Picking The Stick Up From The Wrong End

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Picking The Stick Up From The Wrong End

By David Reavill

 

Back in graduate school, one of my favorite professors was Dr. Smith. He was also one of the oldest members of the faculty. At the time, he must have been well into his 70s. And so, no doubt, lived through the Great Depression.

And so, it was fitting that his specialty was Economic History. After all, he had lived through so much of it!

One of the things that Professor Smith would warn us about was picking up the stick from the wrong end. He meant that we should never mistake a supply issue for a demand issue and visa versa.

When I first heard him make that statement, I confess I wasn’t quite sure what he meant. But as I’ve gotten older, I have recognized this as one of the most significant errors in economics.

And an error that I’m afraid that most of our policymakers are committing currently.

Now, at its heart, this is a very straightforward issue. And that’s especially true for this current inflation problem we’re experiencing. Do all these higher prices come from too much demand or too little supply?

And depending upon which of those factors you choose, demand or supply will lead to a very different strategy to move the economy back into equilibrium.

As luck would have it, this weekend, Neel Kashkari, President of the Minneapolis Branch of the Federal Reserve, appeared on “Face the Nation” to give us some of the Fed’s answers to the source of inflation.

Kashkari gives us some fascinating answers to how the Fed sees inflation and how the Fed is preparing to fight inflation.

First, as to what inflation is, Kashkari says (quote): “Inflation is when demand is outstripping supply.” And from most traditional academic perspectives, it is right on the money: a plain, straightforward explanation.

An understanding that I believe differs from what we’ve seen before. It also sets the Fed up for its next step. But before we get there, let’s talk about today’s version of inflation.

I found it particularly insightful that throughout the interview, Kashkari carefully avoided mentioning energy as a primary cause of inflation. He talked about everything else: the war in Ukraine, the supply chain issues, Covid 19. But never about energy.

And yet, as we discussed before, energy is the primary cause of the current inflation. Representing as the Bureau of Labor Statistics notes, nearly one-half of all inflation.

There is a reason that Kashkari avoids the mention of energy, and we’ll get to that in just a moment. But first, let’s continue with his argument.

Remember his argument, and I believe the Fed’s fundamental argument is that demand is outstripping supply. So Kashkari sees this as an issue of too much spending by the average consumer.

Quoting again:

“But if wages are climbing, such that the economy shows that it’s overheating, that tells me that the Federal Reserve has more work to do to bring inflation down to bring the economy into balance just at its basic level.” Then he repeats: “Inflation is when demand is outstripping supply.”

And that has to be the Fed’s fundamental argument: demand is too high. Because if that is not the case, then the Fed’s raising interest rates makes no sense.

And that is where I believe the Fed is heading. They will bring the demand side down to balance with supply. And by reducing, demand will get stable prices. And it will, no doubt, work. But at a tremendous loss of jobs and business activity.

But, I believe that the Fed has “picked up the stick from the wrong end.” The current inflation we’re enduring is not demand-driven. Today’s inflation is, in fact, supply-driven.

Oil production is our nation’s chief source of energy. Over the past two years, we’ve experienced a dramatic reduction in our country’s oil production. In November 2019, the country produced a record 12.9 million barrels of oil for the month.

Then, a considerable drop in production was caused by the Pandemic lockdown when production dropped to levels not seen in two generations.

This year, oil production once again rose. Earlier this year, we were producing  11.7 million barrels per month. Still 10% lower than 2019.

And then the second blow hit. The President shut off all Russian oil imports. At the latest reading, we are producing 100,000 fewer barrels than earlier this year, and overall, 1 million fewer per month than in 2019.

Consider that for a moment. We are currently running this economy with just 90% of the oil and gas we ran on just two years ago.

I suppose we could price that gas and oil out of the reach of most people. That would undoubtedly reduce demand, balance with supply, and bring inflation under control.

But wouldn’t it make more sense to increase the oil and gas supply? Bring production back to 2019 levels.

The Federal Reserve has “picked up the stick from the wrong end.”

