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Politicians Play With Fire by Risking Inflation

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Prices are rising, government spending is soaring, and trillions of dollars of new money appears as if by magic. It’s all intended, we’re told, to sustain the economy through the pandemic and then get individuals and businesses back on their feet as COVID-19 fears retreat. But many observers can’t help but wonder if rising prices are a sign not of a country returning to health, but of money losing its value in a world starting to suffer a renewed bout with an old enemy of prosperity: inflation.

“Unfortunately, we’ve turned our backs to inflation during the past decade, and we’re about to relearn a painful lesson about respect,” warns Connel Fullenkamp, a professor of the practice of economics at Duke University. “The Fed and the Biden administration are dismissing the latest inflation data, claiming that the jump in prices is merely temporary. Besides, they continue, it will be good to let the economy run hot for a while. In other words, don’t worry—higher inflation won’t be a big deal.”

The Biden administration isn’t quite dismissing inflation worries, but it is downplaying them and putting them in the context of a return to normalcy after prices for many goods collapsed when demand disappeared during the pandemic.

“We take inflation very seriously,” White House Press Secretary Jen Psaki told reporters on May 17. “But there are a number of factors, as the economy turns back on, including — there are areas like the cost of airline tickets where, you know, if you look back at pre-pandemic, they dropped by about 20 percent.”

Psaki added that rising prices have “not changed our view and the view of economists, I would say, around the country that there’s more that needs to be done to put 8.5 million Americans back to work.”

Prominent among what “needs to be done” according to the Biden administration, is lots and lots of federal spending to revive the American economy—with politicians in charge.

“Mr. Biden’s plans add up to about $6 trillion and reflect an ambition to restore the federal government to the role it played during the New Deal and Great Society,” Glenn Thrush of The New York Times summarized at the end of April.

That figure may be trimmed a bit during congressional negotiations, but it still constitutes a massive sum, on top of the trillions already spent in pandemic-era “stimulus.” Worryingly, much of that money was created by the Federal Reserve out of thin air, with M2, a standard measure of money supply, rising from $15.2 trillion in February 2020 to $19.6 trillion a year later.

“While the Fed can create money out of thin air, that does not mean it does so without cost,” cautions William J. Luther, assistant professor of economics at Florida Atlantic University. “Indeed, there are two potential costs of creating money that one should keep in mind. The first results from inflation, which denotes a general increase in prices and, correspondingly, a fall in the purchasing power of money.”

Even with relatively low inflation, that fall in the purchasing power of money can sneak up on you, eroding the value of any currency you hold. That’s why the 2021 dollar will buy only about half of what a dollar would purchase in 1990. A sudden inflationary surge erodes the value of money even more quickly, eating into people’s income and savings.

And, in fact, the widely watched (and equally criticized) Consumer Price Index is up 4.2 percent from April 2020 to April 2021. That’s “the largest increase over a 12-month period since a 4.9-percent increase for the year ending September 2008,” according to the Bureau of Labor Statistics. Production and transportation disruptions, as well as shifts in the way people live, contribute to (presumably) temporary spikes in prices for some goods. But businesses and individuals alike are seeing price increases across the economy, and anticipating more. “[F]orecasters have raised their projections for several measures of inflationary pressures – the consumer price index, the personal consumption expenditures price index and the PCE measure excluding food and fuel – for each quarter through March 2022,” reports Bloomberg.

That’s a problem for policymakers relying on the American public’s long resistance to higher prices to keep a cap on inflationary pressures. If people resign themselves to rising prices no matter what, it’s easier for sellers to respond to the pressures they face to charge more for finished products.

Policymakers feel comfortable ignoring warning signs because we’ve been largely insulated from such pressures for a decade says Duke’s Fullenkamp. In part, this was because China based its recover from the financial crisis on becoming the world’s factory, reducing costs of production. At the same time, it became increasingly easy for consumers to compare prices and shop online for the best deals. Stagnating wages for some people also placed a cap on price increases. “And the icing on the cake was the fall in energy prices, primarily due to the explosion of hydraulic fracking in the U.S.,” he adds.

But even before the pandemic, Fullenkamp saw signs of inflation in rising prices for stocks, bonds, and real estate. “Most people aren’t used to thinking about skyrocketing stock and home prices as inflation, but much of the 214 percent increase in the S&P 500 and the 73 percent increase in the Case-Shiller home price index over the past decade was due to all the extra money the Fed dumped into the financial system through quantitative easing,” he writes.

If true, that means that inflation potentially remains as great a threat as it has been in periods such as the 1970s when the annual inflation rate, at times, exceeded 13 percent. That devoured the value of money, so that a 1980 dollar purchased less than half as much as a 1970 dollar.

And flirting with inflation is only arguably worth the risk if massive government spending and expansion of the money supply actually is necessary to restart the economy. But industrial production has revived to the point that it is only 2.7 percent below its pre-pandemic level. And the 6.1 percent unemployment rate has not only dropped dramatically from its 14.8 percent high last April, but would probably be even lower if the government would stop paying people to not work. More massive federal spending isn’t stimulating the economy—it’s distorting it.

“The Fed-driven economy relies on the creation of trillions of dollars — literally out of thin air — that are used to purchase bonds and push money into a pandemic-ravaged economy that has long been dependent on free cash and is only growing more addicted,” Axios Markets Editor Dion Rabouin warned in December, even before economic activity picked up.

Politicians may like that addiction—addicts are dependent on their sources, after all. But, if they trigger a new round of inflation and devalue money in the process, nobody will be very happy.



Source: https://reason.com/2021/05/24/politicians-play-with-fire-by-risking-inflation/


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