Social media allows people who know very little about a topic to speak about that topic like experts. If the person in question has a large following, that is usually interpreted as credibility. On social media, if you are popular and rich, your followers will believe you to be an expert in all areas. And if all the people from the same stream are grouped into niches that are always repeating the same ideas to each other, it tends to create a kind of self-contained and self-validating digital tribe. This facilitates the spread of false ideas. This confident ignorance allows people who know little to think they know a lot. Which could quite explain the great abundance of nonsense that we hear on the networks.
Changpeng Zhao (CZ), the CEO of Binance, on Twitter on July 13, used a rather peculiar formula based on the monetary issue to calculate the real rate of inflation. On his Twitter account, CZ explains that 80% of the dollars currently in circulation have been issued in the last two years. 80% of the money issued in the last two years is five times the original supply. Therefore, the inflation rate should actually be 500%. Thus: 5M=5P. I must point out that the tweet in question has been spread in various media to highlight the alleged anti-inflationary properties of Bitcoin due to its limited supply.
Source: @cz_binance/twitter.com
After reading that tweet, I’ve come to suspect that suddenly the friend CZ is not an expert on the subject. It is true that CZ is a highly successful man. It is true that CZ is very influential in the crypto community. In fact, his tweet got a lot of traction from the Bitcoin community. My respects to CZ. Nevertheless, it is possible that the study of the monetary issue and its relationship with inflation is not one of your areas of competence. Well, it’s not the end of the world. No one is an expert in all areas.
Regarding the causes of inflation, monetarism focuses on the supply/issue of money (M) as the only possible cause. This happens because, according to the monetarists of the Chicago School, the other variables of the Fisher exchange equation (MV=PQ) are relatively stable variables. Of course CZ took this a bit further with his much more direct formula of 5M=5P.
Sixty years ago, in 1962, after an extensive study on the subject, Milton Friedman coined his famous phrase: “Inflation is always and everywhere a monetary phenomenon.” And, indeed, for the time and for several decades, there is sufficient empirical evidence to show that variables V and Q were quite stable. The problem is that this was true for 1962, but it is no longer so true today. For many reasons, the velocity of money (V) and production (Q) are much more unstable today. Therefore, the issue of inflation has become somewhat more complex today. In fact, it is a much more multifactorial phenomenon than before. The monetary, certainly, has a great weight. But that does not mean that the role of other factors is insignificant. The ZC formula could be an extreme and wrong simplification of the matter.
Of course, the late Milton Friedman is still an idol for many libertarians and many conservatives. And the political factions are not very good at updating their doctrines. I am afraid that his famous phrase is still taken too literally by many of his followers. So if someone on the street suggests that inflation is not just a monetary phenomenon. Due to political polarization, the poor devil will surely be pejoratively branded as a “Keynesian” progressive. The most certain thing is that, due to the confirmation bias, anecdote will be used as evidence and false causes will be attributed to inflation for reasons more political than scientific. Now, we must remember that economics is not a doctrine. It is a methodology. The left has its favorite economists. And the right has its favorite economists. But economics as such is apolitical. It is a science. The object is to describe the “objective” truth using the scientific method. Which implies that knowledge is always being updated. Political dogmas, on the other hand, tend to remain unchanged over time. A critical thinker, however, changes his mind in the face of strong arguments.
Eggs, gasoline, real estate, used cars, lumber, corn, wheat, sugar, and sunflower oil have all risen in price quite a bit lately in the United States. Why? In a free market, price is defined by supply and demand. A balance is created between orders and those delivered at a price. That is quantifiable, of course. If demand rises sharply, that balance can be upset. Therefore, prices go up. If supply decreases for some reason, that balance can also be broken. Therefore, prices also go up. I mean, a rise in prices can be induced by demand. It can be supply induced. And it can be due to a combination of both forces.
The eggs? Supply has fallen due to an epidemic of bird flu in more than 15 states. The gas? Production costs have risen due to a drop in oil production. The problem with oil production is partly structural and partly caused by sanctions on Russia. The real estate? Supply has fallen due to a decrease in construction. Used cars? Demand has risen due to a drop in new car production due to shortages of microchips and other inputs. Timber? The offer has fallen due to logistical failures with transport. Corn, wheat and oil? Supply has fallen due to the war in Europe and other logistical factors. The sugar? Rates. In addition, many producing countries have dedicated themselves to producing more ethanol with sugar cane due to the rise in oil prices.
The rise in prices has not been the same in all areas. The emphasis has been on energy, cars, real estate and food. The services sector, for example, has not felt the same inflationary pressures as goods. Which is quite relevant because the service sector is the most important employer in the most developed economies. A very sharp drop in demand can certainly lower inflation in goods. But it can also cause unemployment in the services sector due to falling incomes. Now, if the demand, due to an adjustment of the monetary policy, is balanced with the supply, the prices can be stabilized. Nevertheless, economic growth may suffer as a result.
If units demanded and units supplied are equal at a given price, we have an equilibrium. If there is then a drop in the number of units supplied, the price must rise to create a new equilibrium. Now, if the intention is to lower the price by reducing demand, this is possible. However, the number of transactions will be less. In other words, the units demanded will be lower, the units supplied will be lower and the price will be lower. In other words, reducing inflation by lowering demand in an environment of supply-driven inflation implies that growth will decline. Recession? Correct. Of course, there are recessions that are milder and shorter than others. It remains to be seen what lies ahead. In conclusion, inflation is a much more complex phenomenon than a simple M=P.
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