“Inflation came out of nowhere” C. Lagarde

For Christine Lagarde, “inflation came out of nowhere”… Come on.

Where does inflation come from?

It comes from an imbalance between supply and demand.

The offer is everything that sells. That is to say essentially natural resources transformed thanks to human genius.

Demand can be represented by the amount of money in circulation.

All other things being equal, increasing the amount of money in an economy will have the effect of creating inflation. Illustration with the parabola of the island:

“Three castaways on a small island organize themselves to survive. Every day, one of them catches fish, another brings back portions of fresh water and the third bananas. And so that everyone makes as much effort as the others, it is decided to establish a currency.

They choose a rare shell on the island and end up with 24 shells, or 8 each. Every day, the castaways exchange all their food. In view of the amount of work required to obtain each commodity, the prices are established at 2 shells for a fish, 1 shell for a banana and 2 shells for a ration of water. With 24 shells, there is enough money to buy all the food that the castaways usually collect every day.

One fine day, the shipwrecked person responsible for the fresh water stumbles across a pile of 4 seashells. Excited by his discovery, he decides to buy an extra ration of fish the same evening…

But the fisherman did not catch more fish than usual. Besides, the banana picker wants his usual portion. So much so that the water carrier offers 6 shells to convince one of them to cross out his portion of fish and give it to him.

Ultimately, the same quantity of foodstuff sold for 28 shells, against 24 shells previously. That is an inflation of 16%. The new prices will be in effect the next day without ever lowering.

But not for Christine Lagarde, President of the European Central Bank:

“Inflation in the eurozone hit a record high today.
Here is the President of the European Central Bank saying that inflation came out of nowhere. »

Energy and inflation

No one can deny that the amount of money keeps growing.

In the fiat system, every dollar, every euro, every yuan comes from debt. It is therefore enough to follow the evolution of the debt to know exactly the quantity of money in circulation.

The debt of the American government, for example, has gone from 17 billion dollars in 1929 to 30,000 billion today.

We are even at 91,000 billion if we add the debt of companies and individuals. The orders of magnitude are similar for all advanced countries.

That said, creating money does not necessarily generate inflation. The “all other things being equal” written above is important.

The possibilities are reduced on a small island. But things are different when one enjoys unlimited resources (energy, raw materials).

Creating money to build new means of production ultimately lowers prices. As well as investing in research to find technological tricks aimed at increasing productivity. A tractor for example.

All of this was well summed up by Milton Friedman:

“Inflation is always a monetary phenomenon in the sense that it is and can only be generated by an increase in the quantity of money faster than that of production”.

Humans have continually made their lives easier. It has become particularly easy since the industrial revolution and the burning of coal, oil and gas. These fossil fuels still represent 80% of the global energy mix today.

The combination of energy and machines (technology) has given us immense gains in productivity (output per person). But this comfort (purchasing power) depends on our ability to extract the energy needed to power these machines. Without oil, 95% of global transport ceases…

The imbalance

A very simple observation is that production no longer increases as fast as the quantity of money injected into the economy via the debt. Between 2008 and today, overall debt has increased by almost 100% while GDP (which measures production) has only increased by 50%.

This decorrelation has been flagrant since 1970 and has accelerated further since 2008.

Why so much difference? Because in 2008 we reached the peak of conventional oil. That is to say that we have been producing less and less oil since 2008, which is not very expensive to get out of the ground:

That said, since the peak, the exploitation of unconventional oil has taken over. We are talking about shale oil (or source rock). Simply put, these are “drawer bottoms”.

World production of conventional crude oil
World production of conventional oil in millions of barrels per day (oil that is cheap to get out of the ground) / Source : ourfiniteworld.com

The consequence of this more expensive oil to come out of the ground is that the price per barrel, which fluctuated between 10 and 40 dollars before 2008, is now moving between 70 and 100 dollars.

This is not nothing when you know that oil represents 30% of all the energy we consume. Energy which, again, directly determines our production capacity.

In other words, since 2008, countries that consume a lot of oil have been running up debt to compensate for the money they don’t have. And this new money maintains the inflationary spiral which is preferred to the destruction of part of our comfort.

I want to emphasize this point. It is the scarcity of energy that puts the economy under pressure and pushes the headlong rush of debt. Energy scarcity is like the egg, and debt the chicken.

There would be a lot less inflation if we didn’t run up so much debt. But we would also produce less, which comes to the same thing. Except for those who keep their savings in fiat currency. Hence the usefulness of Bitcoin, the best store of value in the world.

Inflation doesn’t come out of nowhere

Christine Lagarde is not completely wrong when she points to geopolitical tensions with Russia. Cutting oneself off from the world’s largest fossil fuel exporter would of course exacerbate inflation linked to the naturally rising costs of fossil fuel extraction.

The International Energy Agency even predicts in its latest annual report that in 2025 Russian oil production will be 2 million barrels below what it predicted in its previous report.

However, blaming everything on the abominable Snow Poutine is far from a sincere explanation. Inflation stems above all from physical limits to growth. Our planet is not expandable. Its resources are limited.

All that said, printing (running debt) shamelessly is the other side of this inflationary coin. Governments prefer to print, knowing very well that they are choosing an inflationary policy rather than an increase in unemployment. It is a choice assumed by Christine Lagarde.

Finally, it should be emphasized that going into debt to buy energy and raw materials from neighbors only works for a while. If you have nothing to offer in exchange, sooner or later there comes a time when your currency collapses. The Euro has lost nearly 30% since 2014 against the greenback…

Quickly, the energy exporting countries will no longer want a monkey currency. And it is probably for this reason that OPEC has just announced that it will cut its production by two million barrels a day, which will keep inflation high in Europe.

Receive a digest of news in the world of cryptocurrencies by subscribing to our new service of newsletter daily and weekly so you don’t miss any of the essential Tremplin.io!

Similar Posts