What is inflation and what is causing it? Inflation is a measure of the rate of rising prices of goods and services, in an economy. It occurs when there are increases in raw materials, production costs, and wages. Inflation also occurs when there is easy money chasing a limited supply of products, and supply side interruptions.
Most people think of inflation as the costs of daily items, like food and energy costs increasing over time. The government provides a simple index of costs called the Consumer Price Index. It is a very rough measure of consumer inflation.
However, inflation is really the result of the loss of purchasing power of a country’s currency. What a dollar can buy today, is substantially less than what it could purchase in goods and services, 5 or 10 or 15 years ago.
A 1947 Dollar has the purchasing power today of less than 8 cents.
Arthur Burns, Federal Reserve Chairman under Richard Nixon, said it best, I believe. “A major cause of Inflation is Government Deficits.” That is if the U.S. Government spends more each year than it takes in through taxes, and fees, the difference causes extra dollars to be borrowed, to balance the books. With more dollars being borrowed each year, the “Value” of each existing dollar, declines.
Now the introduction of more dollars into the economic system by the Central Bank, Federal Reserve, also causes “asset inflation” As monetary authorities print more money there becomes a general increase in the competition for stuff. As more people want something, and there is a limited supply of that product the price goes up. This is particularly true when people can also borrow money at low interest rates to leverage their purchasing power.
It is much easier to buy a home for $300,000 if I only have to provide a 20% down payment and borrow the balance from my friendly banker. The demand for homes would increase dramatically, if the down payment required was reduced to 10% or even 5%.
Now, the National Debt has been increasing over the last 50 years and has gone into “runaway mode” the last few years under Presidents Bush, Obama, and Trump. With each President and Congress adding Trillions to the National Debt, year in and year out. With a record increase of adding $3 Trillion in Debt in the last year of the Trump Presidency.
You cannot have a first class Military, and provide first class services to Businesses and the Population, if people and corporations are not willing to pay the necessary level of taxes.
Borrowing the difference each year only passes the fiscal problem to the next generation, and at the same time decreases the value of each dollar, resulting in inflation.
So inflation has been increasing slowly over the years, but has been mostly unnoticed by the introduction of low cost labor from China and Mexico. The result of Globalization.
So how has inflation jumped up so quickly this past year? As Hemingway is supposed to have said, when asked how he managed to go bankrupt, he replied, “Slowly at first, and then All of a Sudden.”
How bad is it going to get? I don’t know. But I do know that the National Debt is now $33 Trillion Dollars and the interest payments of that Debt are slowly becoming the fourth largest expense item on the budget, after Defense, Social Security, and Medicare.
Why is inflation such a problem now? The recent spike in oil and commodity prices due to Russia’s war in Ukraine, together with the record increase in the National Debt caused by tax cuts, and covid relief spending, are the toxic mixture setting off the present record increases in consumer and asset prices.
In the past 50 years the only President who produced a government surplus was Bill Clinton, who increased taxes, and reduced social welfare spending. He was roundly criticized by all sides of Capitol Hill for doing that. But the major part of the criticism was from those who are the major beneficiaries of inflation, Wall Street and Corporate America.
The only way the Federal Reserve could tame inflation would be to increase interest rates, which will make it less likely that people and corporations will borrow to buy things, reducing demand. Without scaring you, in the 1970’s inflation period, Fed Chairman Paul Volker had to raise interest rates to almost 12%.
Another major contributor to inflation is the concentration over the past years of the production of goods and services into fewer and fewer corporate hands. Because of corporate mergers, companies can afford to increase prices without concern about losing customers. For example when there are basically only two soft drink companies, let’s call them P&C, they can raise prices almost at will as long as their competitor(s) does the same.
Record profits might suggest they should reduce prices, but they have no incentive to do so. They can also use the excuse that some of their costs have gone up slightly, and they are “only” pacing along their cost increases.
Can Congress meet its challenge? Can the Federal Reserve increase interest rates without causing a recession and a stock market sell off? Stay tuned.