Assuming you're expecting inflation to moderate over 10 years.
I think people who expect we're going to go back to pre-pandemic supply chains are vastly underestimating the difficulty of bringing a complex system like the economy up from a cold start. In my experience with complex systems that are much less complex than the economy (merely a few hundred million lines of code), it can't be done. You have to incrementally build a new system and then cut over parts of old system as their replacements start to function better than the old degraded experience.
This'll likely take a decade or two. Expect it to be a good decade for startups as changing relative prices make new business models viable against soaring existing prices. It's going to be very bad for consumers and for incumbents, though.
Luckily, this is completely tradable, so if you believe that inflation is going to average 3% over the next 10 years you can buy all those treasuries and I can short all those treasuries and one of us will be rich and the other broke. Events will tell who is who.
your point cannot be overstated. my biggest fears around the pandemic shutdowns came from my own experience managing production systems, and I think our policymakers were frighteningly naive as to what it meant to shut down the economy. and here we are.
I don't think there's even going back to pre-pandemic supply chains solely because how the West's cancel culture effectively ended globalization when Russia invaded Ukraine.
There will be no global supply chain any more. Any country with a brain now knows they have to be completely independent of the West in every aspect. Sovereign assets must be within their borders. Currency reserves? Held at domestic banks as much as possible. Even within the West there needs to be some level of distrust because history shows that there are no perpetual alliances.
We are going to have several hundred supply chains that often don't interact, even if it would make economic sense for them to do so. This is tremendously inflationary and it's only just begun.
I guess economic sanctions against belligerent aggressor nations is also 'cancel culture' now. Is that another one of those terms that is just slowly morphing to mean 'thing I don't like'?
I'll go even further: de-globalization pits governments (who want to become independent of other nation-states) against their people (who have benefitted from cheap goods, and will have to deal with the inflation). The likely outcome is that at least some of those governments are going to fall, and the nation-state system is likely to collapse.
Unfortunately this by itself isn't good for globalization, because it relies upon free trade, stable legal systems, and secure supply lines to work. So even if you get rid of the governments that seek to detach from the world economy, the goods can't get to consumers when they get intercepted by warlords.
I think that eventually the world may converge upon city-states as a cultural unit and corporate feudalism as an economic one, but it's likely to be an exceptionally bloody transition.
Standing in the way of corporate or city-state primacy is the hyper-efficiency of the modern global economy.
Bearing the cost of ones own defense and foreign policy, instead of outsourcing it to your host government, is incredibly inefficient and leaves you open to price competition from your government-sheltered peers.
That's the entire reason the global economy of politcal-economic alliances and trade policies was created: to benefit from global, lower-cost manufacturing while still retaining the benefit of government protection.
It seems more likely we'll revert to a multi-polar late-Cold War state of affairs, with global supply chains much more influenced by current military alliances.
I would've agreed with you until about 5 years ago. The reason I disagree with you now is because technology and methods of war-fighting have changed.
Emerging defense technologies like drones, lasers, robots, micro-scale manufacturing, and self-driving vehicles - along with the latest generation of existing weaponry like MANPADS and anti-tank missiles - all preference the defender. They allow a group of relatively untrained and loosely organized defenders who know the terrain well to deploy extremely effective resistance against an attacker, as long as it's at short range. A drone swarm can quite literally destroy all hostile forces within an area without risking a single person, but it can't do this beyond say 100 miles out. These technologies are all for defense, not power-projection.
This has a similar effect as the development of the musket in the 1500s. The musket allowed relatively untrained militias to enjoy superior firepower over the knights and longbowmen that had trained professionally their whole lives. As a result, smaller city-states and colonies could defend themselves against the large standing armies that kings and emperors could wield, and so the feudal system collapsed. This reversed with rifles (their greater accuracy benefitted from more professional training) and modern armor & explosives (which required an industrial base and supply chain greater than any city could muster), ushering in the era of nation-states. Military technology is changing again, and that's why I believe the nation-state system is again going to revert to smaller decentralized units.
> Emerging defense technologies like drones, lasers, robots, micro-scale manufacturing, and self-driving vehicles - along with the latest generation of existing weaponry like MANPADS and anti-tank missiles - all preference the defender.
> They allow a group of relatively untrained and loosely organized defenders who know the terrain well to deploy extremely effective resistance against an attacker, as long as it's at short range. A drone swarm can quite literally destroy all hostile forces within an area without risking a single person, but it can't do this beyond say 100 miles out.
