The government and central bank have created enormous amounts of new money and credit, and for decades measured inflation has read low single digits. The central bank now aims at 2% a year. The small number you’re shown is a net. Underneath it, two huge forces are pushing against each other. Technology pushes prices down, year after year. The government and central bank push them back up by creating new money and credit. The published figure is what’s left over after those two forces cancel. Reading it as “not much is happening” is the mistake. The calm of the number is bought by the violence of the cancellation.
If you take the 2% at face value, you draw two false conclusions at once. You conclude the money system is roughly stable, and you conclude technology doesn’t really lower the cost of living. The natural state of a free market, under a money nobody can add to, is falling prices, but you can never see that state directly across the whole economy, because policy cancels it before it reaches the till. You have to reason your way to the prices that should have existed. That’s what we’re doing here.
The two forces
The downward force is technology. When a firm gets better tools, the same goods take fewer hours and fewer inputs to make. Competition then forces the saving into the price, because a rival with the same tools will undercut anyone who tries to keep the difference. So in an honest system prices drift down toward the cost of making one more unit. That holds for everything technology has changed the making of. It doesn’t hold for housing, care, teaching, or building. And where nobody can copy the cheaper way, the saving stays with the business. You can’t see the whole of the fall in the shops, for a reason I’ll get to, but its size is about the rate at which output per hour of work grows, which is what the productivity figures measure. In Britain that was near 2% a year before 2008, and between 0.7% and 1.3% a year from 2009 to 2019, depending on which of the statisticians’ two measures you take. The push keeps getting stronger, because the tools are improving faster than they did, as software and now AI spread into more of the economy. You won’t see that in the official productivity figures yet.
The upward force is money and credit creation. Our money is loaned into existence. Most new pounds are created when banks make loans, and the debts are fixed in pounds, so the amount you owe stays the same whether prices rise or fall. If prices broadly fall and nothing is done to stop it, wages and revenues follow them down, but the repayments don’t shrink.
A system built on debts fixed in pounds can take a slow fall that comes with better tools. In that fall it’s the cost of making things that drops, and pay drifts down slowly behind it, so the money to meet a fixed payment is still there. What it can’t take is a sudden fall in the prices credit pushed up, houses first, because then the losses spread through the banks. In that fall it’s the lending that has stopped, so incomes and the house fall together and at once, and the fixed payment is hit from both sides in the same year. Houses come first because people buy them with borrowed money. The debt takes a bigger bite of everyone’s income. And where the loan was written against a house, the house is worth less too, so the bank stands to lose more on that loan. So every time a sudden fall in those prices threatens, the system is rescued with new money, and the rescues keep getting bigger. In between, the central bank targets 2% inflation and does whatever it takes to get there, with rates and with asset purchases [buying bonds with newly created money].
Say technology would have moved prices to minus 2% this year, as it would have at Britain’s rate before 2008, and the shops show plus two. To get from minus two to plus two, policy had to move prices by roughly four points, against the current. Picture a moving walkway. It runs backwards at two steps a minute, which is technology pulling prices down. Walk forward at two and you stay exactly where you are. To end up two steps ahead, which is what the shops show, you have to walk at four. Someone watching your position sees a figure barely moving and concludes there’s no effort anywhere in the scene. The walking is the money creation. The barely-moving position is your 2%.
How each hides the other
The money creation hides the deflation because the prices you should have had never appear on any receipt. You can’t see the £55 weekly shop that would have existed after a decade of the fall reaching you. The one you can see costs £80. So the fall in the real cost of making things is invisible everywhere except the few categories that fell so fast the average couldn’t hide them, like electronics and software. People then conclude that rising prices are a law of nature, and economists teach that a little inflation is necessary. Central banks publish why they aim at 2%. They want room to cut interest rates in a downturn, they know wages resist falling, and they say the official measure of prices overstates the rise. Those are the reasons they give, and the debts aren’t among them. The debts show up in the rescues, not in the everyday 2%.
The deflation hides the money creation because the collapse in the cost of making things absorbs part of the new money that lands in the shops. The trillions created since 2008, and for decades before, would have shown up in the shops as inflation of up to twice what was recorded, in a world where costs stood still. Costs didn’t stand still. Where technology reached, they fell hard, and the fall soaked up part of what landed, so the average price level stayed tame and the money creation looked free. The saving from better tools quietly paid the bill for the policy.
Each force hides the other. That’s why the public argument about whether inflation or deflation is coming misses the point. Both are happening at once, in different layers, and arguing about the net keeps everyone from seeing the full size of either force before they cancel.
