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All The Curves, From Supply To Demand To Yield

Technically speaking, the rebound from the 2020 recession wasn’t strictly a supply shock. That was a huge part of it, no doubt, but a near-concurrent…



This article was originally published by Alhambra Investment Market Research

Technically speaking, the rebound from the 2020 recession wasn’t strictly a supply shock. That was a huge part of it, no doubt, but a near-concurrent demand shock, if you will, also materialized. The combination of the two left the public bewildered, believing it an actual inflationary impasse which could only be further passed on into this year.

Consumer prices did rise, of course, and they still are rising, though not because of (monetary) inflation. Rather, the first half of 2021 was an anomaly rather easily explained by simple, small “e” economics.

The first part of it, supply, that was all the impediments imposed by both non-economic (lockdowns, reconfiguring product lines) and economic (money and credit) factors which left the supply curve far more inelastic. This simply means suppliers and producers (along with shippers) are less responsive to changes in demand.

Sketching supply inelasticity out like any middle-schooler might upon their very first introduction to economics, the basics of it would look something like this:

It must be noted that these changes were applied globally and not just to or in the United States. Various national parts of the global economy were affected by them differently and to different degrees, by and large this was a universal phenomenon.

What then followed the evolution of supply inelasticity was the demand “shock” in the form of various government interventions; again, not just domestic US, all over the world. Those originating from the American government were the most pronounced, therefore created the biggest bounce to the right for the demand curve. Others followed to lesser extents.

The combined result is somewhat surprising considering how much the economy has been described, repeatedly, especially in America, as red hot and dangerously overheating. On the contrary, supply inelasticity means that most of the effect is illusory in terms of price whereas overall output doesn’t necessarily increase much at all.

Though these drawings are admittedly cartoonish, they aren’t very far off the actual data. Look at GDP or Industrial Production all over the world. Prices went up, especially here, but output not so much.

This has been excused as difficulties sourcing raw materials and whatnot, but that’s baked right into the inelasticity of the supply curve! And while others blame a purported labor shortage, it’s far more easily and readily explained by producers who aren’t producing nearly as much therefore aren’t as willing to pay market clearing wages (or even hire more workers).

Either way, as the supply curve shifts back more elastic, prices begin to come down as output actually rises…only if all things are equal (ceteris paribus). We know, however, they are not equal.

Even as the supply side twists slowly back toward its long run stable state, unless there’s (actual) monetary expansion behind the demand shift, demand won’t stay toward the right, either. Instead, it’s going to migrate back to the left toward its own long run stable state.

Depending upon other factors, output might rise again but much more slowly or in more limited fashion than it otherwise could have, all the while prices descend in the direction of their own starting equilibrium (assuming there is such a thing, or that there is one which could be stable).

Viola, there’s yesterday’s generally ugly GDP figures along with the PCE numbers (monthly) published today. The general supply curve is becoming less elastic (pumping out massive inventory into the supply chain) while the effect of the previous government interventions (including Uncle Sam) fade further and further into the past.

Prices haven’t yet backed off, though they have started to exhibit the general tendency toward deceleration (not all at once, therefore three camel humps that I’m told can’t describe a camel at all). In some places, though, we’re seeing perhaps the beginning stages of outright reversion (like China’s producer prices or US services prices).

The biggest macro problem is that the private economy’s actual state is obscured underneath this “inflation.” Labor shortage, red hot, etc. Because the mainstream treats each and every outbreak of consumer price acceleration as the same thing, especially those times when it is due to something other than money (true inflation), it can only result in mass confusion.

In fact, at some point, the bottleneck of forced price increases actually inhibits the demand curve staying to the right; prices rise faster than the economy’s ability to maintain even the same levels of demand (because it’s not caused by monetary expansion). Thus, what we saw in yesterday’s GDP along with today’s Personal Income and particularly consumer spending:

Even though the labor market has likewise struggled to recover (consist with the low changes in output) despite the artificially-fueled spendy frenzy, incomes have been rising though nowhere near enough to absorb the equally artificial increase in the general price level.

As such, private economy labor falls further and further behind (fails to catch all the way back up) exacerbating the demand curve shift back left.

Economists (capital “E”), however, they all believe (without evidence, only regressions) such interventions as last year’s massive helicopters produce lasting effects – a more durable perhaps permanent move in the (aggregate) demand curve out to the right. Furthermore, after the extreme price changes last year, most (Larry Summers!) are more worried that the curve had been pushed too far to the right and will remain too far out that way.

This group now includes the FOMC whose members then add psychological hokum to their even more primitive curve graphics thereby manufacturing the hawkish double-taper, triple-maybe-quadruple rate hikes for 2022 all the while real markets reject all these things.

True economics, the lack of money impulse, and now more upon more data all bely these mainstream interpretations. It’s only a “growth scare” in the context of merely assuming those first, that Economists and central bankers employing standard DSGE assumptions have anything worthwhile to say about the situation.

Rather than “growth scare”, the actual situation appears to be nothing more than the other side of last year’s double anomalies. One supply. One demand. None monetary.

monetary expansion


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