"Inflation is Always and Everywhere a Monetary Phenomenon" is > The Fallacy of Composition (6 min read)

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6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs follows up in detail on CO’s excellent post regarding Trump’s proposed tariffs with his own explaining how good economists have known for centuries tariffs are not inflationary, no matter how hard the press tries to frame them that way.

Photo: British economist David Ricardo understood in 1801 what Janet Yellen and the media still don't get in 2025.

Last week CO ran a short post explaining that tariffs don’t cause inflation unless the money supply is expanded alongside them. The week before he ran a post criticizing Janet Yellen for blaming “COVID supply chain bottlenecks” for the last four years’ inflation, rightfully rebutting that:

“If that were true prices would be back down already. Sorry, try again.”

The Economics Correspondent wants to revisit another, even more popularly cited excuse for inflation: higher energy prices.

All of these scapegoats for inflation—supply chain bottlenecks, oil prices, and tariffs—originate from the same economic fallacy. Although the scapegoats sound good to those uninitiated to monetary theory, the logical error was smoked out at least two centuries ago for being rooted in the “fallacy of composition.”

We’ll explain the fallacy of composition as it relates to money in this column, but for the moment let’s go back to high energy prices.

OIL

During the worst period of our recent inflation—fall 2021 to summer 2023—we heard endless blame heaped on “high energy prices” from the White House, from Democratic politicians, from the mainstream media, from the business press, and from (some) academic economists.

The excuse making went something like this:

”Higher oil prices (aka. ’Putin’s war’) and the evil Sith lords of Big Oil have caused this inflation for consumers. Oil is an input in just about every sector of the economy: shipping, distribution, transportation. When energy prices go up, the higher prices force manufacturers, wholesalers, retailers, etc. to pass the cost on to consumers by hiking their own prices, and you get inflation.”

Again, this is an ancient fallacy which was discredited at least as early as 1801 by British classical economist David Ricardo. But in the early 2020’s the constant repetition of the same fallacy remains parroted by left-leaning liberals and even some conservatives were citing it, understandable since the inflation apologists control the media.

The Correspondent wishes to dispel, once again, the fallacy with both empirical evidence and theory.

The easiest empirical evidence lies in today’s oil prices: they’re 40% lower than the 2022 peak. In fact the current price per barrel is hovering near summer of 2021 and the summer of 2018 levels. 

So if higher gas prices were really the culprit behind inflation in 2022 and 2023, and gas prices have since fallen back to summer of 2021 levels, then inflation must have reversed itself and consumer prices fallen back to 2021 levels as well.

Have they? 

How many people in CO Nation can say they’re paying the same amount of money to live today as they were in July of 2021?

Even the St. Louis Federal Reserve, using conservative government figures, says today’s consumer price index is 17% higher since June of 2021.

So much for higher energy prices being the culprit—at least empirically.

Higher energy prices were also blamed by politicians, intellectuals, and most of the press during the inflation era of the 1970’s, especially right after the OPEC oil embargo that began in 1973.

Well, oil prices did rise sharply—from $11.65 per barrel at end of 1973 to $35 in 1980, effectively tripling—and there was no shortage of politicians and compliant journalists blaming the 1970’s inflation on OPEC.

But by 1986 oil had crashed back down to $10, even less than in 1973. 

So did the cost of living also fall back down to 1973 levels?

Nope. According to the Fed the 1986 consumer price index was 139% higher than 1973. That’s right, even after oil prices plummeted by 72% overall consumer prices had still more than doubled, not fallen as the energy “cost push” theory predicts.

Meanwhile in an incredible coincidence (sarcasm) the money supply measured by M2 was ballooned by 221% from 1973 to 1986: from $849 billion to $2.73 trillion. 

Now we’re getting somewhere.

THEORY

To understand why higher input costs don’t create inflation one has to go back to the seminal “equation of exchange” that defines the relationship of real economic factors to prices.

In nerdy math the formula is mv = py where m = money supply, v = monetary velocity, p = price level, and y = total real output.

But in plain English, only three factors move the general price level: the money supply, output of goods and services, and velocity of money.

Note that nowhere in this formula is there a variable for “higher oil prices,” nor is there one called “corporate greed.”

British financier and economist David Ricardo was the first to associate money, output, and velocity to prices, and he too was confronted with an early 19th century version of the same "cost push” inflation fallacy during the Napoleonic Wars.

From 1797 to 1821, during which time Britain was usually at war with Revolutionary and Napoleonic France, Parliament suspended the gold standard and the Bank of England printed lots of new paper money to finance the conflict. By 1801 prices were rising everywhere. 

Britain had also suffered from two bad wheat harvests prompting a group of businessmen, dubbed the “antibullionists,” to blame high wheat prices for causing general inflation. 

The logic, just like with Joe Biden and oil, was that wheat was a major food staple and input in most people’s lives which in turn pushed up their living costs which in turn pushed up their wages which in turn pushed up prices on everything.

Once again, the classic “cost push” theory that we hear today.

But Ricardo and fellow economist Henry Thornton, leaders of the dissenting group dubbed the “bullionists,” rejected this explanation.

Why?

Well for once the Correspondent would like to let someone else explain: of all people, the Federal Reserve (yes, that Federal Reserve).

From an excellent 1998 Fed paper titled “Historical Origins of the Cost-Push Fallacy”:

”Led by quantity theorists David Ricardo, John Wheatley, and Henry Thornton, one group of economists, the bullionists, blamed the Bank of England for creating inflation through excessive issues of paper notes. The Bank, they said, had simply taken advantage of the suspension of convertibility to generate an inflationary overissue of the currency. Seeking to correct this state of affairs, they recommended that England return to gold convertibility at the prewar parity as soon as possible.”

