February 27, 2021

The Alfred E. Neuman School of Inflation: What Me Worry?

by Hal Gershowitz

Comments Below

This is no time for America to be worried about inflation, right?

Don’t be so sure. The bond sell-off last week tells us a lot of investors aren’t so sure either, at least with respect to asset prices. If we pretend the threat of inflation is non-existent or even ridiculously remote, we do so at our own peril. While the beast of inflation is not salivating and just waiting to pounce, the beast never dies. Coaxing it can be dicey and dangerous, and we’re about to coax it…again.

While the country has gone through a terribly rough time because of the Coronavirus lockdowns last year and the resulting loss of over a half-trillion dollars of economic activity, we are concurrently poised for a heated comeback as the pandemic diminishes.

Here’s why. The so-called M2 or, in normal speak, the nation’s highly liquid money supply is already bulging in bank savings and equivalent accounts. Much (certainly not all) of the pandemic financial assistance that has been provided to date has simply accumulated in bank accounts because many households (certainly not all) have been bottled up in their homes with fewer ways to spend money.

Today, without Biden’s additional $1.9 trillion of so-called COVID relief, $1.6 trillion has already accumulated in liquid accounts compared to a year ago (that’s trillion with a “t”). That’s money largely available to be spent that has had nowhere to go for the past year.

It is important to keep in mind, as left-of-center economist Lawrence Summers advised recently, $3.5 trillion has already been pumped into the economy to offset the ravages of COVID-19. The build-up of liquidity in household accounts means that household spending will begin to surge before the end of the year as the constraints imposed by the pandemic wind down. The non-partisan Congressional Budget Office projects that unemployment will plunge to 5.3% by the end of this year.

The Biden $1.9 trillion coronavirus relief package, which has passed the House, will now advance to the Senate for passage and then to the oval office to become law. The package includes $1,400 for tens of millions of households for pandemic relief. Why $1,400? Because $1,400 added to the $600 the prior Administration mailed out equals $2,000. It’s that simple.

Two thousand dollars is a nice, big, juicy, politically appealing round number, and that’s why the Biden Administration is insisting that $1,400 be added to the $600 the prior Administration provided. It also happens to be what President Trump, otherwise known by President Biden as the “former guy,” said should have been provided last time. No government analysts with green eyeshades came up with that number. It was born of political banter.

Is there anything wrong with this extra $1,400 infusion?

The issue isn’t whether there is a need for additional pandemic relief. There is. However, the Biden $1.9 trillion, swollen with excess payments, much of which will go, untargeted, to households that are already pretty liquid, is probably far in excess of what is really needed. The ten Republicans who came to the White House with an initial offer of $618 billion of pandemic relief, may have been much closer to what the crisis calls for then Biden’s $1.9 trillion.

The point is, we’ve been borrowing like crazy to deal with the pandemic. When the nation operates at a deficit of revenue relative to expense the difference, of course, must be borrowed. Even before the pandemic, the Trump Administration was operating at an annual deficit approaching a trillion dollars. Then came COVID-19 and our debt has gone through the roof, and now it’s about to exceed the highest previous level of debt to GDP (134%) not seen since the height of World War Two. Traditional economic wisdom taught that debt exceeding 75% to 80% of GDP was dicey.

The size of the United States economy by the end of 2020 was just under $21 trillion, which represented a decrease of about a half-trillion dollars because of the loss of economic activity imposed by the pandemic. Concurrently, however, the debt the United States already owed has increased by $4.54 trillion to a staggering $27.75 trillion. This includes about $7 trillion the government has helped itself to from other government designated trust funds such as the Social Security Trust Fund.

The point? The prevailing wisdom has been that the skyrocketing national debt doesn’t matter that much because borrowing cost (interest) is so low. Well, keep in mind, interest rates are only as low as lenders are willing to accept relative to the risk they perceive. With the nation’s debt now at 134% of GDP, lenders might begin demanding that these super low interest rates be adjusted upward given the relative risks associated with such high debt to GDP.

So, what’s wrong with a little inflation?

Supposedly nothing because the Fed says it has the tools to deal with inflation if the beast raises its head. And the Fed does have a powerful tool. Interest rates are so low the central bank will begin raising rates to starve the beast when necessary. Just keep in mind that when the Fed begins raising interest rates to squeeze inflationary pressures out of the system, they squeeze consumption and construction. Interest charges go up on credit cards, auto loans, home mortgages, and all other borrowings, and concurrently, of course, labor is squeezed and, often, squeezed hard. Workers lose jobs. And that’s the idea. That’s how the Fed fights inflation.

So, to those in the Alfred E. Neuman School of Inflation; well, a little worry right now, might go a long way.

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5 responses to “The Alfred E. Neuman School of Inflation: What Me Worry?”

  1. Steve Hardy says:

    One of the reasons we haven’t seen much inflation in the past few years or so is due to the low level of money velocity. Velocity measures how well money created by the Fed gets into the economy. One reason it is low is that the Fed is paying interest on bank reserves which is disincentivizing banks to loan the money. If interest rates rise this could change. More money plus increased velocity means higher inflation. Keep an eye on velocity https://fred.stlouisfed.org/series/M2V .

  2. Robert borns says:

    What taxpayers think of wild crazy insane excess spending is of no concern to politicians of either party. Why? Because they wish to be re-elected by delivering as much as possible to their supporters no matter what it costs. Do they expect to pay the debt off? Never. Are you kidding. They will be long retired so they kick the can down the read. As Hal says -who me worry? How will the debt be serviced? By inflation. Borrow a dollar and pay the interest in a future dollar with a 5 cent value of the currency. Or maybe less. Remember when a current cheap project house that sells for $390000 now cost $20000 in 1960. The fake experts talk of their tool box of preventive fiscal and economic controls. That’s talk for fools and succers. They operate with the expectation that wild raging periods of inflation will bail them out. Bill gates is buying land like crazy. He is America’s largest landowner. The question should be not be is inflation coming sometime but are we personally and family wise prepared for it.

  3. Susan Duman says:

    Whatever you say, ditto from me. The numbers are above my pay grade.

  4. Perry says:

    With this administration I would not expect them to get much
    right. That being said it’s so terrible the specter of runaway
    inflation.

    At last a column I not only agree with but welcome too.

  5. Ray Galante says:

    All about future effects of rate increases , inevitable. Good one, Hal.

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