And when the upward force briefly ran ahead of the fall it was cancelling, the mask slipped, as the mechanism says it should. In 2020 the amount of money in the United States grew by about 3.7 trillion dollars, in a country where corporate profits after tax in 2019 came to about 2.2 trillion. Even if every dollar of those profits had been taken, it wouldn’t have matched the new money. Consumer inflation duly arrived, peaking near 9% in the United States and above 11% in Britain. Blocked supply chains pushed the same way at the same time, so the spike wasn’t money creation’s work alone. It fell back fast once the emergency creation stopped, partly because each year’s rise is measured against the year before, and the year before had been unusually high. The spike confirms the mechanism. Push one side hard enough and the net turns visibly positive. Then the downward pull from technology shows through again.
What the small net number hides
1.An annual transfer measured from the wrong baseline
From zero, 2% looks like a rounding error. The right baseline is the fall that should have happened, a point or two a year on the published figures. Measured from there, the gap is at most three or four points a year in what your money can buy. A point or two of that gap is the productivity gain that workers and machines really did produce. Part of it reached you as higher pay, late and unevenly. The rest went to whoever the new money reached first instead of reaching you as lower prices. The gap compounds, year after year. No official statistic reports it, because statistics measure what happened, and this is the distance between what happened and what should have happened.
2.Where the new money went
New money spreads unevenly. It enters at specific doors, and the people closest to where it enters benefit first, before prices adjust. That’s called the Cantillon effect. And in the years of bond-buying it chased assets first. Inflation is measured on the CPI basket, the consumer price index, the official list of everyday prices. Houses aren’t in that basket, or barely so, and shares aren’t in it at all. A doubling house price gets recorded as wealth. Inside the basket the average hides a violent split too. Electronics got cheaper for decades while rent, healthcare, tuition, and insurance kept climbing. Both stories are true at once, which is why the index can read 2% while the essentials you can’t skip feel far worse. Then there’s shrinkflation, the same price on the shelf for a smaller portion or a worse service, which is a price rise the index struggles to catch.
3.Whose life the number prices
Inflation and a wage that buys less are the same event from two sides. If prices rise faster than your pay, your pay fell in real terms, full stop. A 3% raise feels good until rent and food jump 8%. The asset owner gains what the wage earner and the saver lose, so the 2% world runs a yearly transfer from wage earners and savers to asset owners. Then we spend our politics arguing about the symptoms.
4.The growing dose behind the flat number
Because technology compounds, what it takes to cancel the fall keeps growing. Between 2000 and early 2018 the world added roughly 185 trillion dollars of debt to buy about 46 trillion of growth, four borrowed for each one gained. The rescues that met the two big crises grew, from hundreds of billions in 2008 to trillions in 2020. A stable-looking 2% means a system that has had to run harder each time a big crisis came, to hold the same two steps of lead on that walkway. That flat number is what fragility looks like from outside.
5.The corruption of the price signal
Prices are information. When every price is part the cost of making it and part policy, prices tell you much less about what anything is worth, what’s scarce, or which projects pay. Money flows into ventures that only make sense because more money is coming. The 2% hides that prices, the economy’s way of measuring what things are worth, have stopped measuring well.
Taking the number at face value
“The statisticians aren’t lying.”
Mostly agreed, and it doesn’t matter. An honest CPI answers the wrong question. It measures movement from zero, and the transfer has to be measured against the prices that should have existed, which no basket is built to capture. Some choices of method do flatter the number at the margins. When a product gets better, the statisticians mark its price down in the index, and that’s called hedonic adjustment. And 2% is defined as success, so the measure becomes the goal. But the baseline error is the main event.
“If printing were that big, we’d see hyperinflation.”
You see the inflation in whatever the new money chases. It chased assets, which the index doesn’t price, or barely so, and in the shops part of it was cancelled by the collapse in the cost of making things. When creation went extreme in 2020, consumer inflation arrived twelve to eighteen months later, with blocked supply chains pushing the same way.
“We need 2% or people stop spending.”
People still buy phones, laptops, and TVs even when they expect next year’s model to be better or cheaper. What does get put off is the purchase that can wait, and sometimes that’s a big one, like a car. What falls when people wait is the borrowing that would have paid for it, and life carries on. People don’t stop spending when prices fall, so the 2% isn’t needed to keep them spending.
Priced in a money nobody can print
Change the ruler. Price the same goods in a money nobody can create more of, and you see a movement the pound price can’t show you. Measured in bitcoin across multi-year stretches, houses and much else have been getting cheaper even as their pound prices were rising. Same houses, same world, different unit. Nearly all of that fall is bitcoin getting stronger as people move their savings into it, so the comparison shows you a price moving with its unit, and it can’t show you the size of the fall technology should have delivered. You still have to reason your way to that. When the unit holds still, movement shows up as movement. When the unit is moving too, the reading carries both movements and separates neither. The real cost of making things falls, the pound loses value faster, and what you read on the price tag is the difference between them.
Measured inflation is a net, and the net is what two enormous forces leave behind when they cancel each other. What the number hides starts inside that cancellation.