And their destractors resisted:

”An opposing group of practical businessmen and bankers, known collectively as the antibullionists, rejected this monetary explanation. Instead, they attributed the price rises to such real shocks as domestic crop failures… …they highlighted cost-push influences directly affecting the individual prices of specific commodities, notably grains and other staple foodstuffs that constituted the principal component of workers budgets. These food-price increases then passed through into money wages to raise the price of all goods produced by labor.”

Again, the classic “cost push” theory, which brings us to the crux of the decisive argument:

“This notion, however, hardly went unchallenged. Bullionist writers, especially David Ricardo, criticized it for confusing relative with absolute prices. Ricardo contended that, in the absence of inflationary monetary growth, aggregate nominal demand, as measured by velocity-augmented money MV, would remain unchanged. With total spending (and full-capacity aggregate output) fixed, a rise in the relative price of food requiring workers to spend more on that commodity would leave them with less to spend on other goods whose prices would accordingly fall. If so, then the rise in food’s price would be offset by compensating falls in other relative prices, leaving general prices unchanged.”

That is the monetary fallacy of composition: believing that the rise in price of one commodity drives a rise in prices of everything else, when in reality some goods can rise in price while the resulting lower monetary demand for other goods allows them simultaneously to fall in price—but ONLY if the central bank doesn’t print more money.

The same is true for energy prices in 2022. If companies were forced to pay more for energy, they would have less money leftover to pay for other goods whose prices would correspondingly fall… but ONLY if the central bank didn't expand the money supply.

And we all know the Fed didn't hold back from expanding the money supply. From the outbreak of Covid to the summer of 2023, the U.S. money supply measured by M2 rose from $15.45 trillion to $20.76 trillion, a stunning 34.4% increase.

And here, once again as is always is the case, is our culprit for inflation: Fed-induced growth of the money supply.

To wrap up why some economic myths never die, our Fed paper concludes:

”With these arguments, the bullionists exposed the logical flaws inherent in each component of antibullionist cost-push theory… … Nevertheless, they proved impossible to kill. Though flawed, they possessed the advantage of being at once simple, transparent, intuitively appealing, and consistent with the everyday experience of practical businessmen. Illustrating the adage that popular economic theories (no matter how fallacious) never die, they survived to flourish in subsequent monetary debates.”

Wow the Fed (or more accurately one of its contributing writers) got something right!

And here we are in 2025 where governments, who love inflation, and their allies in media and academia are more than happy to keep propagating both the “cost-push fallacy” and “fallacy of composition.”

In the 224 years since David Ricardo first criticized the theory a long list of distinguished economists has repeated his absolutely correct position: from Knut Wicksell to Irving Fisher to Friedrich Hayek, and—most recognizably for Americans—Milton Friedman who famously summated: “Inflation is everywhere and always a monetary phenomenon.”

The excellent and very Friedman-esque Fed paper can be read in full at:

https://www.richmondfed.org/-/media/richmondfedorg/publications/research/economic_quarterly/1998/summer/pdf/humphrey.pdf

Fiscal Stimulus Fails in China (again)

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In his recent January 9th column the Cautious Optimism Correspondent for Economic Affairs wrote, regarding the poor track record of "deficit stimulus" packages like those China is using to jump-start its sagging economy:

"This is why so often after a stimulus package, we read headlines that GDP got a bump, only to slump right back a quarter or two later… sometimes into a 'double dip' recession."

Eighteen days later from today's Bloomberg:

"China’s economic activity unexpectedly faltered to start the year, breaking the momentum of a recovery sparked by stimulus measures and underlining the need for Beijing to do more to prevent another slowdown."

Read "China’s Economy Stumbles in Sign Rebound Hinges on More Stimulus" at...

https://www.bloomberg.com/news/articles/2025-01-27/china-s-factory-activity-cools-ahead-of-major-new-year-holiday

The Economics Correspondent would like to think he's right so far about China but he could just be lucky, and he's definitely been lucky on the close timing of their bad news—that, despite yet another CCP stimulus package, the economy only got a one quarter sugar-rush bump and has already sunk back into malaise.

And adding a bit more detail from his January 9 column:

"This also explains why stimulus isn’t going to solve China’s problems. The central bank and government central planning mistakes that plowed so much debt and so many resources into ghost cities and giant construction projects have to be corrected, not propped up. Production lines that were wrongly diverted to those sectors must be allowed to reallocate to other industries that consumers both prefer and are able to support without a bubble."

"That will take some time and there will be some pain, but the adjustment is necessary."

If you missed the recent column explaining in more detail why government "stimulus" virtually always fails to end recessions quickly and instead prolongs them the Economics Correspondent recommends reading it at...

https://www.cautiouseconomics.com/2025/01/keynesianism-11.html

...so the next time recession hits the USA and the New York Times and WaPo's readers righteously thunder "We need more government stimulus. The last one wasn't big enough and those Neanderthal Republicans in Congress are holding up recovery," you'll have the ammunition to explain to them why stimulus doesn't work, why it fails over and over, and why it needlessly burdens future generations with trillions in debt all for nothing.

Yet Another Unprovable Keynesian Counterfactual Excuse: Controlling Inflation Would Have Cost 15 Million Jobs

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Among Janet Yellen's mixed bag of commentary the last four years the Cautious Optimism Economics Correspondent has heard quite a few zingers, but in her last week at Treasury it looks like she's stumping for a new job at Babylon Bee.

"We would have thrown 15 million people out of work if we'd controlled inflation..." 

...is the ultimate Keynesian excuse for the Fed's massive inflation failure of 2021-2023. It belongs in the pantheon of legendary rationalizations like 2009-2015's "Well the recession would have been WORSE if we hadn't borrowed and spent trillions" or "The deficit stimulus package just wasn't big enough to end the recession quickly."

