We Need To Talk About Inflation

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• Inflation has been the hottest financial topic of the last 12 months, but it’s also a significant long-term concern for government, central banks, consumers and investors alike.
• Stephen D. King’s latest book, “We Need to Talk About Inflation,” is an accessible analysis of inflation and its evolution over time.
• Why is inflation a relatively modern concept, and what can history teach us about the phenomenon of inflation today?

Books about economics usually aren’t page-turners, but Stephen King’s are an exception.

No, the modern master of literary horror isn’t weighing in on concepts like marginal utility and market equilibrium. I’m talking about Stephen D. King, the British economist and the author of four books, including his latest: “We Need to Talk About Inflation.” 

On an Ideas Lab installment of Top Traders Unplugged, host Kevin Coldiron posed an intriguing question to Stephen: If he was constructing a central bank like the Fed from scratch, what would he do? 

“First of all, I probably wouldn’t start from scratch,” says Stephen, who serves as HSBC’s Senior Economic Adviser (and formerly served as its chief economist). “I know this is evading your question to a certain degree. But central banks have traditions, they have reputations, they have embedded credibility, hopefully. And you want to hang on to some of that if you possibly can. So history matters. Reputation matters.”

Stephen and Kevin’s wide-ranging discussion includes his takes on the uneasy relationships between governments and central banks, how past inflationary periods can help us evaluate the present and many other lessons of economic history. Read on for Stephen’s insights on the evolution of inflation over the 20th and 21st centuries, how socioeconomic groups experience inflation differently and what revolutionary France can teach us about the importance of public trust.

Why money matters

Kevin found “We Need to Talk About Inflation” to be an accessible, concise and clear guide to a complex topic. At the end of the book, Stephen condenses his arguments into 14 lessons we should all know about inflation. The first one: money matters.

“I think that’s intuitive to most people,” says Kevin. “The more supply we have of something, all else equal, it’s worth less — or it should be worth less. When I started working at the Fed in the late 1980s, that was the dominant philosophy. Control the money supply, control inflation.”

He asks Stephen how that became the dominant view.

“For many years, people thought that money didn’t matter at all,” says Stephen. “Back in the happy days of Keynesian economics in the 1950s and 1960s, macroeconomic policy was aimed at lowering unemployment and bolstering growth as much as it could.” 

At that time, the prevailing wisdom was that “inflation was not likely to be a problem at all,” he adds. “[But] it did come along in the late 1960s, particularly in the U.S. It forced a complete rethink of how [monetary] policy works.”

In the 1970s, the buzzword was “stagflation,” a phenomenon policymakers never saw coming — very low growth (or high unemployment) as well as sky-high inflation. 

“These two were not supposed to go together at all,” Stephen notes. But when it did happen, it stirred a reevaluation of macroeconomic policy. 

By this time, we began to realize that if there was too much money floating through the economy, it could increase inflation. 

“Worse, if policymakers were seen to be turning a blind eye both to the higher inflation and to perhaps the monetary excesses, people’s expectations of inflation would become increasingly embedded,” says Stephen. “Before you knew it, you had a huge problem whereby for any given growth rate, you’re getting higher and higher rates of inflation, which was a very unsatisfactory state of affairs.”

The Volcker era

The 1970s and the early 1980s saw “a return — I use the word carefully — to prior monetarist views of the world; i.e., that money did matter and that if you ignored it completely, you were likely to end up with some nasty or unpleasant inflationary outcomes,” says Stephen. 

In 1979, President Jimmy Carter tapped Paul Volcker to become the 12th Chairman of the Federal Reserve. He was “determined to bring the money supply back under control” in an effort to alleviate inflation — and “lo and behold, in the 1980s, that’s exactly what we saw,” Stephen observes.

Just after he stepped down from the Fed in 1987, Volcker gave a speech in which he admitted that by the late 1970s, policymakers “almost begrudgingly recognized” that defeated inflation “was a necessary precondition of achieving other macroeconomic aims” like low unemployment and a decent rate of economic growth. 

In other words, “a precondition of controlling inflation was controlling monetary growth,” Stephen argues. If you didn’t do the latter, you wouldn’t get the former.”

However, attempting to control the money supply doesn’t always work, “as is often the case with economics,” he adds. The relationship between the amount of money in the economy and the level of inflation began to break down, and economists realized that it was statistically nowhere near as robust as they initially expected. In fact, before our recent bout with inflation — in 2020 and 2021 — money supply numbers “were growing at the fastest rate we’ve seen in the entire post-Second World War history,” Stephen notes. 

But “what would have been a major red flag in the 1980s had become just a statistical quirk,” he argues. The Fed and other central banks chose to brush off those record-breaking supply numbers — but Stephen thinks that “ignoring that supposed statistical quirk was actually a major mistake because it was telling us that something wasn’t quite right about the performance of the U.S. and the global economy.”

Hyperinflation, revolution and the power of trust

Today, it’s clear that public perceptions and attitudes matter almost as much as how much money exists. But the phenomenon is centuries old. Stephen dives deep into a particularly fascinating economic era in “We Need To Talk About Inflation”: revolutionary France in the 1790s. 

