In the past few years, a troubling phrase has been plaguing American producers and consumers: supply chain problems. This term is often used by mainstream economists to explain record levels of inflation. But the Biden Administration appears to have turned it into a sign that there is economic recovery. Gina Raimondo, Commerce Secretary states,
“What we have here is a demand issue. The economy is doing better… People have money in their pocket. They’re spending that money. Demand is through the roof… Supply has to catch up.”
Raimondo stated this in October 2021. However, inflation has only gotten worse from an annual rate at 6.2 percent to 7.7 percentage more than 12 months later. This makes one wonder if Secretary Clinton is correct in stating that inflation is a function of supply chains adapting to wealth increases. Yet as it turns out, in the words of the Mises Institute’s Ryan McMaken, “the administration’s defenders are right about consumer demand and spending – even if for the wrong reasons.”
That is, although we’re indeed witnessing a large spike in demand (which is perhaps best quantified by changes in nominal GDP), this increase in demand is a symptom of a larger problem: the massive expansion of the money supply under the watch of the Federal Reserve and the White House. The implications of this unprecedented expansion are two-fold, not only stirring this increase in “demand” but contributing to supply chain issues through the distortion of price signals.
The Money Supply and the Demand
With state governments responding to the rise of Covid-19 by imposing lockdowns and forcibly closing “non-essential businesses,” both the Fed and the Trump and Biden Administrations stepped in with an extraordinarily expansive monetary and fiscal policy, respectively.
M2 refers to the money supply. It grew by over $6.2 trillion between February 2020-2022, a 40% increase. This is the result of a variety of initiatives, from the Fed’s quantitative easing and purchase of over $2 trillion in assets to new federal programs such as stimulus checks, PPP loans, and the $1.9 trillion American Rescue Plan Act.
These ventures flooded the economy and gave Americans more money. This was a problem because the money became much less valuable. That’s because an increase in the money supply, without a corresponding increase in economic output, means an increase in prices, with more money chasing roughly the same quantity of goods.
This is where Raimondo serves to mislead viewers in her comments; just because Americans have more money, doesn’t mean they’re any wealthier. There certainly is a large spike in demand, but that doesn’t represent an increase in the real wealth of Americans, but an increase in the amount of money they have access to thanks to an unprecedented monetary expansion.
This can be best illustrated by comparing nominal and real GDP per capita. It’s a rough proxy of standard of living.
If you were to look only at nominal GDP per capita (the blue line) you would think that the average American’s wealth has increased greatly since the pandemic. This, however, is incredibly misleading, because it doesn’t take into account inflation and the decreasing value of the dollar.
Inflation and Price Signals
Raimondo and other economists do not believe that there has been a growth in economy or an increase of wealth. However, the large increase in demand does reflect an increase in money supply, which has caused upward pressure on prices. Yet just as the Biden Administration declares that “supply has to catch up,” the ability for producers to do so has been greatly strained by inflation (not to mention the aforementioned lockdowns).
That’s because of the role prices—which economist Alex Tabarrok refers to as “a signal wrapped up in an incentive” —play in coordinating economic activity. Prices change often communicate changes in the demand or scarcity of different goods, products, or resources. When the price of something in a company’s supply chain increases, this hurts the company’s profitability and incentivizes it to economize and find a more efficient alternative.
Economic growth or recovery is achieved on a macro level by thousands, if certainly millions of businesses and companies finding new ways of innovating and maximising profits. This is accomplished through comparing the prices for different inputs and production techniques. Inflation can increase the overall economy’s price and affect each product differently. This can cause economic disorganization and confusion as prices do not reflect changes in efficiency and scarcities.
Even if inflation impacted all prices equally, we still wouldn’t know to what extent a rise in the price of a certain resource reflects actually important information about it, given that the rate of inflation is always changing and can only be measured in hindsight.
This has led to firms being essentially blindfolded when they try to put back together supply chains that were forced shut down during the pandemic. However, prices cannot reflect the efficiency and effectiveness of comparable alternatives. This is exactly why “supply chain issues” has continued to be a lingering excuse for inflation and shortages, with Volkswagen chief executive Oliver Blume going so far as to say that, “Challenges to our supply chains will become the rule, not the exception.”
This phenomenon isn’t new. Paul Volcker, the late Fed Chairman notable for remedying the United States’ last encounter with runaway inflation in the late 1970s and early 1980s, observed that, “The inflationary process itself brought so many dislocations, and stresses and strains that you were going to have a recession sooner or later.”
Given the fact that the United States technically entered a recession during the first half of 2022—at least according to a common definition of recession—Volcker’s words proved prescient. An unprecedented monetary expansion by the Fed and White House has triggered dangerous levels of inflation. It has also disrupted the supply chain, which agencies use (ironically) as a cover for inflation.
Now, with economic growth stagnant and inflation persisting at high levels, the fate of supply, demand, and the price signals that they convey rests in the hands of the problems’ culprits.