Former Treasury Secretary and
Keynesian economist Janet Yellen

And recall that during the first year of rising inflation Yellen insisted it was all "transitory" and not a problem.

Now she's changed her tune to "Well if we had stopped the inflation [that I said was only transitory] it would have produced Great Depression-level unemployment."

For the record, by the time inflation started to rear its ugly head in the fall of 2021 the economy was fully reopened from Covid lockdowns, the return to normal business conditions produced annualized real GDP growth rates of 5% and 6%, and businesses hiring back all the workers they had previously been forced to let go lowered the unemployment rate from a lockdown high of 14% in 2020 to 4.7% (aka. full employment).

But according to Yellen, if the Fed had backed off ballooning the money supply from +13% a year to a less inflationary +7% a year the return to business as usual would have completely reversed itself and thrown 15 million people back out of work!

Sorry Janet, it wasn't the nonstop printing press that rehired all those millions of workers in the second half of 2020 and 2021. It was the reopening of an economy that had previously been forced into a coma. Now she's writing a fictional version of history to "prove" she and the Fed did the right thing all along.

(BTW 7% more money offset by 5% real GDP growth = roughly 2% price inflation omitting changes in monetary velocity)

Read Marketwatch story at:

https://www.marketwatch.com/story/yellen-says-u-s-couldve-kept-inflation-stable-if-it-threw-up-to-15-million-people-out-of-work-0ef8f975

Why Deficit Stimulus Spending Doesn’t Fix Recessions, Part 2 of 2

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7 MIN READ - You might want to save the Cautious Optimism Economics Correspondent’s new column for the next recession. Here he finally explains the “why” in “why government stimulus spending doesn’t work" and why he thinks stimulus package after stimulus package will only prolong China's current economic malaise.

In Part 1 we looked at historical examples of massive government stimulus not only failing to end recessions and depressions quickly, but stretching them out into record numbers of years or even decades: 

-The Great Depression
-Japan’s post-1990 “three lost decades”
-The “secular stagnation” snail’s pace recovery from the 2008 financial crisis
-Europe’s even worse post-2008 recovery that produced Great Depression level unemployment in several Mediterranean countries

We also mentioned how Keynesian economists like Paul Krugman, when faced with record-long slumps after large stimulus packages are spent, always about-face from initial promises of “stimulus will end the recession now,” to excuses like “well, the stimulus just wasn’t big enough” or “well, it would have been even worse without the stimulus” later.

Today we’ll lay out the theoretical explanation why deficit stimulus spending has made things worse in all these cases, and why Beijing will stretch China’s economic problems out for years or even decades if it resorts to stimulus package after stimulus package like Japan has for thirty years.

But first we’ll briefly explain the theory behind the stimulus rationale to begin with.

KEYNESIANISM

The Keynesians, proponents of British economist John Maynard Keynes (1883-1946), argue when the economy turns south there is a “lack of aggregate demand" or not enough spending from consumers and businesses.

In their eyes, rapid recovery requires more spending. Consumers are hesitant to spend, therefore businesses invest less and create fewer jobs which leads to consumers spending even less, and so on.

So the solution, according to the Keynesian theory, is for government to borrow and spend in ways that get cash into lower and middle-income households’ pockets. Once consumers start spending government cash, business confidence will return and companies will spend more on investment and jobs. From there the economy will run strongly on its own—the so-called “virtuous cycle of spending," or what Paul Krugman has called “liftoff.”

Keynes himself thought spending was so important that he argued it was OK to borrow and spend on socially useless projects, writing that the government should pay people to “fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and… dig the notes up again.” (1936)

Incidentally the “spending on anything is helpful” mantra has provided politicians with decades of intellectual justification for stimulus spending on the most absurd and wasteful programs, such as during the 2009 Obama stimulus.

In fact the theory that “all we need is more spending” is symptomatic of the direction modern macroeconomics has shifted towards for nearly a century. 

The old classical economists like Adam Smith, J.B Say, and David Ricardo tended to look at everything—consumer preferences, capital accumulation, physical capital investment, business projects in the real world, and yes, also money, trade, and spending.

But modern macroeconomics has devolved into mostly theories about money and exchange, neglecting factors such as physical economic resources, consumer preferences, and right/wrong capital investment structures.

FREE MARKET CAPITAL THEORY

The free market Austrian School economists and supply-siders argue the economy doesn’t need more spending: it needs a big adjustment in the real, physical world that goes far beyond simple flow of dollars. To best illustrate this dissenting theory the Correspondent will borrow from his own column on the same subject of five years ago:

Austrian economists argue that blindly stimulating spending just prolongs what was an original physical error that caused the recession to begin with. We’ll use a good analogy the Correspondent credits to Austrian economic historian Thomas E. Woods using a restaurant.

Take a restaurant owner in a small town doing a steady business.

Then one day the circus comes to town. The circus is an unsustainable boom or even bubble, usually produced by the central bank’s cheap money policy, just as cheap central bank money spurred irrational asset bubbles in 1927-1929 (USA), the late 1980’s (Japan and the USA), the late 1990’s (USA), and the 2000’s (at least 32 different countries).

The restaurant owner, not being a free market economist and unaware of the danger, is overjoyed to see his store full of new customers: clowns, trapeze artists, and acrobats. Not having enough tables, food, supplies and employees to serve them all, he borrows from a bank, builds a new, larger restaurant right next door, and operates both. The construction, restaurant supply, and restaurant food distribution industries also ramp up borrowing and investment to meet the second restaurant’s new demand.

This is the pre-recessionary boom which we know is unsustainable, but in the euphoria of the bubble many people (including Keynesian economists) claim “We’ve entered a new era in economics and solved the business cycle forever.”

