Neuter or Bobbit?
What ought to happen does happen…but you can go broke waiting for it.
Inflation is happening, as it should. The feds inflated the money system. And consumers are now reeling from price increases. We’re just waiting to find out what happens next. In a broad-brush way, there are really only two possibilities. Either the Fed controls inflation…or inflation controls the Fed.
Either it neuters inflation…or inflation ‘Bobbits’ the Fed.
As we’ve been describing, inflation ought to be self-correcting. Higher prices should motivate producers and discourage consumers. People should drive less. Buy less. They should stay at home and turn the lights off. Prices ought to come down.
But ‘don’t hold your breath’, was Janet Yellen’s message yesterday:
‘I do expect inflation to remain high, although I very much hope it will be coming down now.’
Ms Yellen has a remarkable ability not to notice what’s really going on. We will only know that inflation is on its way out, for sure, when she tells us it’s eternal.
Money we can trust
In the meantime, let’s try to figure out which way it will go: who will end up singing in a high-pitched, ‘castrati’ voice? The Fed? Or its inflation?
Governments use ‘printing press money’ the way a pickpocket uses his fingers. It gives them access to money that they oughtn’t have. With it, they finance programs and giveaways that neither taxpayers nor lenders would willingly pay for. Naturally, they want to keep the racket going as long as possible.
But inflation is the worst form of taxation. It strangles the goose even before it lays its golden egg. An economy needs money it can trust. High inflation rates make business, investment, and even consumer decisions much more difficult. Few people are willing to make long-term, wealth-creating investments when price increases appear ‘out of control’. Factories don’t get built. Highways aren’t repaired. Innovations and improvements don’t happen. People get poorer.
Prices in the US are rising at an official rate of more than 8%. The things people really care about — food, shelter, fuel — are going up much faster. A Fox News headline: ‘Gas prices climb 5 cents overnight; Americans are paying nearly $2 more from just one year ago’:
‘The national average gas price climbed five cents Monday night into Tuesday and 10 cents since Saturday, now hitting a record $4.92 per gallon, according to the American Automobile Association.’
Redfin says house prices were up 15%. And the FAO says food prices worldwide are up 60% over the last two years.
So, what ought to happen next? Let’s look more closely at how it works.
As bust follows boom
Some inflation is a natural by-product of the business cycle. In boom times, demand goes up…and prices with them. Then comes the bust, and prices go back down.
And sometimes prices move up simply because demand goes up or supply goes down. The approach of a hurricane, for example, has a stimulating effect on sales of generators; plywood prices rise.
Likewise, COVID lockdowns, war and sanctions, too, play a role in today’s price increases.
But there’s something else at work…something more sinister and less responsive to the natural feedback loops of an honest economy. It’s something that was underway long before the COVID Panic or the Russo-Ukrainian war. It is intentional…self-inflicted…a feature of US fiscal and monetary policy…and by extension…a mashup of the world’s monetary system.
As long as the feds keep their policies in place, we should continue to see rising prices. In fact, inflation should get worse. That’s what ought to happen too. Because natural business cycle inflation is self-correcting…wars end…and hurricanes move on. But premeditated inflation is self-intensifying.
That is, as prices rise, purchasing power goes down. Then, ‘inflation’ takes on a life of its own. People must have more money just to maintain their standards of living. Businesses, investors and the government have become accustomed to having more and more money. As prices rise, they need more money to stay in the same place. If more money is not forthcoming, sales fall…prices drop…and a recession takes hold — all the things the authorities are so eager to avoid.
That’s the ‘inflate or die’ trap we’ve been describing. Once you start inflating, you have to inflate more, or the inflation-dependent economy dies.
The strongest recovery never
What’s more, when people come to see that inflation is not going away, they get used to it. They become eager to get rid of their money as soon as possible. Instead of saving money, they spend it quickly, before it loses more of its value. This increases the ‘velocity’ of money, which in turn increases the rate of price increases.
‘Inflation expectations’ are even harder to control than inflation itself. It’s why a central bank wishing to reduce inflation must ‘get ahead of it’. It must show that it is serious by tightening up more than expected.
That is what Paul Volcker did in 1980…raising the Fed’s key lending rate to a breathtaking 20% — nearly 700 basis points ABOVE the consumer price inflation number.
For reference, the current Fed’s lending rate is about 700 basis points BELOW the CPI.
‘Nuff said’, as Howard Ruff used to put it.
Neither is the White House serious about reducing inflation. It’s the ‘strongest recovery in modern history’, say Biden et al.
‘We’re in a good position to really take on inflation’, added the White House press secretary yesterday. But the federal deficit is still on track to exceed US$1 trillion this year.
If you can’t balance the budget in the ‘strongest recovery’ ever…when can you? Never. And if you don’t get serious about tightening monetary policy when the CPI is more than 8%, when will you?
The answer is simple — when you can’t do anything else.
For The Daily Reckoning Australia