Inflation is the lesser evil
By the end of the 1970s, inflation was out of control.
The New York Times wrote a front page story where they interviewed a group of ordinary people to find out how inflation affects their lives.
By that point, the CPI had risen by a cumulative 73% over the decade, or roughly 7% per year. Inflation has been going on long enough that it is finally starting to affect people’s habits:
In interviews conducted across the country, The New York Times found that the “pariah society” of the late 1960s and early 1970s is being replaced, in many cases, by a new economic ethic. People are driving cars longer, dressing more often, planting their gardens and fixing their own plumbing.
Many Americans use the same words to describe this new attitude: “We only buy what we need, not what we want.” But that means some of life’s juice, from new stereos to trips to the beach, is starting to dry up due to the pressure of higher prices.
One of those interviews was with a bread seller named Terry McLamb from Raleigh, North Carolina. McLamb said he “feels powerless to improve his living conditions.” This is what they wrote at the time:
But many others feel frustrated and afraid. Terry McLamb, a bread seller, has seen his income rise from $9,000 to $15,000 a year in five years, but he says, “I was better off with the lower income.” Everything has to come to a point somewhere, but I don’t know where.
In the five years ending in 1978, the consumer price index rose 47%. McLamb’s income rose 67% in the same period. His income exceeded inflation by 20%, but he was miserable.
Clearly, inflation is not the only variable that can affect how a person feels about their financial prospects at any given moment. But inflation can play mind games with you, especially when it occurs in large amounts.
Most people believe they deserve the higher wages that accompany higher inflation rates. No one feels they deserve higher prices. In addition, people get used to high wages faster than high prices because you see the prices every time you spend money.
It’s been more than 40 years since we’ve dealt with very high inflation, so it makes sense that people would be appalled by the price increases we’ve seen over the past few years.
Cumulatively, the US CPI has risen nearly 20% since the start of the pandemic:
The pace of inflation has slowed but these higher prices are now embedded.
Fed Governor Lisa Cook recently said in a speech that she believes most people want prices to return to pre-pandemic levels:
“Most Americans are not just looking to fight inflation. You and I, as macroeconomists, are looking to fight inflation. They are looking for deflation. They want these prices to return to what they were before the pandemic” Cook said.
“This is my own theory,” she concluded. “But I hear it a lot. I don’t have to wait for articles about it, I hear it from my family, from a lot of different people.”
I get it.
People do not enjoy economic fluctuations.
But that’s not how this works. That’s not how any of this works. You can’t keep your high wages while prices return to 2019 levels. Deflation may seem attractive when it comes to prices, but it also means lower wages, lower economic growth, and job losses.
Inflation is not a good thing in itself, but it is the lesser evil.
One person’s spending is another person’s income. Higher wages come from higher prices or vice versa.
As long as the economy is growing, deflation is rare.
This is the annual US inflation rate going back to 1950:
Of the nearly 900 monthly inflation readings in this time frame, there were only 33 monthly deflationary figures. Therefore, prices have fallen by less than 4% since 1950.
Deflation occurred in the 1950s after being high in the post-World War II period, during the Great Financial Crisis and briefly in 2015. That’s about it. The rest of the time prices rose.
Look at what happened in the wake of the inflationary surge of the 1970s. We never had deflation. Prices never went down in the 80s or 90s. They continued to move higher, but at a slower pace.
The biggest difference between now and the 1970s is that people started changing their habits at that time. This does not appear to be the case for the American consumer yet.
Matthew Klein wrote about our current spending habits in The Overshoot recently:
Spending on US-made goods and services rose at a staggering 9% annual rate in the third quarter of 2023. Even after subtracting inflation, real production rose at a rate of 5% annually. Some of this exceptional performance is likely just a fluke, and should be discounted accordingly. But even before the latest quarter, total spending had been consistently growing at an annual rate of just over 6% since the middle of last summer. Moreover, inflation-adjusted spending by Americans — the U.S. gross domestic product excluding the effect of changes in inventories and the trade balance — has been growing steadily at a pace slightly faster than 3% annually in the first quarter of 2023 to the third quarter. By comparison, real domestic demand was rising just 0.8% annually on average in the first quarter of 2022 to the fourth quarter, even as total nominal spending and income rose by about 7% annually.
In other words, while there was a significant slowdown in the rate of price increases from about 6% per year to 3% per year, the rate of growth in the dollar value of spending and income slowed much less (from 7% per year). One year to 6% annually). Until now, This has translated into a tremendous acceleration in the rate of growth of Americans’ living standards.
This is probably one of the biggest reasons Americans are so upset about rising prices — they keep paying them.
Apollo’s Torsten Slok highlighted a survey this week that shows a record number of consumers are planning a vacation in a foreign country within the next six months:
Cruise bookings are being made at a rate 25-30% higher than pre-pandemic levels. Cruise ships are running out of stock.
Look at the sales numbers for restaurant spending in America:
It is well above the pre-pandemic trend.
The best-selling cars in America in 2022 were the Ford F-150, Chevy Silverado, and Dodge Ram.
People are still spending $50-$60,000 on new trucks, going out to eat, taking cruises, and going on European vacations.1
This is not everyone and there are certainly cases where people downsize. But collectively, the biggest impact inflation has had on consumer habits is that we’re all complaining more than we used to. Maybe that’s because everyone is spending more too.
Fortunately, the inflation rate is slowing. We’ll see if our spending rate eventually catches up.
Complacency in the American economy
1This may be an out of the park moment for me, but I feel like no one I knew traveled to Europe when I was growing up. Now, it has become common to hear about European holidays.