We already have this "drone swarm", we just call it a guided missile.
The hard part in fighting a modern army isn't killing them, it's finding them. The defender is inherently at a disadvantage in this regard because they have things to defend, which necessitate that they're position in the vicinity.
Russia is struggling at the moment not because defenders are inherently advantaged but because they're relying on conscripts and relatively untrained soldiers.
> The musket allowed relatively untrained militias to enjoy superior firepower over the knights and longbowmen that had trained professionally their whole lives. As a result, smaller city-states and colonies could defend themselves against the large standing armies that kings and emperors could wield, and so the feudal system collapsed.
The exact opposite of what you're describing happened with the wide utilization of gunpowder. Pre-gunpowder, city-states and small kingdoms enjoyed relative independence due to the sheer expense of penetrating walls. Post-gunpowder, artillery (not rifles) required a whole professional organization to be utilized effectively, and formed the backbone of the army, so small states could no longer field or effectively defend against larger states, leading to increased centralization of authority, well before the creation of nation-states. "Makers of Modern Strategy from Machiavelli to the Nuclear Age" covers this transition pretty extensively.
> Russia is struggling at the moment not because defenders are inherently advantaged but because they're relying on conscripts and relatively untrained soldiers.
Yes; this, and all of NATO is assisting Ukraine with G-2 (intelligence) and G-4 (logistics).
Russia isn't struggling because of conscripts and untrained soldiers. Ukraine has conscription, and many of its TDF troops are relatively untrained. Russia is struggling because of a military philosophy that has lead to leadership failures from the officer level up to Putin himself. In addition to endemic corruption, the Russians also failed to remember things like rasputitsa, the principal of "economy of force", the importance of unit cohesion, of command centrality, of the 3:1 rule of thumb.
In other words, Russia created a military that was bad at being a military.
The only good thing that will come of this conflict is a revitalization in the study of military arts.
Cities are delicate clockwork machines with complicated supply chains: the attacker might struggle against a city’s hacker weapons, but the city will fall because a city is complex and a city needs many specialty inputs to function.
Changing topic: you said upthread “[people are] vastly underestimating the difficulty of bringing a complex system like the economy up from a cold start. In my experience with complex systems that are much less complex than the economy, it can't be done.”. Your personal example is irrelevant because it is a single person trying to restart an economy. Cities recover after earthquakes (my city Christchurch 2010) and wars (I have visited ex-Yugoslavia) due to many independent actors working, perhaps not so much due to your “command economy” example. Capitalist individuals route around damage. Although I admit effective centralised government helped Christchurch recover quickly.
Great synopsis of the trends in military technology. Very much in line with The Sovereign Individual, which states that the logic of violence determines the structure of society.
There will still be global supply chains outside of the pariah states. But purchasing will be diversified across more sources so as to mitigate the risks of disruption from politics, violence, natural disasters, pandemics, etc. This will be a more stable and resilient system, but it will be less efficient (Ricardo's Law of Comparative Advantage), and the average rate of economic growth will slow down.
The supply chain disruptions get worse as the China lockdowns and commodity prices make their way through the economy.
When you have a supply shock on raw inputs, it takes time for that to make its way through the economy. Businesses along the way keep inventory, they've locked in forward contracts, they can eat the cost increases to avoid losing market share until they're sure the price increases are persistent. But eventually they realize that everyone else in the industry is facing similar price increases and they'll go out of business if they don't, so they raise their prices too. This eventually propagates down the supply chain as inventory runs out and new contracts are negotiated. The price increases of late 2021 were triggered by the initial shock of March 2020. The Ukraine war & China lockdown shocks of early 2022 aren't going to be seen until about 2024.
By the time businesses have adapted to this round of shocks, we may be dealing with new shocks like a war in Europe or the retirement of baby boomers.
> The price increases of late 2021 were triggered by the initial shock of March 2020
It was the biggest shock: panic lockdowns across the world, not just initial. Chances are that supply chains have been adapted, and current localized lockdowns in China will not make significant damage.
But we will see.
Fed was aggressively printing starting 2008, and we didn't observe much inflation, meaning those money didn't go to real economy, but went to some big investment speculations and real estate.
This is the truth. What people do not understand is that interest rates will have to rise above inflation for in inflation to slow down. I assume the FED is trying to figure out how much inflation is caused by the money supply and how much is caused by supply chain issues. But too me this means even more trouble because they are waiting when there was obvious asset inflation well before the supply chain issues.