But then suddenly, as is always the case, the circus suddenly leaves town when the bubble bursts, demand returns to its pre-bubble levels, and the owner discovers his error: he's stuck with a new, expensive second restaurant sitting empty and losing money—what Keynesians call “idle capacity.” The restaurant’s suppliers suddenly find demand is insufficient for their new employees and warehouses too.

The Keynesian/Democratic line of thinking is for the federal government to borrow and spend trillions of dollars on stimulus—which often takes the form of payoffs and handouts to political allies and constituents—in hopes of getting something like the circus to come back. If the circus returns the owner can keep paying his workers and go back to ordering food, utilities, and equipment for his second restaurant. This, we’re told, will help his suppliers too.

But the Austrians/supply-siders ask “Is putting the second restaurant on life support really good for recovery?" 

We already know that Circus 2.0 isn't going to last long. The moment the stimulus runs out the second restaurant, which was never sustainable to begin with, will just sit empty again.

So we’re right back to square one, except now we have trillions of dollars in new debt.

This is why so often after a stimulus package, we read headlines that GDP got a bump, only to slump right back a quarter or two later… sometimes into a “double dip” recession.

The Austrians explain that as much as we hate to see the second restaurant idle, there’s no way we can go back to the conditions that prompted its erroneous construction. Because it was all built on a mirage created by the central bank.

So as painful as it is resources, including workers, must be shifted away from the erroneous investments and back to rational ones that consumers don’t need bubbles to support. In other words: liquidation. And the sooner it’s over and done with, the sooner the economy can get back to rational, sustainable growth.

Another common analogy is a binge drinking hangover. 

Like a bubble, drinking too much can be fun for a while. Later, the inevitable hangover doesn’t feel good but it’s necessary: a sign the body is returning back to health, so it’s best to get it over with. The Keynesian prescription, drinking more alcohol (chasing the hair of the dog) might make the body feel better for a little while but we know the hangover will just come back, sometimes even worse.

Yes, it’s a tragedy that the central bank erroneously pushed concrete, parking lot asphalt, and workers to an irrational project, and that the central bank spurred restaurant supply companies to increase hiring and expand as well. Now some resources like restaurant supply, furniture, and dishware will have to be sold off at firehouse prices (ie. devalued capital), although if we’re lucky some ingenious entrepreneur might think of a cheap way to transform the building into a more usable business venue. 

But there’s no reason to spend borrowed money to employ extra workers, food, restaurant equipment, and utilities that consumers won’t patronize without the government borrowing and spending trillions of dollars in perpetuity.

Let’s go reductio ad absurdum to really drive the point home: 

If a speculative bubble spurred a businessman to build the world’s largest shopping mall in Antarctica, would it make sense to borrow trillions of dollars for deficit stimulus every year in the hope of generating enough customers to keep the mall going? 

Of course not. Better to admit it was a mistake and stop pouring even more money and scarce resources into it.

This theory explains why every recession prior to 1929—when countercyclical deficit stimulus spending theories hadn’t been invented yet—ended years faster than the Great Depression, the 2008-2015 Obama “recovery,” Japan’s three lost decades, etc… 

Most of what were called “depressions” in the 19th century, plus the Depression of 1920-21, were ended in one or two years, the recoveries were violently strong and rapid, and full employment was achieved in at most four years after a financial crisis (it took seven years after the 2008 financial crisis to reach full employment). Because before 1929 the economy was allowed to rationally reallocate resources, and do it quickly. The government didn’t delay or prevent the adjustment process with endless “stimulus.”

This also explains why stimulus isn’t going to solve China’s problems. The central bank and government central planning mistakes that plowed so much debt and so many resources into ghost cities and giant construction projects have to be corrected, not propped up. Production lines that were wrongly diverted to those sectors must be allowed to reallocate to other industries that consumers both prefer and are able to support without a bubble.

That will take some time and there will be some pain, but the adjustment is necessary.

Instead, by borrowing and blowing trillions of yuan to keep the real estate and government-sponsored construction projects “stimulated,” the Chinese government—just like Herbert Hoover and FDR, Japan, Obama, and the PIIGS countries—will prevent the adjustment from occurring or at minimum slow it down dramatically.

And when the stymied realignment is finally allowed to finish many years later the government will have needlessly accumulated trillions of dollars in debt that hangs around the country’s neck like an albatross.

If you feel you understand this explanation, the Correspondent will close out by presenting this same theory in nerdy economics language:

“The unsustainable investment errors made by businessmen during the boom must be liquidated, and physical resources and other factors of production that were misallocated must be redirected to rational business lines that consumers will support under normal economic conditions, not temporarily ‘stimulated’ back to boom levels only to slump right back into idleness once stimulus is removed."

and...

"The market process of reallocation results in some temporary job displacement, but the sooner it’s completed the sooner the economy can resume rational growth based on the consumption and saving decisions of the public rather than distortive central bank policy.”

Why Deficit Stimulus Spending Doesn’t Fix Recessions, Part 1 of 2

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5 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff explains in two columns why government deficit “stimulus spending” won’t get China out of its problems and why it’s failed over and over throughout history.

The Economics Correspondent has commented several times that China’s attempts at “fiscal stimulus”—that is, the government borrowing and spending vast amounts of money to reverse the economic downturn—will ultimately fail and that the longer Beijing implements stimulus the longer stagnation or at minimum historically very slow growth will persist.

In fact, the Correspondent thinks China’s borrowing and blowing money on stimulus measures is the best thing its competitors can hope for: a kind of self-immolation of the Chinese economy. Hence he’s offered to buy a business class seat for Paul Krugman to visit Beijing and serve as China’s economic advisor for the next decade.

But why this the conviction that stimulus fails?

The answers are both historical and theoretical. In this first of two columns we’ll cover the notable historical failures of government stimulus.