During that time, France experienced high inflation — “hyperinflation by some measures,” he says. “But the inflation was not just a consequence of printing money, although that was an important part of the story. It was also the sense that people couldn’t trust the money.”

He explains that in pre-revolutionary France, money was based on precious metals — silver or gold “or whatever that provided the backing, the trust, the certainty of what this money was.” But when the revolution began, “those who could take their gold and silver out of the country did so. [There was] this exodus of money … and the revolutionaries thought, Well, what can we do? We haven’t got enough of this gold and silver. We’ll just print paper money instead.”

However, paper money was uncommon and unpopular in revolutionary-era France. 

“There was a deep suspicion about the stuff — this ‘funny money,’ so to speak.”

But that skepticism wasn’t the worst outcome. As it turned out, those who printed paper money didn’t think enough about the possibility of counterfeiting, which is exactly what happened. Counterfeiting became a “massive industry,” and “eventually, the public just refused to use the stuff.”

Stephen puts it this way: “If you were to sell a cheese flan to your customer in exchange for some of this money … the next day, the money was probably worth less than the now stale cheese flan would be worth. The money was actually depreciating more rapidly than the pastry.” 

The lesson? “Public trust matters hugely,” he says.

Apples to apples

When government debt is high, one way to reduce it is through monetary policies that encourage higher inflation — which “seems, on the surface, like a solution that ‘might work,’” Kevin says. 

But Stephen argues that inflation isn’t a democratic solution. It negatively affects certain segments of society much more than others.

“Who really suffers with inflation and who might be in a position to actually benefit from it?” Kevin asks.

“This is something people don’t pay sufficient attention to,” Stephen notes. “There is an incredible arbitrariness about the effects of inflation on society. If you’ve got the perfect macroeconomic model where you assume that everyone is affected by inflation equally at all times, then none of this really matters. But perfect macroeconomic models are not what we actually live with in the real world.”

In the most basic terms, money is a measure of the value of things relative to other things. We often think of money as a means of exchange or a unit of account, constantly using it to gauge things like one’s salary or the price of a particular good. 

But during periods of inflation, it’s difficult to tell the difference between an inflationary trend and a lasting price increase of a particular thing due to a genuine shortage (or an unusual increase in demand). Stephen explains this with a grocery-shopping scenario: You buy a pound of apples at the supermarket for $1 per pound. The following week, you pay $1.20. Is that inflation? 

“Well, it might be,” he says. “It might simply be that there’s been a bit of a shortage of apples because of a bad apple crop — or it might be because the truck that was driving the apples to the supermarket broke down so there’s a shortage of apples. There’s a whole series of different reasons for why the apples might go up in price. But a well-functioning economy is one whereby you don’t have to worry about the inflation effect of changes in apple prices.” 

If apple prices change worldwide, or in an economy where inflation is low, the price changed for “sensible economic reasons,” he adds. If the price of apples rises 10% this month, and then in six months’ time, your wage rises by 10%, you’re ostensibly unaffected by the dynamics of apple economics. However, if apple prices go up by 10% and your wage rises by 5% in six months, you might think apples are getting quite expensive nowadays. 

Inflation’s imbalance

Inflation “creates tremendous uncertainty in terms of trying to gauge the true value of what’s happening and the true reasons for why prices are changing,” says Stephen. “Under those circumstances, you start making mistakes.”

Mistakes happen on an individual basis — perhaps borrowing too much or spending too much — but they also happen at the corporate level. High and/or volatile periods of inflation might discourage investments because leaders aren’t sure they’ll see good returns (because accurately projecting future revenues is more difficult than usual). That’s uncertainty.

But unfairness is something else. 

“Unfairness comes from the fact that some people in society are less able to negotiate their way into a better position as a consequence of inflation than others might be,” Stephen explains. “In terms of the labor market, if you happen to be a member of a powerful union that’s working on your behalf to compensate you for relatively high inflation rates, you might get away with a decent wage increase. But if you’re self-employed, like the millions of workers in the gig economy, “you’ve got no negotiating ability whatsoever,” he says. 

“Equally, if you’re a large oligopolistic company, you might well be able to push through big price increases. If you’re a small supplier when there are many suppliers to the large oligopoly, you may struggle to get the same kind of price increase through. You end up with this incredible unevenness as a consequence of higher rates of inflation.”

Another example: A borrower (whether the U.S. government or a first-time homebuyer) may find that inflation is advantageous. Ten years into a mortgage and high inflation means their debts (the portions in the form of interest) are lower than they anticipated. But a cash saver may find that inflation destroyed the value of their savings and that they’re poorer than they thought. 

Although he makes clear that he knows economic imbalances exist for a host of other reasons, in the U.S., elected leaders make fiscal policy. 

In that sense, we all should consider what side we’re on when we enter the voting booth.

As Stephen admits, “There is no doubt in my mind that inflation creates winners and losers.”

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.