Giffen Goods

There are hidden substitutions underneath the data

Inflation is likely coming back this year, and with it, some old phenomena which we're generally not that familiar with in the industrialized world.

Headline inflation levels have stabilized but there are signs of stress in recent economic data. One particularly worrying sign is increasing household credit card balances which could be an indication that people are funding their consumption on credit, just to make ends meet. If we have a resurgence in inflation or an economic crisis that leads to layoffs, it could be a very bumpy year.

The US has had it relatively easy during the Great Moderation and into the early aughts but the policies enacted after each of the crises in the past 30 years have set off dynamics which will ultimately lead to a decline in the quality of life for the median American.

This essay will get a little nerdy, as per usual. I promise to make it worth your while.

Giffen Goods

Imagine you are a person who eats 6 pounds of rice and 3 pounds of chicken every week. You live paycheck to paycheck and carve out exactly enough money to afford to eat this way. Now, let's say the price of both of these things goes up by 20%. Rice goes from $5 to $6 and chicken goes from $10 to $12. Previously, you were paying $60 per week but now you are paying $72 per week, requiring you to borrow the extra $12. You decide this is an untenable situation and rework your meal plan by buying 8 pounds of rice and 1 pound of chicken which keeps you within your original $60 weekly food budget despite the higher prices. Your nutrition and financial situation have both disimproved but at least you aren't going into debt.

Notice what happened here — the price of rice went up and the amount you bought also went up. Naive application of the law of supply and demand would have predicted that the price of rice going up would have caused you to buy less of it. The phenomenon of buying more of a good despite the price going up is a form of substitution and the good itself is considered a Giffen good.

This is the kind of thing that is very difficult to surface in economic data. There was no change to our hypothetical person’s weekly expenditures so there would be no change in the aggregate data. They have to spend all of their time working and are very unlikely to have the time and energy to report this data or to complain to their elected representatives. They are too busy trying to get by. So, by the time we see aggregate credit card balances increase, this kind of dynamic is already happening beneath the numbers and the stress is overwhelming the most economically vulnerable people. That makes aggregate credit card balance data a lagging economic indicator of financial stress: by the time we see a move in the data, the stress has already been happening for some unknowable amount of time and the changing data doesn’t tell the whole story.

Everything is Energy

It is not only a physical reality (thank you, Einstein) but it is also an economic and social reality that everything is energy. Food is literal energy for our bodies and is just as much of an oil derivative as gasoline or jet fuel. Diesel is used to power the machines that cultivate the land and transport the produce. Petroleum goes into the NPK that prepares the field for planting, etc.

The fact that the United States can indirectly print oil because it owns the printing press for the reserve currency makes oil very cheap for Americans in a global context. More than likely, no one reading this essay is in the circumstance of our hypothetical person and hopefully never will be. Because energy is so cheap, most people probably never think about the price of oil or diesel fuel and how it impacts their lives. That is a convenience purchased by US dollar sovereignty. It’s also an imperfect and impermanent situation.

For a sobering look at the affordability of energy globally, have a look at this chart.

The number of hours the median worker has to work to equal one barrel of brent crude (USD78.43/bbl) as of January 14th, 2024. Wage data from https://www.numbeo.com/cost-of-living/country_price_rankings

The US even gets a discount on the price of a barrel. WTI is USD72.72 at the time of writing versus USD78.43 for brent which moves the US from fourth to third in that chart. The median worker in the top four countries has to work fewer than three hours to afford a barrel of crude oil. The median worker in the median country on this list has to work almost two days.

Cataclysmic Catalyst

The event or sequence of events that brings this party to a stop is uncertain but war is a good first guess. If the US gets pulled directly into a hot war with any of the current belligerents, its treasury will drain just like the treasuries of Europe drained during the first two Great Wars. Trust in the rule of law backing the US dollar is already diminished by the Russian sanctions at the beginning of the Ukraine conflict. Direct involvement in war will likely damage the remaining trust irreparably. The ability to print oil will be taken away in that scenario and the US will have to pony up real goods in exchange for energy like the rest of the world. If any of this happens, America as a culture and as a concept will be completely rewired. Everyone will likely have to make adjustments.

How do we prevent this?

History is cyclical. I've become fully convinced that we as individuals can't stop this cycle any more than we could stop a tsunami by getting into the ocean. We can observe it. We can comment on it. But, ultimately, we have to let it wash over us and see where we are on the other side.

How do we steer through this wave?

The most important thing is probably to stay or become healthy and fit. We'll face physical challenges if our energy bounty diminishes and being physically resilient is just as important as being financially resilient. Personal liberty starts with personal health.

Prefer real things over financial things to preserve wealth. “Real” means different things to different people. Real estate is an obvious one but people also include art, wine, cars, gold, and bitcoin in their list of things which have real value. All of these things have their place but keep in mind that the newcomer in that list has not been truly tested by a real economic crisis and has historically been positively correlated to risk-on assets more than it has been anticorrelated.

One other thing that can help navigate through tough times is to turn your home into the kind of place you would want to “bug in.” Building a “bug out” bag is a fun hobby but if you get to the point where you have to bug out, things have gone fully Mad Max. Bugging in is a much higher probability outcome so being prepared to live comfortably for, at a minimum, multiple days without power, water, and access to grocery stores builds antifragility into your life. If you get to the point where you can bug in for a month, you’re probably covered for 99% of the possible outcomes. If you never need the things you stored up, great! Unclaimed insurance is still useful insurance.

Veblen vs. Giffen

As an aside, it is easy to confuse Giffen goods with Veblen goods. Both are goods whose demand goes up when their prices go up, but for different reasons. Veblen goods are things like sportscars and rare wines which people sometimes want precisely because they are expensive. Giffen goods are things people have to buy more of because other things which they would prefer have moved out of their reach.

---

None of the contents of this essay, or any of my communications, should be considered investing advice.