IMHO, we will not see a recession, we already are in a recession. What we will see a depression.
Can you explain why interest rates will HAVE to rise above inflation for it to slow down? CPI is already slowing down, although we have some very limited data points currently. A lot of inflation is driven by expectation, and raising interest rates is a way to tame those expectations for consumers, but I don't think the rates have to arbitrarily go above inflation to tamper it.
The Taylor rule gives the math behind it, but the layman's explanation is that as long as rates are lower than inflation, you turn a profit by borrowing money and buying a basket of assets, since their price will rise alongside inflation. This incentivizes people to borrow more money, which increases the money supply, which further exacerbates inflation.
This is the first term 'p' in the Taylor rule, which corrects the nominal interest rate that the Fed sets into a real interest rate that accounts for inflation.
There are plenty of assets that don't have an expiration date, like real estate or stocks of profitable companies with pricing power. And those are the assets that people are actually buying, and there prices have been going up to match.
r = nominal fed funds rate
p = the rate of inflation
y = the percent deviation between current real GDP and the long-term linear trend in GDP
As I said, the FED is betting that inflation is being caused by supply chain issues alone. This is obviously not true. It will get worse, so much worse, because the FED is in fact acting too slowly.
"interest rates sharply, and keep them high for several years, even if that causes a painful recession, as it did in the early 1980s in the United States, United Kingdom, and much of Europe. How much pain, and how deep of a dip, does it take to stop inflation and to keep inflation in check? The well-respected Taylor rule (named after my Hoover Institution colleague John B. Taylor) recommends that interest rates rise one-and-a-half times as much as inflation. So if inflation rises from 2 percent to 5 percent, interest rates should rise by 4.5 percentage points. Add a baseline of 2 percent for the inflation target and 1 percent for the long-run real rate of interest, and the rule recommends a central-bank rate of 7.5 percent. If inflation accelerates further before central banks act, reining it in could require the 15 percent interest rates of the early 1980s."
"During periods of stagnant economic growth and high inflation, such as stagflation, the Taylor rule provides little guidance to policy makers, since the terms of the equation then tend to cancel each other out"
Although I wouldn't go as far as to say we are in stagflation, it seems like the current environment wouldn't be an optimal place to use the rule. Ultimately I think the Fed took a view and have stuck with that, for better or for worse, and they are valuing consistency over diverging economic models.
The "2" is actually a parameter of the rule, and is the desired inflation target. OP is just hardcoding it in because the Fed's stated inflation target is 2%. If you leave it parameterized you can't simplify the equation further, as the 0.5 distributes over the desired inflation target parameter as well.
For that matter, the 0.5 is also a parameter, and is basically saying "Weight the goals of full employment and stable prices equally." If, say, you wanted to weight Fed policy 80% toward controlling inflation (to a target of 2%) and 20% toward maximizing employment, the equation would be r = p + 0.2y + 0.8(p - 2) + 2.
Risk-free loss? But maybe it's better than cash, the only other risk-free alternative? Perhaps you're paying for preservation of capital as the asset bubble deflates, and maybe that's not a bad deal?
If inflation somehow keeps rocking at 8.5% for a decade straight we have a much bigger problem on our hands than the relative yield of a treasury bond. Technically anything is possible…but I’m willing to risk saying that won’t happen.
I get what you are saying but the point of my comment - and I see why it didn’t come off this way - is that it won’t be 8.5% for a decade, so no, buying a treasury bond is not -5.5%. To emphasize this point, I said we’d have a lot worse problems because for it to be true the US would be experiencing an unprecedented economic catastrophe.
Yet the government keep spending like debt isn't high ($40B to Ukraine aid) and ignoring causes of inflation for political gain (Biden tweeted: it's time to for corporations to pay their share to bring down inflation)
I personally believe that the vast majority of the inflation we are seeing today has nothing to do with government debt/deficits, so the government reducing its deficit will have minimal impact on inflation.
However, a lot of people do believe, or at least claim to believe, that inflation is almost entirely being driven by government deficits, in which case corporations paying more in taxes would certainly have an impact on inflation, so tying the two together is certainly not misinformation, and if this view is correct, then it will reduce inflation.
Treasury bond yields are 3%, inflation is 8.5%, so in real terms you are guaranteed to lose 5.5% annually if you hold bonds.
Or basically instead of risk-free gain you are holding gain-free risk.