- - Monday, July 19, 2021

Both individuals and countries are very good at getting themselves into situations with no easy or painless way out. The U.S. now faces a major inflation threat, an unraveling in Afghanistan, a dependency on China for most of the base compounds for antibiotics and many other pharmaceuticals, and a dependency on one company in Taiwan for most high-end semiconductor chips. All of these situations could have been prevented before reaching the current dangerous situation, although they were seen by some.  (This column will deal with inflation, and the other issues will be dealt with in future columns.)

The Washington establishment, and more specifically the Federal Reserve and the U.S. Treasury, were taken by surprise by the latest inflation numbers (more than 5 percent in the Consumer Price Index), even though many of us in the private sector had been warning about the situation for months. The Fed and Biden Administration have argued that the higher inflation numbers are only temporary and caused by short-term supply shortages as the economy rebuilds after the COVID-19 shutdowns. There is some truth to this argument, particularly shortages in some basic materials that have caused big price surges that are already beginning to abate.

However, there is a more fundamental problem, and that is there has been an enormous surge in the money supply.  Much of this money supply increase is held in the form of record-high savings, particularly by higher income groups, which is inducing them to buy goods and services at a rapid clip. This would be fine if supply, in many cases, was not being restricted by government policy. For instance, very high government unemployment payments, which are continuing in some states, have the unintended effect of causing many potential workers to stay home rather than take available jobs. As a result, businesses cannot hire the needed number of workers, causing them to reduce hours or production.

When the pandemic started, Washington policymakers decided it would be a good idea to make payments to all of those workers who were being laid off because of the mandated shutdowns.  The result was that most everyone received payments whether they needed them or not.  At the same time, it became difficult to spend money because of the government ordered economic shutdown.  This, in turn, caused a big increase in savings and also the federal deficit.  People were – and still are – getting paid for not working, causing an increase in money without offsetting increases in the production of new goods and services.  More money and fewer goods cause price increases to clear the market, and these broad price increases are what is referred to as inflation.

Getting rid of the “inflation” is not going to be easy.  At the beginning of the 1980s, Fed Chairman Paul Volcker and President Reagan correctly decided that inflation costs – which was in double digits at the time – were too great, and inflation must be largely eliminated.  The Fed reduced the growth in the money supply, and the Reagan Administration greatly reduced regulations to lower costs.

The adjustment was painful, and the economy was in a planned recession in most months during 1980-82.  Mr. Volcker and Mr. Reagan were tough guys and willing to endure the huge amount of political heat they were taking because of the induced recession, but they knew it was necessary to wring out the inflation. The policy worked, along with the major tax cuts, so by 1983, the economy was growing at a record rate – with much lower inflation.

President Biden and Fed Chairman Powell so far have not come across as tough guys willing to endure the economic downturn that will result when they are finally forced to reduce money growth. They are betting that the increased supply of goods and services will be large enough to absorb the previous and current monetary growth.  Yet, at the same time, they have engaged in supply restricting regulations on business and particularly the fossil fuels industry.  Their efforts to increase minimum wages and impose other costly labor measures on business will again result in higher costs and less output, meaning more inflation – not less. 

There are lags between changes in economic policy and economic performance. The lags can be as long as 18-24 months – in the same way that the big increase in money supply beginning a year and a half ago is only now showing up in higher prices (inflation). 

I bet that as the inflation numbers get worse (there will be monthly ups and downs), the Biden Administration, rather than deregulating, will continue their high regulation and tax policies (which restrict increases in supply) and start blaming the price increases on “greedy” businesspeople. Their media allies will pick up the drumbeat, which will lead the government to impose wage and price controls (like Nixon did).  Wage and price controls never work and are always a disaster, leading to all sorts of economic distortions and huge incentives for black markets. The Roman Emperor, Diocletian, tried and failed price controls back in 301 AD.  Despite hundreds, if not thousands, of attempts by governments everywhere to impose price and wage controls, there is a 2,000-year unbroken record of failure; nevertheless, the Biden people will try once again – and fail!

• Richard W. Rahn is chairman of the Institute for Global Economic Growth and MCon LLC.

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