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An Unprecedented Inflationary Experiment

Garrett Fisher
February 20, 2022

Conventional discussion around inflation tends toward a reference to the 1970s in the United States. After the Nixon Shock, Arab Oil Embargo, and a few other circumstances, inflation began as would be expected. Monetary policy would have called for raising rates to quash incipient price rises, except the Federal Reserve opted to manipulate its method of measuring inflation, attempting to reason away the inevitable. By the end of the 1970s, a new Fed chair raised rates significantly, plunged the economy into recession, and stopped inflation. Discussions to this day tend around a single factor: if the economy has run too hot, when will the Fed raise rates, before making the problem and its cure worse?

Monetary and fiscal policy brought on from COVID-19 is an experiment on many dimensions greater than the simplicity of seemingly proper monetary policy. When the economy came to a symbolic halt, under planned government coordination worldwide, we embarked on an experiment that had not been done before. The thinking process at the time was to keep society from collapsing, by rushing money into the hands of those idled by public health measures. As long as the economy was partially shut down, there was little in the way of consequence economically for such a choice. In fact, it seemed at the time to be an innovative emergency response to a new crisis.

If the stock market is at all efficient at pricing future expectations into current share prices, then it was the world’s greatest leading indicator for what came next. To the surprise of many, equities markets were back in business, if not downright healthy within a few months. The fact that share prices reversed in tandem with significant central bank pronouncements regarding liquidity and Congressional spending packages indicates, in retrospect, that those measures were more than enough to forestall recession. In fact, one could say that they were too much.

Inflation is measured in lay terms around money supply. If M2 increases significantly, then history shows that inflation follows. The common person knows that printing money has the effect of runaway prices; nobody gets a free lunch…. not even the day-to-day worker, and this is something we all understand. Prior to COVID-19, continuing quantitative easing in the developed world raised ongoing alarms about the value of money and inflation expectations, even if its effects were seemingly restricted to investable asset classes.

As a side note, we may have escaped the worst from QE due to the simultaneity of deflationary and inflationary characteristics. While QE is an inflationary tool of monetary policy, it was used in the presence of a number of factors which worked against it: eurozone fiscal rot, systemic employment issues, the hangover from 2008, globalization, automation, and so forth. It was this deflationary reality that caused central banks to employ the tool in the first place.

So, back to the printing press. Whether it is Weimar Germany, Zimbabwe, or any other nation of ill fiscal repute, to run the press generally results in the diminution of value of currency which can collapse society in the most extreme of circumstances. That much is simple and is to be expected. Where things went into experimental territory with COVID-19 derive from precisely how we spent that money. If there were a formula to disrupt an economy as much as possible, we might have found the way.

In the United States, stimulus and unemployment benefits were first paid out indiscriminately, regardless of need. Those still working and earning a healthy wage had money printed and handed to them. When it came to unemployment benefits, existing state programs tended toward being a non-living wage, for a variety of political purposes. Since computer systems could not make reasonable calculations regarding actual wages lost, lump sum surpluses were printed and added on the federal level, often paying workers well more than they were earning while working. The PPP program in the United States, initially designed to create a mechanism for businesses to retain employees during what was to be a short initial lockdown metastasized into a nearly blanket program for many small businesses, with printed grants for unaffected small businesses well into the hundreds of thousands of dollars each.

The perfect storm that we have created is a world with rising prices, supply constraints, excess demand, and no end in sight to a reasonable equilibrium. It is now normal that things cannot seem to be produced as they were before while we pay significantly more for them. Why is this the case?

Supply and demand are the age-old mechanism to explain price. Tinker with one or the other in an efficient marketplace and one gets a textbook result economically. Policies around COVID-19 tinkered with both. We simultaneously did the following:

  • Idled a significant portion of the economy by public health order
  • Paid people sometimes more than their wage not to work
  • Paid stimulus to those who did and did not need it
  • Printed exorbitant amounts of money
  • Lowered rates to zero and into real negative territory
  • Kept parts of the economy idled
  • Interfered with the non-idled economy by introducing vastly increased paperwork and public health rules
  • Closed schools, forcing many to withdraw from the workforce to care for children

To put things in plainer terms: as a society, we have made it much harder to work, paid people in excess not to work, and printed money. Is there any wonder that the oft-stated “supply chain disruptions” are a part of everyday life? Everyone wants things they might not have been able to pay for while the ability for businesses and employees to produce them is made difficult. A price rise from decreasing supply while increasing demand is an economic given. We printed money on top of it as a solution.

While COVID-19 and related public health, fiscal, and monetary policies are in unprecedented experimental territory, the single solution to the entire series of problems comes back full circle: raising interest rates through normal monetary policy. It is safe to say that we need a recession.

Should the Fed embark on an otherwise appropriate aggressive rate raising campaign, the yield curve will flatten and invert, and the foretold recession that arises as a result would follow at some point later. What would happen?

  • Excess leverage would unwind, as it would become expensive alongside declining asset prices used as collateral.
  • The stock market would come off all-time valuation highs and return to reasonable valuations. It would be a significant bear market.
  • Debt-financed consumer purchases would halt, including overpriced cars, houses, and credit card financed purchases.
  • The economy would enter recession.
  • Demand would slow down.
  • Supply would normalize against any continued public health policy interference.
  • Pressure on the supply chain would allow it to catch up and normalize.
  • Moral hazard (incentivizing economically counterproductive behavior), zombie companies, and other systemically poor practices would be curtailed.

While no one looks to a recession as a good thing, they are essential fixtures of capitalism, markets, and business cycles. Each major recession in the United States was preceded by some form of financialized bad behavior which, if left unchecked, would have spread much more pain and devastation in the long run. Unsustainable economic excess is like any personal addictive behavior; it rewards in the present, often with superfluous positives, while presenting a long-term negative. At every juncture to cease a damaging an addictive behavior, a person must face the long-term consequences of their choices, doing so without the fleeting positives of an addiction.

Economic excess operates on a similar paradigm. It is well known that deflation is destructive to an economy. For as long as we put up with excessive inflation, then we are either pricing in future deflation to correct it, or a permanent diminution in the value of our currency as an alternative. There is simply no good reason to continue letting the damage spread into the system, as resulting therapy and economic rehabilitation would be even worse. While we have largely slowed the printing of new money, excessive inflation means that the task is not done. We owe it to ourselves to pay the cost of our profligate money printing sooner for less rather than later for substantially more. Besides, we might be back to the good old days when basic consumer goods were in stock when we wanted to buy them….