1) Historically, stimulus in response to an endogenous economic downturn has failed every time it’s been tried. The more deficit stimulus spending, the longer the downturn drags on.

Even though British economist John Maynard Keynes famously advocated stimulus spending in his 1936 book “The General Theory of Employment, Interest, and Money,” the first great deficit stimulus experiment actually preceded him by seven years—at the start of America’s Great Depression.

President Herbert Hoover responded immediately to the 1929 stock market crash with a rash of interventionist measures including fiscal stimulus. In his four years in office Hoover doubled federal spending (when adjusted for inflation), and the deficit grew from a surplus of 0.8% of GDP in Calvin Coolidge’s last budget to a deficit of 5.8% of GDP in Hoover’s last budget.

By the time Hoover left office the economy was in shambles with 26% unemployment, although the great banking crisis of early 1933 was a major contributor to that astonishingly high unemployment rate as well.

Franklin Roosevelt continued to borrow and spend on stimulus, running a deficit for every one of his 12+ years in office, something unheard of at the time.

Result? The depression dragged on for another 13 years, only ending in 1946. In 1940 unemployment was still over 15%, far higher than in 1930.

Even with all that stimulus spending the Great Depression lasted nearly three times longer, as measured by time required to return to private full employment after a financial crisis, than the next longest depression in American history.

Some Keynesian economists claim the economy recovered in 1946 because for the first decade-plus the government just didn't borrow and spend enough, but starting in 1942 it finally did what was necessary: borrow and spend Herculean amounts of money to pay for World War II and balloon the national debt from 44% of GDP to a record 119% in four years.

This is an odd argument considering deficit stimulus spending never existed as a policy or even an economic theory prior to 1929, yet every other preceding depression in American history (and there were several of them) ended in, at longest, one-third the time.

The Keynesians also leave out that FDR effectively ended his New Deal during World War II and finally stopped crushing American business with strangling regulations—because he needed them to function properly and deliver record numbers of tanks, planes, and ships—and *that* is what really ended the depression.

The Correspondent has previously written in detail about what ended the Great Depression in several articles including this one:

https://www.cautiouseconomics.com/2019/06/the-great-depression-15.html

2) Japan suffered from the mother of all cheap money asset bubbles in the late 1980’s which burst in 1990. At its peak Tokyo's real estate was worth more on paper than all of America’s real estate, Japan’s real estate was worth more on paper than the rest of the planet, and the Japanese stock market’s capitalization was greater than the United States’ stock market capitalization despite Japan’s economy being less than 40% the size of the USA’s.

Then the bubble burst and created a financial crisis and the Japanese government responded with the mother of all stimulus packages: nearly three decades of borrowing and spending on every government program imaginable.

From 1990 to 2024 Japan went from one of the most fiscally sound OECD governments to worst debt-to-GDP ratio on earth: from about 65% to 264% which is worse than Venezuela, Sudan, and Greece.

(For reference the USA’s now-record debt-to-GDP ratio is 121%).

34 years later Japan is widely acknowledged as having endured three decades of stagnation, the so-called “three lost decades.” In fact Japan is already being cited as a story China might repeat: building up an export-driven economy with cheap central bank money and too much debt.

If China responds the same way Japan did, with years or decades of fiscal stimulus, the story is even more likely to repeat itself.

3) When the 2008 financial crisis struck the Obama administration responded with classic fiscal stimulus: borrowing and spending over 8% of GDP for three straight years, then 6.7% and 4.1%, and swelling the national debt from $10.7 trillion to $19.8 trillion—nearly double—in eight years.

The result was not only the second longest recovery to full employment in American history (only faster than the Great Depression), but the eight year annualized economic growth rate from the crisis was by far the slowest ever in American history: an average of 2.1% per year versus anywhere from 3.5% (after the Panic of 1907) to 5.3% (after the Panic of 1893).

More details on how Obama’s record slow recovery compared to all the others are available at:

https://www.cautiouseconomics.com/2018/09/macroeconomics-01.html

Also forgotten but laughable was Obama’s prediction that (paraphrasing) “If you pass this stimulus budget, unemployment will fall to 5.6% by 2012, but if you don’t pass it unemployment will remain much higher.”

The attached chart shows the famous two blue lines that Obama's economic team sold the public and which the media first lauded but has since buried.

The dark blue line represents how quickly Obama claimed unemployment would come down with his stimulus package and the light blue line represents the horrible predicted consequences of not passing his stimulus.

The red-dotted line was added later based on actual unemployment figures, obviously not added by Obama’s team. The evidence showed with stimulus the result was worse, far worse, than even the alleged bad consequences of passing no stimulus at all.

The pro-Obama media obviously never published the revised chart, and when confronted with why unemployment remained stubbornly high Keynesian (pro-stimulus) economists and Obama himself said (paraphrasing) “We didn’t realize how bad the recession was and the stimulus just wasn’t big enough.”

Again, strange that in the 140 years before 1929, when stimulus was never tried, economic recovery growth rates were usually double that of Obama’s and unemployment came down far faster. In the old days the government just sat back, did nothing, and let the economy recover on its own.

4) Lastly, after the 2008 financial crisis most western European countries immediately implemented massive fiscal stimulus. This went on for three to four years until their debts grew so large that credit markets wouldn’t lend to them anymore, but in that three to four years unemployment reached Great Depression levels in the PIIGS nations (16% in Portugal, 25% in Spain, 28% in Greece).

With things getting worse, not better, the left blamed “draconian budget cuts.” According to them governments weren't spending enough and were actually slashing spending. For years the liberal U.S. and European press ran story after story about supposedly self-evident “massive austerity” in Europe although they never reported actual budget statistics.

Well the Economics Correspondent actually dug up government spending numbers from Eurostat which you can see below. 