Economic News

Two giant economic reports are coming in overnight. Both may mean that we have to sharpen our pencils and re-figure the current Street estimates on the economies of Europe and America.

First, out of Germany comes the answer to what happens when the supply of Russian gas becomes limited and the price goes sky high. The predictable result: retail sales crater. Yesterday Germany reported that retail sales fell nearly 9%, the most significant free fall in this 25-year history of the report. Analysts are hitting their spreadsheets and calculating the impact this will have on the European Union. And more than a few analysts are whispering the “R” word, Recession.

Wholesale Prices Paid a one-time report and are not yet enough to build an economic scenario. But we’ve been watching those lower industrial supply prices: Copper lower, the cost of lumber down, as well as other commodities. While here in the United States came a bolt from the blue.

The Institute for Supply Management reported yesterday that Manufacturing Prices Paid took a massive 22% drop.

As I say, this is too early to draw a significant conclusion. But to me, it indicates that we may be on the verge of some severe demand destruction. And for those who are curious, you may want to look back at the 1930s to see the full ramification of demand destruction.

We will get the latest JOLTS Report on Job openings in a couple of hours. The Street expects no significant change here, with around 11 million job openings. As the steady drift lower in open positions continues.

We’re coming into the heart of earnings season now, with well over 200 companies reporting results. So far, the positive side has been: BP British Petroleum and leading the way ride-share company Uber Technology, whose stock is trading up over 10% in the pre-market. Trading lower currently are Caterpillar Tractor and S&P Global.

West coast companies, Advanced Micro Devices, Starbucks Coffee, Gilead Sciences, and PayPal Holdings are on the calendar for later this afternoon.

~~~
BIO

David Reavill

Financial Writer

writer + finance +iconoclast + hiker + Pennsylvania

#valueside
daily podcast + comment + thinker
valueside.com/links

 


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GuvGeek
GuvGeek
7 days ago

Demand is outstripping supply because the Government limited supply. Specifically the supply of Energy. The Government is also flooding the Economy with worthless Fiat Currency. Too much money in circulation adds to Inflation. Runaway Inflation causes a currency to collapse. That is the Godless Communist Globalist Democrat Liberal Loser’s goal.

President Trump created an economy so strong that even the Covid Hoax shutdowns were unable to bring it to it’s knees. The Economy was roaring back and Trump was going to be President. The Democrat’s last resort was to steal the Election. Once in Power the Democrats began destroying the economy. They thought shutting down Energy would be the death blow to the Republicans – didn’t work. They then turn to war; Europe got in the way. Putin out flanked Traitor Joe’s sanctions and now controls Europe’s Energy Supplies. Now Democrats think an out and out war will keep them in power. Democrats are insane. They have become a Cult Addicted to Power. They will turn America into a Nuclear Waste land if they think it will keep them in power. We must Destroy Democrat Politicians and their Party. You can’t reason with Mad Men.

There is No Free Economy right now in America. There is No Supply and Demand because there is near total Centralized Control of the economy right now. An expanding and prosperous economy is the enemy of the Rich, the Oligarchs, and Tyrants because a middle-class can compete against the Rich, the Oligarchs, and Tyrants. The poor are always too busy trying to survive to worry about the Rich, the Oligarchs, and Tyrants. Inflation has little to do with supply and demand in a controlled economy. In a Controlled Economy, Inflation is buying power and when buying power declines that is recession. When buying declines by 20%, that Depression. We are in a Government created Depression.

We need a “New World Order” and it must start with the implosion of poorly run massive corporations and banks which require “free money” from the FED and Government welfare (regulation) to survive. That would result in a massive number of rich people heading to the poor farm and a massive expansion of the middle-class small business to fill the gap.

PanamaPat
PanamaPat
7 days ago
Reply to  GuvGeek

Your analysis is spot on. Right now the Obiden Junta is creating the illusion of war with the CCP that they believe will allow them to retain power in November

David Reavill
David Reavill
6 days ago
Reply to  GuvGeek

Guv: Thanks for all your comments. I really enjoy reading them. As Panama Pat says: You’re spot on!