Inflation: Interest Rate Increases May Not be the Best SolutionBy Patrick Theros - July 29, 2022
Rampant
inflation will damage the economy but, as usual, politicians are
playing political games instead of doing something about it. The
Republicans see it as a cudgel to beat the Democrats in the November
midterms rather than working with the administration to find solutions.
Why give Biden a lifeline? The Democrats, for their part, variously
deny, deflect or blame Putin. Let’s stop making political points and
consider how to cure inflation without tipping the country into
recession, as happened 40-odd years ago when Fed Chairman Paul Volcker
hit the brakes hard and killed both inflation and the economy.
Conventional
economic theory posits that too much money in the economy leads to
inflation. Most economists blame Biden’s 2021 $1.9 trillion stimulus
bill and advocate that the Federal Reserve raise interest rates while
government slashes budgets. But will these measures lower inflation? Or
will they do more harm than good?
Biden’s 2021 $1.9 trillion
stimulus bill, following Trump’s $3 trillion stimulus, did indeed pump
too much money into the economy, especially as it came just as American
households started spending the immense savings they had accumulated
during the pandemic. Americans started splurging on "revenge travel” and
other deferred consumption. But the recovery from covid came with a lot
of great benefits, e.g., the lowest unemployment and best wage
increases in a generation. While managing inflation we need to protect
those long-delayed working middle class gains.
Interest rate
increases make sense if increased money supply is the only cause of
inflation. It is not the only cause. Many other factors, not just an
increased money supply, disrupted markets. Businesses are short of
workers; a problem they caused. Too many companies took the stimulus
payments intended to keep their employees on the payroll, distributed
the money to shareholders and executives and fired their workers anyway.
Now demand is back with a roar but most of their old employees have,
given what happened, gone elsewhere. Anyone unlucky enough to take an
airplane this last month has seen the result. Lost luggage and canceled
flights cost both consumers and businesses a lot of money.
Can’t
find a new or used car? When demand for new cars died at the beginning
of the pandemic, automotive companies canceled their advance orders for
the sophisticated computer chips integral to modern cars. The
electronics industry--suddenly swamped with new demand for computers and
other IT equipment as locked down populations turned to ZOOM, online
education, and Amazon--stepped in and filled the order books of the chip
manufacturing companies. Now the pendulum of demand has swung back to
cars. Unfortunately, the computer chip manufacturers cannot pivot that
quickly. To complicate matters, Taiwan, South Korea and China make 84%
of the advanced computer chips in the world and supply chain disruption
threw a monkey wrench into the gears.
Ninety percent of the
world’s commerce moves by ship. Covid19 closed ports around the world
leaving thousands of merchant ships stranded waiting for ports to
reopen. Demand has returned but shipping has still not gotten untangled.
The cost of shipping one container from Shanghai to Los Angeles, for
example, rose from $2,000 in 2019 to $18,500 in 2022; now it looks to
settle at a ‘new normal’ of about $8,000. All this happened after the
Trump administration imposed tariffs on commodities essential to the
manufacturing sector such as lumber, aluminum and solar panels. The
finely tuned marvelous world of “just-in-time-low-inventory”
manufacturing, wholesaling, and retailing fell apart leading to shortage
of goods just as demand increased.
Spending one hundred dollars
to fill your gas tank? Normal supply and demand calculations don’t apply
in this market. Saudi Arabia colluded with Russia to kill American
fracking companies when demand dropped during the pandemic. They dumped
crude oil on the market driving prices so low that US companies had to
pay refineries $39 a barrel to take their crude oil. The world started
driving again and demand soared. The Saudis and the Russians got
together again and restricted production, pushing crude oil to $139 a
barrel. Unfortunately, American fracking companies now lacked the cash
to drill for more oil to meet demand.
Finally, came the war in
Ukraine. The US and our allies targeted Russia’s oil and gas exports to
bring Putin to heel. Putin responded by reducing exports to Europe, no
sweat off his back as the resulting price increases have actually
increased Russia’s net revenues. The war blocked Ukrainian (and some
Russian) exports of grain and other food commodities at a time when
world weather had clobbered food production. Given that those two
countries are the biggest grain and vegetable oil exporters in the
world, food prices soared even more.
Raising interest rates would
cut US consumption but do nothing to address supply chain disruptions,
and shortages of chips, oil and gas, containers, and food deficits.
Slashing US government costs sounds good but what do we cut? The US
Government has been starved for resources for decades. For example, our
consulates are so understaffed that they must delay business visa
interviews for months, exacerbating the cost of doing business.
Politics
have made things worse. Out of fear of political attack, the Biden
administration has been afraid to revive the JCPOA, the nuclear
agreement with Iran that Trump killed in 2018. Iran may be the only
country in the world with sufficient excess capacity to put a couple of
million barrels a day into world markets by year's end. For the same
reason, the Biden administration fears to reverse Trump's tariffs, a
quick way of increasing supply of key goods and lowering prices in the
US. Reversing Trump's tax cuts would reduce the money supply as much as a
Fed interest rate increase, without targeting the middle class. But
imagine what the Republicans would do with that. As we said in the
beginning, politicians need to cooperate, not to score points, if we are
to get out of this mess.