Governments Cause Inflation, Not Banks Making Loans

Christopher Wynne is a U.S.-born businessman based in Moscow. His company, PJ Western, owns and operates PapaJohn’s Pizza locations throughout Russia. His businesses employ over 9,000 people within the country, which at the very least is hopefully a reminder of who will suffer attempts by foreign nations to make “Russia” pay for the sins of its leader.

Notable about the 45-year old entrepreneur is where the financing for his businesses comes from. According to the New York Times, backers include Alex Ovechkin, the future Hall of Fame hockey star for the Washington Capitals, the Russian private equity firm Baring Vostok, plus a Finnish private equity operation by the name of CapMan.

There are all sorts of businesses and businessmen in Moscow and around Russia since the happy dissolution of the Soviet Union in the 1990s, which on its own renders mention of Wynne’s sources of finance kind of humdrum. Figure that up until Russia’s invasion of Ukraine, U.S. investment banking giants Goldman Sachs and Morgan Stanley could claim substantial commercial activity in Russia. Both announced a pullout last week, but it’s not unreasonable to speculate that their departure will prove short-lived.

What’s useful about the financing of Wynne’s PJ Western and Russian finance more broadly is that it illustrates yet again the global nature of capital. It knows no borders. Where money is treated well (and sometimes where it’s not treated well such that capital commitments are met with impressive rates of return) is the driver of capital flows.

This is worth keeping in mind as monetarist philosophers like Berenberg Capital Markets senior economist Mickey Levy opine oh so predictably on what the Federal Reserve should do about inflation. When it comes to interest rates and capital access, it seems we’re all central planners now. Members of the Right who were plainly influenced by the late Milton Friedman’s mostly free-market views also plainly embrace his embrace of the central bank as capital allocator. Which means Levy isn’t unique in calling for the Fed to “raise rates and take away the accommodative monetary policy that is fueling underlying inflation and rising inflationary expectations.” Please think about Levy’s expressed desires in terms of Wynne.

In doing so, try to remember that the United States isn’t some autarkic island of economic activity as Levy’s models would have you believe. Assuming the Fed can shrink credit access from the banks through which it projects its wildly overstated influence, banks are but a small and shrinking portion of total credit not just in the U.S., but around the world. Stated basically precisely because it’s basic, what the Fed takes will be made up for by market actors around the world. Goodness, assuming the Fed’s rate machinations actually result in more expensive credit (not very likely, but let’s pretend), that would merely mean that the central bank’s actions would create fatter margins for domestic and global capital providers.

But wait, can’t the Fed shrink so-called “money supply” inside banks through sales of interest-bearing assets to banks? Not really. The Fed buys highly marketable and liquid securities from banks, and by extension sells highly marketable and liquid securities to banks when its aim is to reduce their lending. Which is why all the fiddling is so meaningless. If banks find intriguing lending opportunities, there’s a big and liquid market for the securities on their books.

It’s all a reminder that the Fed can’t shrink money and credit availability where each will be treated well. Finance is lucrative. Money and credit follow opportunity. Levy’s alleged solutions to what he deems inflation will achieve much less than nothing. Neither would a reversal of what Levy desires. In other words, the Fed can’t stimulate what isn’t economically viable. Assuming a lack of credible financing options in and around the U.S., Fed fiddling won’t alter this truth. Basically, markets work. While economists continue to try to make markets do as they wish, reality always intrudes. The Fed can’t make Palo Alto a cent poorer, nor can it make East St. Louis a cent richer.

All of which raises a question: if the Fed can’t shrink credit, how can it tamp down inflationary pressures? It’s a useful question. The answer is that credit is produced in the real economy. We borrow money for what it can be exchanged for. Unless the productive around the world stop going to work, credit will always be abundant where it’s treated well.

Which brings us to inflation. Leave it to politicians and economists to blame inflation on lending. What a joke. Why on earth would delayed consumption by one party that is shifted to another party cause inflation? To find inflation in the shifting of resources from one set of hands to near-term better hands to redefine the word. Which is what Levy does. Leave it to economists to blame finance, as opposed to government, for inflation.

The economist also fears “a stock of personal savings” of $2 trillion+ will add to inflationary pressures. Translated, Levy fears a so-called “savings glut.” A non-economist by the name of Henry Hazlitt once marveled that even the ignorant could fear too much savings, but Levy does. Since he does, he wants the Fed to act. Back to reality, savings by their very name never sit idle. Levy would have readers believe $2 trillion has sat dormant only for it to suddenly emerge such that prices soar. Demand-driven inflation! No, and no.

First, no act of saving ever subtracts from demand. Second, demand doesn’t cause inflation in the first place. That is so because all spending is about tradeoffs. If our spending is suddenly focused on airline tickets such that demand outpaces supply and prices rise, that just means we have fewer dollars for other goods and services.

Inflation is a devaluation of the currency. Which means it’s always and everywhere a policy choice entered into by government. And since it’s a policy choice, the solution to what some deem inflation is a stronger, more stable dollar. Nothing more, nothing less. If Treasury wants a stronger and more stable dollar, it need only communicate that. Markets will comply. Indeed, if markets don’t “fight” an outsourced arm of Congress and Treasury (meaning the Fed), they certainly won’t right Treasury on the matter of a more credible dollar.