The Inequality of Supply & Demand
All of us (people, businesses, government) exchange wealth (i.e., spend money) for needed goods and services.
This is the “demand” side of the economy.
Some of us produce those needed goods or provide the services, receiving money in exchange.
This is the “supply” side of the economy.
For an economy to produce maximum wealth:
“demand” equals “supply”
What happens when things get out of balance, and this is no longer true?
In my prior blog, “How Much Wealth in a Dollar”, I used the “egg example” at a very micro level to establish the following relationship:
If the aggregate supply of goods and services decreases and if all the other economic forces are strangely constant, then the value of the dollar will decrease, inflation happens. If the aggregate supply increases, all else being constant, deflation happens.
Meaning that if the “supply” is less than the “demand”, inflation happens. Which is of course happening now, implying that that our economy is out of balance, that either the “supply” is too low, or the “demand” is too high.
Or both are true.
Either way means that our economy is not as efficient as it should be, that we are not producing as much wealth as we should be. And if the production of wealth gets low enough, we will be in a recession.
Why are we in this state of inequality, and what will it take to achieve balance?
What are the reasons for the “demand” being too high?
1. Interest rates were too low, implying that the Federal Reserve had created too many dollars. That it created excessive demand for debt, and that on average, consumers and businesses had too much easy credit and were borrowing and spending too much.
2. For this same reason, the U.S. Government was/is borrowing and spending too much.
3. Many businesses and consumers have directly received Covid related financial assistance, thanks to the previous item.
All these items have enabled more spending, which increased the “demand”, and contributed to our present high rate of inflation.
What are the reasons for the “supply” being too low?
1. Companies were paid by the government not to produce products.
2. People were paid by the government not to work.
3. Many choose early retirement because of the dramatic increase in home prices.
4. Excessive Covid lockdowns, resulting in a shortage of parts and goods.
These items either directly resulted in a shortage of goods and services, or resulted in a shortage of labor, which in turn resulted in a shortage of goods and services.
All contributed to our present high rate of inflation.
Note that there is often a cross-dependent relationship between the high “demand” and the low “supply”. For example, in order to pay people not to work, the government had to borrow more.
How to fix? What will it take to achieve balance, to bring down the rate of inflation? To make our economy more efficient?
Actions that will increase the “supply” or reduce the “demand”:
1. The Federal Reserve must take dollars out of the system. This is already happening and is why interest rates are rising. There will be a decrease in spending as credit tightens, reducing the “demand”.
2. The government must stop rewarding unproductivity and instead encourage productivity. Stop paying able bodies adults to not to work. Stop paying companies not to produce. This will increase the “supply”.
3. Lower the cost to produce goods and to offer services. Reduce regulation and lower the taxes that business and service providers pay, and lower sales taxes. This will increase the “supply”.
Unfortunately, even as the Federal Reserve is taking the necessary steps to reduce the “demand”, the government is not taking any steps whatsoever to reduce the “demand” or to increase the “supply”. We can only hope that the actions of the Federal Reserve to reduce the “demand” will alone be enough to balance the equation.
If it is not, then expect high inflation to continue.
The proposal to forgive students loans is a step in the wrong direction. While beneficial to a few, any loan forgiveness will increase spending, an increase in the “demand”, opposite of what is needed. This “on the surface” benevolent action will contribute to even higher inflation, the regressive tax on all of us.
Of concern is the opposite directions the Federal Reserve and the U.S. Government are taking. To increase interest rates, the Federal Reserve is reducing its debt holdings, reducing the demand for debt, including U.S. Treasury debt. As the demand for debt drops, the price of debt drops, and interest rates increase. An example being the 10-year yield more than doubling in that last year.
Apparently not aware or not understanding, the federal government recently passed large, unfunded spending bills that will increase the amount of U.S. Treasury debt on the market even as there are less buyers for this debt.
The result will be even higher interest rates, perhaps even high than the Federal Reserve is targeting, because as explained in my prior blog, “Who Sets Interest Rates”, it is the secondary market, and not the Federal Reserve, that actually establishes interest rates.
Continued high inflation and high interest rates.
No wonder the stock and bond markets are both correcting downwards.