Inflation Caution vs. Inflation Hysteria

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If you believe mass media reports, the United States economy is about to be crushed by inflation. When gasoline prices went up, there were widespread panic stories about the impossibility of living with high gas prices. When gas prices went down again, that apparently wasn’t newsworthy. Now food prices are up and there are widespread panic stories about how people will survive with higher food prices. And of course, Joe Biden is to blame for everything.


Inflation can represent a serious problem. Inflation rewards those who can make rapid financial adjustments to hedge against price change. Inflation punishes people whose sources of income are inflexible. Employers can raise prices more quickly than workers can increase their wages. Price changes can be accomplished by managerial fiat. Workers have to ask their employers for raises; the employer does not always say yes. When prices are rising, but wages are fixed, workers become relatively poorer.


Inflation also rewards liquidity and financial nimbleness. An investment bank can move money between currencies to minimize inflation risk. The bank can move into real assets such as commodities or land. The bank can hedge against inflation through the use of derivatives. Employers who have to purchase particular inputs regardless of price and use particular equipment or facilities regardless of cost of operation or rent do not have the ability to move their assets wherever they like to profit from changes in the value of currency. The net effect of inflation is to transfer money to financiers from employers and to employers from workers. When Milton Friedman said “Inflation is the cruelest tax of all”, he was quite correct that the poor suffer more from inflation than does any other economic group.


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But inflation is not the only problem that a national economy can have. A bigger problem is unemployment. When inflation is high, people have to pay more for groceries or for rent. When unemployment is high, they can’t pay for groceries or rent at all because they have no money. Inflation may be a nuisance. Unemployment is devastating.


Note that not all inflation is bad. Sometimes inflation has a good cause – or inflation is a tool to getting other problems solved. One cause of overall inflation is wage inflation When the economy is at full employment, or labor markets are tight, employers have to compete among themselves to get workers. This means they are forced to increase wages and to offer employees better working conditions. The increase in wage and benefit costs leads to those employers raising their prices.


There can be no better news for the people who live and work in an economy than prices going up because there is full employment and wages are high. Everyone who wants to work can find a job. Standards are living are high. Prices may be going up – but workers have the money to deal with that. When the economy is so good that poverty is going down, there is generally going to be some inflation.


High energy prices are good for stopping global warming and saving the planet. Right now, the Amazon and most of the other rainforests of the world are being destroyed by widespread logging. More and more of the world is being polluted as we go to ever more remote locations to extract oil. The replacement of fossil fuels with solar and wind power has been limited. The only way we are going to keep the carbon layer and the environment as a whole from being destroyed is by conservation – by using less energy. High energy prices make people conserve. When gasoline is expensive, people buy fuel-efficient vehicles and if need be, drive less. Inflation caused by energy prices is an economic nuisance. However, the destruction of the ozone layer or the exhaustion of the world’s energy sources won’t be a nuisance; it will be a catastrophe.


Inflation can produce a weak dollar. This makes foreign travel more expensive for American tourists. It makes it more difficult for us to buy foreign goods. Since many of the products used by American consumers and firms come from China, a weak dollar will make many of those products inaccessible.


However, a weak dollar also creates American jobs. When Americans can’t buy goods from foreigners, they buy goods from American producers. They buy a Ford rather than a Toyota. They drink California wine rather than French wine. American companies find that their goods are more competitive overseas because dollars are relatively inexpensive. While a cheap dollar would probably not be enough to make our manufactures price-competitive with those of China, it would certainly help us to compete with the Europeans and the Japanese.


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That said, inflation is not a zero problem. I spent the summer of 1994 in Brazil when Brazil was experiencing a 2477% inflation rate.


Not 24.77%.


2477%.


Currently, the U.S inflation rate is 8.3%.


Life in Brazil under 2477% was ungodly hell. In that period, the Brazilian cruzeiro was the unstable currency. The American dollar was more stable. People would have to go in the morning to change their dollars into cruzeiros to make their morning purchases. Your dollar would be worth more in the afternoon than it was in the morning. If you needed afternoon money, you changed your currency again. If you were going drinking in the evening, you found someone who would change your money at 7 pm. Upper class and middle class people were able to weather the storm by using connections to get dollars – and then changing those dollars just at the last minute whenever cruzeiros would be needed. Poor people had no access to dollars and could not leave their jobs to go wait in line at banks. Their money just became progressively worthless. There was nothing they could do about it.


At 8 percent we are in good shape. However, at some point, action will have to be taken about inflation to prevent more extreme problems from developing. The standard approach to inflation control is to have central banks raise interest rates. There are many signs that the Federal Reserve Board intends to do that.


Another approach is to reduce government deficits. For some people, cutting government deficits always means cutting government spending. A perfectly reasonable alternative to cutting government spending is to raise taxes. Either alternative reduces the deficit. Right now, the United States faces very real needs for defense spending. We are supporting the Ukraine against Russia. There are potential conflicts with Iran or North Korea. The security of Taiwan is an unresolved issue. Arbitrarily cutting defense spending might not be wise.


Domestic programs are equally important. Does anyone want to see social security reduced? Does anyone want us to stop repairing highways and bridges? Does anyone want the government to stop providing financial aid to students? Does anyone want us to reduce border security? These are all federal expenditures.


On taxation, the question is who would pay those taxes. The poor can’t pay much. The middle class is already heavily taxed. The 1% who in theory have infinitely deep pockets –already pay a disproportionately large percentage of America’s taxes.


A lot of American corporations pay zero tax. They pay zero tax because of entirely legal loopholes. The law explicitly allows them to take massive deductions that make whatever profits they earn, essentially, tax-free. (See the essay on this website: The Zero Tax Club. https://www.samuelcohn.net/current-affairs-1/the-zero-tax-club)


Many of these companies, or the stockholders of these companies, are the people who are complaining the loudest about inflation.


If you want to reduce government deficits, this is a very logical place to turn. And contrary to the rhetoric, taxing corporations does not reduce employment. (See the essay on this website Why Tax Cuts Don’t Create Jobs. https://www.samuelcohn.net/development-1/why-tax-cuts-do-not-create-jobs)


People can use inflation to create generalized discontent so they can replace Biden and the Democrats with politicians more to their liking. They would do the same if there was no inflation and there was unemployment instead. Because under Biden, we have had full employment, his opponents have to go after inflation because it is the only grievance they can find.


But if you ask these same people if they would be willing to pay more taxes to stop inflation – suddenly the story changes. If you ask these people if they would like to see their donors and contributors pay more taxes – then suddenly inflation is a secondary priority.


In my opinion, full employment is much more important than currency stability. High prices for energy and for imported products are a good thing rather than a bad thing. But if you want to keep inflation under control, get the deficit under control. You get the deficit under control by raising taxes to cover America’s necessary expenses. If we need to help the Ukraine, a way needs to be found to pay for it. If we need to secure the border, a way needs to be found to pay for it.


A German banker once observed in reference to American public finance “Americans don’t like to pay their bills.” Germany has long run far more balanced budgets than does the United States. They provide more benefits to their population than the United States does. (An obvious German example is universal health care.) They pay for this with higher taxation. For much of the last fifty years, German economic growth has been on a par with the United States. Until Germany got stuck with absorbing the moribund East German economy, the unemployment rate in Germany was much lower than that of the United States. German economic management has always emphasized strong fiscal discipline and rigid control of inflation.


Paying our bills would do a lot to control the small-scale problems of inflation we have currently. Are Americans really ready to do this?