Editor’s Note: This is a continuation of the discussion of the financial crisis, global developments and the COVID-19 pandemic as they change the long-term direction of our economy. The column is by David B. Prilliman, principal at Professional Investment Counsel Inc. in El Paso.
Politicians and bureaucrats love to make excuses and deflect blame away from themselves, and the continued spike in inflation is a good example of this.
As everyone knows, inflation started to rise at the beginning of last year. This has created an ever-changing narrative and a list of excuses designed to explain rising inflation.
At first, the administration and the Federal Reserve repeatedly said inflation was “transitional” — caused by the pandemic and resulting supply bottlenecks. They concluded that inflation would simply disappear once the temporary imbalance between supply and demand returned to normal.
Now that it is obvious that inflation is integrating into the US economy, that explanation has simply disappeared. The Fed took the unusual step of declaring that it would stop using the word transitional to describe inflation.
As inflation continued to rise last year, the new argument was that the situation was caused by “corporate greed”. This explanation never held water since the United States has a highly competitive business environment, and it was obvious that input costs, including transportation, raw materials, and parts, were all rising. There was also an apparent lack of worker availability.
Then they told us that inflation was a “good thing” because it showed that consumption was increasing. Who could believe this ridiculous argument?
So it must be the oil companies causing the problem by not supplying enough oil to meet demand so they can raise the price of oil.
This argument doesn’t make much sense. Production constraints caused by the elimination of the Keystone pipeline, stopping drilling on federal lands, added red tape, and an unwillingness to lend to the oil industry all combined to reduce production by 1. 5 million barrels per day over the past year. Part of this shortfall has been made up by Russia, which exports 650,000 barrels a day to the United States.
We are now pleading with OPEC and potentially Venezuela to produce more oil.
And, finally, the most ridiculous excuse is that the gas prices and our inflation problem were caused by Vladimir Putin.
Admittedly, Russia’s invasion of Ukraine has caused the price of oil to soar in recent weeks. But everyone knows that gasoline prices were already high on February 24 when the invasion began.
All of these arguments are excuses to divert attention from two of the main causes of our inflationary dilemma.
Inflation is a product of supply and demand. If the demand is high while the supply is low, then inflation is created. Conversely, if there is excess supply and weak demand, then there is downward pressure on inflation.
The Fed has taken an overly dovish stance for most of 2021 by printing money through the purchase of mortgage and Treasury-backed securities — $120 billion a month — while keeping interest rates low. short term close to zero. This caused an explosion in the money supply and the Fed’s balance sheet.
The problem was that this policy was continued long after it was needed. The Fed should have known that the overly accommodative monetary stimulus in response to the pandemic crisis in 2020 was no longer needed in 2021, since GDP and other economic indicators were all improving.
Additionally, the Fed should have taken a preemptive approach to inflation in early 2021 when its 2% inflation target was breached. If they had followed this monetary approach, which the Fed had followed for 40 years, then much of the embedded inflation we are experiencing now could have been avoided.
Now the Federal Reserve needs to catch up and has adopted a kind of pivot. With bond purchases halted and the Fed announcing a 0.25% interest rate hike, they run the risk of doing too little, too late.
Short-term interest rates at 0.25% have no effect when inflation approaches 8%, so the Fed will have to be much more aggressive as the year progresses.
What the Fed should have known from the country’s experience in the 1970s is that it’s easier to fight inflation when you’re in front of it. When you’re chasing inflation, you have to be more aggressive to get it under control.
Congress has also played a key role in our inflation situation.
When the pandemic first hit in early 2020, Congress and the administration responded quickly with a series of stimulus packages aimed at reducing the impact of the imposed lockdowns and the pandemic. In total, about $5 trillion has been allocated to this effort.
Of course, the government had to borrow money to pay for the stimulus packages. As a result, the debt-to-GDP ratio reached its highest level ever, surpassing the record high reached at the end of World War II.
The big problem is that more than half of the $5 trillion issued by the Treasury was bought by the Federal Reserve. To put it more bluntly: the United States printed money to buy its own debt.
Taken together, the Fed and Congress have created an imbalance between supply and demand that fuels inflation and inflation expectations. These policies have caused too much money to chase too few goods and services.
It seems obvious that high inflation will be with us for the foreseeable future. The Fed now holds most of the cards as it rediscovers how inflation takes on a life of its own the longer it persists.
Email your questions or comments to David B. Prilliman at firstname.lastname@example.org.