Home > Main > MMTer’s and Austrians kinda sorta agree: China isn’t absorbing that much Inflation

MMTer’s and Austrians kinda sorta agree: China isn’t absorbing that much Inflation

January 13, 2011 Leave a comment Go to comments

One of my favorites, Mish, is talking about the impossibility of Cost-Push Inflation, and how China’s price level doesn’t make a difference to the level of Inflation to the United States.  He talks about cost-push inflation from an Austrian perspective.  The argument is that in an economy with a constant supply of money, an increase in the cost of one good immediately means a decrease in the cost of some other good.  I think this is a place where Austrians have a small patch of common ground with the MMT crowd.

But how can we demonstrate this minor agreement?  Well, I used a similar idea in my post to estimate how much inflation China was absorbing.  My model is more useful, and just as easy to understand.

Here is simplified model Mish is using:

Total Money Available:  $100

Good A Price: $50

Good B: Price: $50

If the price of Good A goes up to $60, then there is only $40 left for Good B.  Total cost to live in this society is still $100.  So no matter what happens to the one price, the total cost to live in this society must be $100.

Mr. Shedlock then goes on to add the demand for money to this, so there is really a third commodity, money.  We can put this into the model quite easily.  Imagine the demand for money goes from $0 to $10.  Now the Mish model looks like this:

Money Demand: $10 (aka Demand for Savings)

Good A: $60

Good B: $30

This increased demand for money causes deflation, because the total amount paid in the economy is only $90 for the same goods we had in the first scenario.

MMTers agree with this to an extent.  The major difference is the idea about how money is created. Overall, they (or is it we?) do not disagree about that demand for savings being a huge factor in determining the inflation level in the world.

I think my model is a bit more useful. Instead of just thinking about the U.S., I considered China and the U.S. as one country that could divvy up the inflation between them in a variety of levels.

Here is more on the math:

To do this exercise, I will treat China as a U.S. state that uses U.S. currency exclusively, and size China’s economy at its 2009 Purchasing Power Parity (PPP) size relative to the United States.  If we do this, we just add the two economies together to get the total size of the USD economy.  Then, we take the amount of inflation in each country and multiply it by the size of the economy to get the total amount of inflation.  After that we can play with how much inflation the U.S. would have with various China scenarios.

The math is basic, and it is as easy adding up two pies and dividing them in different ways.  My 3rd grade son was doing exercises like this the other day. I just use real world numbers that he would find more boring than watching a unicorn cartoon, but he could do the math.

The total amount of inflation out there for China and the U.S. is about 4.5%. I even used a high number for China 10% instead of the official inflation rate.  So even if China was to allow us to fully experience the inflation we should, we would have at 4.5% inflation. I think this is so unlikely as to be impossible because China will not allow their currency to float.  A more reasonable assumption – that China will allow a limited rise in the Renminbi – results in roughly 2% inflation.

Whatever China does, Inflation will be tame in the United States.

More on Inflation:

Mish ignores credit in this post.  Mish has a good idea about credit, and he has a regular ongoing dialog with Steve Keen.  Steve Keen is not quite a MMT guy, but closer to MMT with his idea of endogenous money than he is to the Austrians by any measure.   And for the MMT crew, let’s not forget that Randall Wray was a PHD student under Minsky.  Keen also is a huge fan of Minsky.  Credit and its implications are etched on the bones of every MMT person out there.  Mish talks enough about credit that I am not going to call  Mish out for ignoring credit in this one post.

Also, I think this very simple mental model leaves out many important aspects of the real world.  Importantly, it leaves out the ever improving quality of goods, and their relative worth over time.  Is the minivan (I am not a car guy) I drive today worth a huge amount more than the 1967 Buick LaSabre that my uncle gave me?  Even if they  were both new, and I could choose freely between them?

Everything about the Minivan is much, much nicer – except maybe the low purr of the LaSabre engine down the highway on a Tuesday afternoon in the Summer.

But in the $100 total world, if the car gets more valuable, then everything else gets less valuable. Should my food be worth less because my car is worth more?  But what if that other good cannot be produced at for profit at $30? Then, the world stays the same and no innovation happens.  We do not get a better car.

And everyone with kids knows that having the second kid doesn’t make the first kid less valuable.  I know I found a whole bunch of extra value in my world that simply didn’t exist before my second son was born.  To an Austrian, this innovation of the second son made me “value” my first son less.

This gets back to the very reason that Austrians hate inflation – the devaluing of things that have stable value. Should improvements in quality  for one good come at the expense of paying less for unrelated goods?  If the money supply doesn’t grow, then it must.

P.S. Can you imagine the ambulance bills if we were all perfect Austrians?  There is no doubt that the Ambulance drivers would show up and then evaluate the relative need of the person, and then quote a price to the family to take them to the hospital, especially in rural areas without easy natural competition.

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