comparison of supply and demand. It means that our demand for renewable biological resources is roughly five times as great as our supply! And even though many of the goods and services we have to purchase are not simply land, or biological resources, these things influence the price of pretty much everything else: farms need land, factories need land, stores need land, warehouses need land, and so on.
And, of course, when we look at things like the massive drought in the Southwest, and the historically low levels of Lake Mead, these numbers and charts become much more than theoretical.
The simple fact is that we are trying to house and feed more people than our land can carry. And no matter where you look, the data – both statistical and anecdotal – offers confirmation of this conclusion.
Now look again at the US population chart above. I drew your attention earlier to the blue line, showing total population levels. But now look at the green chart on the bottom. This is the population growth rate. And you’ll notice immediately that this line is trending downwards. So that’s good, right? The problem is solving itself, isn’t it?
Now let me call your attention to another aspect of this chart. Notice that the baseline for the growth rate is zero. This seems to imply – as many economists will tell you – that our population growth rate should always be above zero, and that the best we should hope for is something close to zero. In fact many economists – along with Elon Musk – will tell you that we risk economic catastrophe if our population growth rate falls much lower.
This has been so ingrained in our thinking that it is hard for us to question.
But let’s look at it a bit differently.
What would you think if your doctor showed you a chart of your blood pressure, with it going upwards every year, but then tried to tell you that the good news was that the rate of increase was slowing down? If your blood pressure is above a safe level, wouldn’t it be good news to see it going down? Which means that good news would mean a negative growth rate. And wouldn’t a high starting level, coupled with a positive growth rate, mean that you were on the road to killing yourself pretty quickly?
This is where we’re at with human population levels. They’re already too high, and they are still increasing.
For the purposes of this article, the implication is that demand is high, while the supplies of land, water and other natural resources are finite, and already insufficient to meet demand.
Which means that inflation is likely to continue.
But Why The Sudden Jump?
If everything I have said so far is true, then you would expect that inflation would have been at a high level long before this recent spike.
And, in truth, if you look at something like home prices, you can see the inflation rate in this area has been high for some time now.
And yet it’s only in the last few months that economists and the media have started to worry about inflation.
My theory is that these inflationary pressures, based on population demand vs. natural resource supplies, have been fairly constant for some time now, but have until recently been counterbalanced by other factors:
- Improved productivity based on use of better technology;
- Economies of scale based on industrial consolidation and globalization;
- Increased application of industrialization, especially in food production and distribution;
- Labor displacement and globalization of supply chains, as cheaper labor in one country is used to produce goods and services for citizens of another country;
- Intense price competition at the commodity end of the markets, keeping prices low enough for mass affordability.
In effect, I believe that these five other factors have effectively been masking the effect of a growing imbalance between population levels and natural resource levels.
However, the effects of the pandemic, accompanied by the financial stimulus provided to cushion the economic impacts, have been to blow the lid off of this Pandora’s box, unleashing these inflationary pressures that were previously suppressed and masked.
In particular, as the pandemic has thinned out the ranks of suppliers, leaving those who remain with less competition, and feeling more confident about their ability to raise prices, the flood gates of inflation have been raised, and are not likely to be closed again any time soon.
The Bottom Line
Most of our experts, prognosticating based on their understanding of what has happened in the past, are predicting that it will just be a matter of time before inflation is back under control. In the housing markets, I’ve lost count of the number of op-ed pieces that have said that housing prices are only so high because we haven’t been building fast enough.
The problem is that, if we back up and look at the big picture, there are other factors at work, new factors that weren’t present historically.
And so I very much doubt that the future of this inflationary trend is going to look much like ones of the past.
December 12, 2022