Spoiler: By 2012 nearly every European government was spending more money, usually a lot more money, than before the crisis—all for stagnant populations and no inflation. And of the one country spending less in 2012 than 2007, the cut could hardly be considered in any way “draconian" (-0.9%).

In the second installment we’ll discuss the theory that explains why all these large stimulus measures have failed over and over.

ps. Note that all four of the previously cited economic depressions were preceded by asset bubble economies that were inflated by central bank cheap money policies, an important factor that will serve as part of the theory explaining why stimulus fails in the second column.
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British government spending:

2007: 544B pounds
2008: 576B pounds
2009: 621B pounds
2010: 661B pounds
2011: 681B pounds
2012: 688B pounds (+26.4% from 2007)

Source: hmtreasury

2) Spanish government spending:

2006: 378B euros
2007: 413B euros
2008: 451B euros
2009: 484B euros
2010: 485B euros
2011: 480B euros
2012: 493B euros (+19.4% from 2007)

Source: Eurostat

3) French government spending:

2006: 952B euros
2007: 993B euros
2008: 1030B euros
2009: 1070B euros
2010: 1095B euros
2011: 1118B euros
2012: 1151B euros (+15.9% from 2007)

Source: Eurostat

4) Italian government spending:

2006: 723B euros
2007: 740B euros
2008: 765B euros
2009: 788B euros
2010: 782B euros
2011: 788B euros
2012: 793B euros  (+7.2% from 2007)

Source: Eurostat

5) Greek governments spending

2006: 98B euros
2007: 109B euros
2008: 123B euros
2009: 128B euros
2010: 119B euros
2011: 112B euros
2012: 108B euros (-0.9% from 2007)

Source: Eurostat

6) Cypus government spending:

2006: 6.2B euros
2007: 6.6B euros
2008: 7.2B euros
2009: 7.8B euros
2010: 8.0B euros
2011: 8.3B euros
2012: 8.3B euros (+25.8% from 2007)

Source: Eurostat

7) Portuguese government spending:

2006: 73B euros
2007: 75B euros
2008: 77B euros
2009: 84B euros
2010: 88B euros
2011: 84B euros
2012: 78B euros (+4.0 from 2007)

Source: Eurostat

"Rising Poverty" in Milei's Argentina, Where the Annual Inflation Rate is Down 98%

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5 MIN READ - An Argentina inflation and poverty dispatch from the Cautious Optimism Correspondent for Economic Affairs (and Other Egghead Stuff).

Monthly inflation rate down 91% this year, annualized down 98%

As Cautious Rockers who have been following Argentina may have noticed Javier Milei is the first libertarian president of a major country in history. In his first year in office he’s closed thirteen government agencies, slashed federal spending, achieved Argentina’s first monthly balanced budget in over a decade, and is on track to post the first annual balanced budget in a century.

INFLATION

All these deep government spending cuts haven't been carried out for the sake of itself. Prior to his election the central government was running annual deficits exceeding 15% of GDP and ordering the central bank simply create monetary reserves to fill the gap and credit them to the federal government’s account (ie. print the money).

By comparison the Biden administration’s FY2024 deficit of $1.8 trillion is running at 6.2% of GDP, itself considered alarming, and America’s central bank—the Federal Reserve—is not allowed to simply create $1.8 trillion in new reserves and credit them to the Treasury’s General Account no matter how many Modern Monetary Theory devotees say so. In the United States the difference has to be borrowed using existing dollars. 

Furthermore, as the Argentine central government spent the newly created money, the reserves entered the banking system where they multiplied to even larger M1 and M2 balances via the commonplace process of fractional reserve lending which occurs in every country.

The endgame of 15% of GDP in new reserves for the government alone—multiplied over and over via commercial lending—was a 170% rise in Argentina’s money supply in the year before Milei’s election (as measured by M2).

It’s hard to compare the numbers to the USA where the Fed switched to a “plentiful reserves” floor operating system in 2008—something very different from Argentina—but we can go back to before 2008 for a more relevant comparison.

In December 2007 the U.S. monetary base (reserves plus currency) was $837 billion supporting an M2 of $7.484 trillion and GDP of $14.7 trillion. If the federal government ran a deficit of 15% of GDP ($2.21 trillion) and, like Buenos Aires, could command the Fed to credit $2.21 trillion in reserves to the Treasury General Account, the monetary base would increase 295% to $2.96 trillion. Assuming the same fractional reserve money multiplier, M2 would roughly quadruple the money supply in a single year whereas M2 in America normally tends to rise on average by 4%-6%.

Incidentally, decades of large fiscal deficits combined with an accommodating central bank explains why long-term prices in Argentina have risen 1,640,000,000,000,000,000% (1.64 quintillion percent) since 1960 compared to 977% in the United States.

The result of large, neverending deficits and money creation, along with the expectation that more inflation was still ahead prompting Argentinians to spend their money faster and faster (ie. rising monetary velocity), was the rampant inflation that preceded Milei.

But now that the budget is balanced and there is no longer need for the central bank to provide the government with new money, inflation has fallen sharply from (depending on what source you use) anywhere from 211% to 3,700% annually last year to 2.4% monthly today, itself a decline from 2.7% a month ago.

(The Argentina National Institute of Statistics and Census reports monthly inflation was 25.5% in December 2023 when Milei took office. Compounded over 12 months that translates to an annual inflation rate of 1,427%)

2.4% monthly inflation compounded over twelve months is 32.9% per year. So since taking office Milei has reduced the annual inflation rate from—according to official sources—1,427% per year to 32.9% and falling.

“RISING POVERTY”

Milei’s achievements after just one year aren’t going unnoticed domestically, and even the left-wing international press has been forced to admit his rapid progress in lowering inflation.

However he still has plenty of critics, mostly those ideologically disposed to socialism who will castigate Milei no matter what he does.

