Don't Miss This Simple Truth About Inflation

People ask me a lot of questions and I can give you a couple of rules. The more often per unit of time that I hear a question, the more often, "Is this important?" "Is this going to affect things?" "Is this going to impact the stock market?" The more I hear that, the more the answer, almost axiomatically, goes to, “No, it won’t”. Why? Because everybody’s worrying about it. They’re involved in something that's already been priced. 

A great example is all of the chitter chatter as we ended 2024 and began 2025 and now, about, "is inflation resurgent?" "Will it be resurgent?" "Will we have another up leg in 2025 in inflation?" Now, of course we have to say, well, what do you mean by an up leg? Do you mean the normal volatility that occurs in the indexes that are often used to measure inflation, like the Consumer Price Index, which went up one tenth of 1% between January and December? Because if you do, that's just normal volatility in given months. Do this or that—they have nothing to do with whether they're doing this or that. 

Now inflation, as Milton Friedman said when I was young, is everywhere and always a monetary phenomenon. It is too much money chasing too few goods. It's the growth in the money aggregates exceeding the growth in GDP. If you increase, the growth in the money aggregates more than you increase the growth in GDP. This being the Federal Reserve doing that or central banks outside of America. Then what happens is the difference with a time lag becomes inflation. 

Now, in reality, there's some problems in what I just said, in that there isn't a singular perfect measure of the quantity of money. Money is whatever we use to actually engage in transactions, and there's multiple different sources of that. And at a given point in time, there's a propensity to use this kind of money versus that kind of money. But the fact is that if you do not have a pickup in that spread— growth in the quantity of money less the growth in GDP—you will not, with a time lag, get a pickup in inflation. You may get monthly variation on the way to whatever is the major trend. During—but people always get this wrong—they think government spending causes inflation. They—it doesn't. The government spending doesn't impact the quantity of money directly at all. They think inefficiencies of some form, in some category, like the cost of shipping, impacts inflation. It doesn't. 

They think, and you can hear this a lot right now, Trump's tariffs will cause inflation. It won't. I'm not a fan of tariffs. Tariffs are bad policy but it's not because of inflation. All of these things like some big problem with shipping, or tariffs, or government spending channel demand. They don't change demand. They channel demand from these to those, increasing the price of these things while reducing the demand for those things, but not changing the overall price level. Inflation is the rate of change of prices. 

So, let me go a different direction. All throughout last year, people were hoping, and President Trump said during his campaign that he was going to, you know, bring down prices. In the developed world, we don't bring down prices in any market way. We may bring down these, which puts pressure on those to go up. We may put pressure on those to go up, which brings down these. 

But the fact of the matter is overall price levels we don't bring down big time, because to bring down price levels in a big way means shrinking the quantity of money relative to the size of GDP. And what we learned a long time ago, and is true for fundamental reasons, is that when you shrink the quantity of money, with a time lag, it's a little bit like taking your necktie and tightening it way too tight to the economy, and you get depression. If you look at the stupid amount of inflation that central banks created in react to Covid in 2020 and 2021—bad monetary policy by the major central banks of the world. That magnitude of inflation, comparable to the magnitude of inflation that had happened in the 1920s, would require to offset it, a recession or depression comparable to what we had in the Great Depression, to bring down the quantity of money to match what had been previously increased. We don't do that in the Western world, because the war on depression is a bigger and uglier war than the war on inflation. 

The war on inflation has been won. Quantity of money is growing at some of the lowest rates that it has since the 1980s. Just recently, all the central banks have to do is keep it at those levels, and inflation goes to the levels that they wanted. Now, mind you, the central banks—and I've written about this quite a lot—this last fall I wrote about this in my New York Post column. Central banks, for what I consider to be dastardly reasons, want 2% a year inflation. It helps them manage their government's debt. Therefore, because that's what they aim at, that's more or less on average, what we'll get. If you expect to see no inflation, that's not going to happen because the central banks want 2% inflation and they will increase the quantity of money relative to GDP enough to get that. But where we are right now, we're not very far in the indexes that they actually look at, which is not the Consumer Price Index, to hitting their goal. And therefore with a time lag to that, the CPI will hit their goal and you'll see 2% inflation, which isn't a lot better than what we have right now at an annual rate just recently of 3%, and I do not expect to see, unless we have some crisis that makes the central banks do something stupid again, that we'll see a big pickup in inflation anytime in the next 12 months. 

Or let me say that again and say it the reverse of the way I said it. I don't think we'll see a big pickup in inflation until the Fed, again, whether it's in 2025 or 2026 or 2027, does some next stupid thing. Increasing the quantity of money in a significant way relative to the growth of the GDP.