“(It is) somewhat similar to acute pain – totally absorbing, demanding complete attention while it lasts; forgotten or ignored when it has gone, whatever mental and physical scars it may leave behind.” – Adam Fergusson (1975), ‘When Money Dies’
Inflation is a mystical topic. Most people understand that it refers to changes in the general price level. If prices rise faster than incomes, you can afford to buy fewer goods than before. To track how changing prices affects households, one way inflation is measured is using the consumer prices index (CPI). This ‘basket of goods’ represents the average household’s consumption and tracking it is useful to understanding how changing prices affects our wellbeing.
Most people also know that it is on the rise: in February 2022 CPI was 4.5% in Sweden, 6.2% in the UK and 7.9% in the US. This measures the change in prices of the basket of goods compared to a year earlier. This rise is significant. Across Europe there is debate around the ‘cost of living crisis’ as essentials like food, energy and fuel are rising faster than incomes.
Not as many people understand how it can become an economic nightmare – as it did one hundred years ago…
Let’s backtrack for a moment. Ray Dalio’s ‘The Economic Machine’ (which you can watch here) beautifully models how money and credit flow through the economy. Whether it is a mortgage to buy a house or a loan to invest in your business, available credit is fundamental to the success of modern capitalism. The availability of this credit, which depends upon interest rates controlled by the central bank, is crucial for understanding inflation. If interest rates are low and credit is easy to access, people borrow more and demand more goods and services. This ‘Demand-Pull Effect’ makes prices rise and means central banks must act carefully to stimulate growth without prices rising beyond target.
Most readers (sorry to the early 90’s oldies) have probably had low inflation throughout their entire lives. However, ultra-low interest rates thanks to expansionary monetary policy (the Riksbank currently holds almost 400 billion SEK of government bonds) has created the ideal conditions for inflation to spawn. Meanwhile, a quicker than expected recovery of the economy after the pandemic and energy price booms associated with Russia’s invasion of Ukraine have meant upward-pressure on prices are stronger than ever. For the first time in decades, a return to persistent inflation seems likely.
The gloomy quote at the start of the article is from a book which describes the horrors of Weimar hyper-inflation in 1922-23. It is a fascinating narrative of why and how ‘wheelbarrow-inflation’ (referring to the literal wheelbarrows of money used to buy goods) led to misery and hardship for an entire population. The government printed money to pay its post-WW1 Treaty of Versailles debts. A vicious cycle arose as high inflation expectations became entrenched: if prices will go up tomorrow then consumers spend their savings today instead. In less than a year, a loaf of bread went from 160 to 200,000,000,000 marks. The impact of this economic chaos is hard to imagine. Savings and pensions were wiped out and people made financial decisions day-by-day, or hour-by-hour at its worst. The events of 100 years ago might render current concerns of 6-8% inflation feeble. They should instead remind us of the privilege of foresight and the importance of action before it is too late.
Although there are no expectations of a return to hyper-inflation, we ought to remember that history’s verdict on high inflation is clear: once it is let loose, it is deeply and universally painful until it is reigned back in.