Milei, his critics say, has raised the poverty rate from 42% to 53% since taking office.

”Argentina records sharp rise in poverty,” –BBC

”Poverty in Argentina soars to over 50% as Milei’s austerity measures hit hard. Far-right president has been battling inflation by imposing steep cuts in spending, resulting in widespread poverty,” –UK Guardian

“Argentina’s poverty rate spikes in first 6 months of President Milei’s shock therapy,” -AP

“A year into Javier Milei’s presidency, Argentina’s poverty hits a new high,” -Al Jazeera

While the Economics Correspondent freely and gleefully admits a small number of the newly impoverished are now-unemployed government bureaucrats and employees who previously “worked” for the likes of the Ministry of Culture, Ministry of Social Development, and Ministry of Women, Genders, and Diversity, the reality is the poverty rate has not actually increased and more likely has come down. Milei’s policies have simply revealed the true poverty rate from the artificially lowered levels reported under previous administrations.

The reasons have to do with the poverty rate being counted based on income. As the central bank printed money that the central government gave away to the public, more recipients’ “income” rose above the official poverty line.

But with the massive inflation and price controls imposed by the government, most citizens couldn’t buy many basic necessities with their “income” due to price ceiling-imposed shortages. The inability to buy goods and services with “above poverty” income was not factored into calculating the official poverty rate—by design.

It’s not unlike saying Venezuela, with its shortages of milk, butter, meat, water, electricity, toilet paper, etc… is “lowering poverty” because the government is printing more money and handing it out to citizens.

For this point, the Economics Correspondent will defer to a most excellent comment he read online. Although Milei himself explained this phenomenon in a recent podcast interview, it’s hard for even him to beat the succinctness of this online commenter named J.J. Parson:

”The official poverty numbers went up when Milei removed price controls. But that wasn’t an increase in poverty—it simply revealed the actual poverty level which is masked by price controls.”

”When there was [a] price control on eggs, for example, nobody was allowed to sell eggs above that price. The result was they stopped selling eggs. You could not buy them. But government poverty statistics would say—based on the price of eggs and your income—you fall above the poverty line (those were fake statistics because of the price controls—they hugely undercounted the number of people under the poverty line).”

Kudos to J.J Parson, whoever you are.

The same phenomenon was recently reported with Milei’s repeal of rent control—also a price control/price ceiling. Back when rents were capped by the government more incomes were officially “above” the poverty line, but many people couldn’t find housing to rent with that money. One in seven apartments in Buenos Aires was being withheld from the market.

Not one in seven vacant apartments; one in seven of all apartments.

When Milei repealed rent control the supply of available housing tripled within months, meaning a huge portion of the capital’s available housing had previously been taken off the market. 

Those citizens who now have a roof over their heads likely don’t feel more “impoverished,” and the same calculus applies to tens of millions of Argentinians who previously may have had more money, but who were watching their money rapidly depreciate, who couldn’t buy many basic goods and services with that money, and who were perversely being classified as “above the poverty line” by the previous government.

A Political and Economic History of China, Part 28: The Northern Expedition of 1926-28 and Chiang Kai-shek Turns on the CCP

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6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff chronicles the very bloody opening shot in the war between Chinese Nationalists and Communists.

Photo: from the April 12, 1927 "Shanghai Massacre." Links to more brutal photos at end of article.

By 1926 Chiang Kai-shek had gained control of the Nationalist Party (“Guomindang” or KMT) through a bloodless coup. His main rival, left-leaning Wang Jingwei, had left for France. The Soviets, who supported the Nationalists on the condition they admit the small Chinese Communist Party, felt China was not yet ready for full communist revolution and instructed the CCP to continue working with the KMT which Moscow still supported.

THE NORTHERN EXPEDITION

Given his assumption of full leadership Chiang decided the time had come to carry out the late Sun Yat-sen’s vision of defeating the provincial warlords by military force. Chiang and his new army, trained at the Whampoa Academy that he commanded, would march from Guangdong in southern China northwards, unifying the country one province at a time.

The so-called “Northern Expedition” began in July of 1926.

Chiang’s multiyear campaign enlarged Nationalist-controlled territory applying multiple strategies, each deemed appropriate for the targeted rival warlord. If a warlord felt weak and feared soldier defections to the stronger Nationalists, he would join the KMT without bloodshed.

If one warlord was fighting another, he might join the KMT in the hope their combined forces could then defeat his rival—as was the case when the “Christian general” Feng Yuxiang joined Chiang Kai-shek to battle Manchurian rival warlord Zhang Zuolin who had just handed Feng a decisive defeat.

Some warlords simply stood their ground and resisted Nationalist forces, nearly always losing to Chiang’s ever growing armies. Some battles were quite bloody and lasted several months, with KMT victories coming at considerable human cost on both sides.

Throughout the expedition the Chinese communists played their own role, organizing workers to strike, sabotage and disrupt warlord territories in the path of advancing KMT armies.

While the CCP inconspicuously took credit for these behind-enemy-lines operations, their scale was actually quite limited. Much more commonly the Communists preferred organizing worker strikes and disruptions in newly liberated KMT territory—after Nationalist armies had already conquered them.

As KMT troops fought sometimes bloody engagements to seize provincial cities and countrysides and moved on, the Communists came up from the rear and operated in a pacified environment. After Chiang’s Nationalists had done the hard work the CCP began organizing workers and peasants to strike and disrupt the businesses, farms, and economies of newly-won KMT territories.

While Nationalists were fighting and dying on the front, the Communists were recruiting workers and peasants at a dizzying pace. CCP membership, which was only about 200 at the party’s founding in 1921, had grown to several million by 1927.

Furthermore, communist activity was causing real headaches for Chinese farms, businesses, and the establishment in general. Communists were redistributing land wherever possible, “fining” and imprisoning landlords, and “canceling” debts faster than American college grads in the Biden era, all while general strikes were grinding business production to a halt.

A rift was beginning to form between the Nationalists—always a party of the established classes—and the Communists, a revolutionary party that aimed to completely reorganize society into a proletarian dictatorship. The two parties even disagreed on where to move the new Nationalist capital with Chiang preferring Nanjing and Wang Jingwei, who by now had returned from France to capitalize on the KMT left wing’s resurgence, preferring Wuhan.

THE SHANGHAI MASSACRE

As complaints poured in from Nationalist officials and businessmen from all over KMT-controlled areas, Chiang surveyed the Communists’ ballooning membership rolls and growing strength. His armies were doing the heavy lifting, liberating China from warlords often one bloody province at a time, and the Communists were moving in after the dust had settled to sow chaos and transform recently won territories into Marxist strongholds.

Thus Chiang, already distrustful of communism and the USSR since visiting Moscow a few years earlier, decided to end the Nationalist/Communist alliance. After a brief period planning his next move he launched what the CCP has ever since named the April 12 Incident—a violent purge of the CCP from the Nationalist Party.

At dawn on the morning of April 12, 1927 Nationalist troops and Shanghai gang members attacked known communist offices and hideouts all throughout Nanjing, Shanghai, and other Chiang-controlled areas. Communists were arrested and killed later in the day, many dragged out into the streets and beheaded. The number of communists killed ultimately reached into the thousands, and even communists in the left-wing stronghold of Wuhan were purged and/or executed.

Chiang was supported by establishment intellectuals and government officials who were petrified at the sight of millions of workers and peasants seizing farms and shutting down factories, sometimes violently. Business interests also supported Chiang’s purge including his old friends in Shanghai’s Green Gang who in turn provided many henchman to carry out the killings.

The Communist Party was nearly decimated with only a few key leaders escaping the purge with their lives. The Correspondent recalls reading about Zhou Enlai, who later engineered Chinese-U.S. reconciliation with Henry Kissinger in 1971, barely slipping away from the massacre.

Meanwhile the Soviets were initially undecided about how to respond. Paralyzed by what was now a power struggle between Leon Trotsky and Joseph Stalin over who would succeed the late Vladimir Lenin, the Soviets couldn’t yet bring themselves to sever relations with the KMT. 

At the same time Chiang’s son Chiang Ching-kuo, studying in Russia and semi-brainwashed by the communist environment, publicly denounced his father as an imperialist counterrevolutionary, but the Soviet Communist International (Comintern) remained unmoved. 

Years later the young Chiang Ching-kuo would regret criticizing his father and by 1975 assumed the presidency of Taiwan as one of the world’s most vocal anti-communist heads of state.

Meanwhile as the Nationalist left wing and Chiang rival Wang Jingwei floundered and the Chinese communist movement was being decimated, instructions from the Soviets reeked of delusional fantasy.

Communiqués from Stalin instructed the KMT left wing to continue seizing and redistributing land—a difficult task in itself given the havoc being wreaked by Chiang’s purge—but to leave alone land belonging to military officers. Verifying whether each plot belonged to an officer or not and disseminating instructions to peasants on the ground, all while Nationalist forces were butchering communists, was a near impossible task to carry out. Stalin also ordered a tribunal organized to punish “reactionary” officers, again oblivious to the tactical difficulties involved in identifying every officer among the confusion let alone which ones were actually “reactionaries.”

Stalin’s instructions were effectively unenforceable.

In light of the purge and unrealistic directives from an ally that seemed completely out of touch with the reality on the ground, the Chinese communists became increasingly irritated with what they viewed as counterproductive interference from Moscow. This was the beginning of many disagreements between Chinese communists like Mao Zedong and Soviet representatives like Mikhail Borodin, and the friction between CCP leaders and Soviet advisors would linger for many more years.

With the left-wing in retreat and seemingly powerless to stop Chiang’s violent purge Wang Jingwei, always the opportunist and vacillator, blamed himself for the party’s schism and announced that Chiang was right, all before packing up and moving to Europe again.

Chiang Kai-shek was once again in control of the Nationalist Party, his rival again having departed China. Most of the Communists had been wiped out. Although a few survived, their organizational framework was gone and Chiang had the support of most of China’s establishment. Frictions between what few Communists remained and their Soviet advisors were at an all time high.

The CCP would never forget April 12th and even today commemorate it as the fateful day a treacherous Chiang Kai-shek betrayed them, firing the opening salvo in what would become a 22-year on again, off again civil war.

With most of China seemingly under Chiang’s control he set out to complete the Northern Expedition, advancing further north to Beijing. In April 1928 Zhang Zuolin, the most powerful of the warlords and based in Manchuria, elected to fight but by June his army was defeated and the Nationalists integrated Beijing into their domains. Little did Zhang know that he would soon be assassinated by the Japanese that same month.

The Northern Expedition was over. Chiang had successfully reunified China’s most populated eastern provinces from Guangdong in the south to Beijing in the north. Those sparsely populated areas in the west that he didn’t control directly were still effectively subservient to him via warlord alliances and agreements.

For the first time since Yuan Shikai’s death twelve years prior it seemed China was finally unified.
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Links to more brutal photos of the 1927 Shanghai Massacre:

https://lh3.googleusercontent.com/BpBGEQYTA6gTHDXbxzZGQnmEgMd7p3ovk6Ieho887OxhTg8tPk7zkJsYvoHnEoGLgcstOpVbEUY_F79I2DYA-7_jpiLXbO2DNGF68g=s1200?

https://cdn.thecollector.com/wp-content/uploads/2023/11/shanghai-massacre-1927.jpg

https://i.scdn.co/image/ab6765630000ba8a4d4df39cd205c6c91f991918