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‘Money does not stink’

Pecunia Non Olet

Adam Johnson, Publisher
Posted 1/25/22

Inflation has hit its fastest pace in 40 years, and its future path, as always, is unpredictable. The Consumer Price Index (CPI) clocked in at 7% in December. The CPI is flawed, though an in-depth …

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‘Money does not stink’

Pecunia Non Olet

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Inflation has hit its fastest pace in 40 years, and its future path, as always, is unpredictable. The Consumer Price Index (CPI) clocked in at 7% in December. The CPI is flawed, though an in-depth discussion of those flaws is a topic for another time or place. But to take the most available and relatable component as an example, home price increases are not included in the CPI; instead, a survey of what homeowners think they could rent their homes for (were they not living in them) is the driver of the Housing component of the CPI.

This phantom figure is known as owners’ equivalent rent, and it accounts for a full 24% of the total CPI. Or, to take another example, in the 20 years after my first year at the University of Tennessee (1998 – 1999), tuition increased at an annual rate of 8.1% -- this inflation shows up nowhere in the CPI. …But back to the December headline inflation number of 7%.

The causes of the recent inflation are subject to debate, and partisans always will find a way to blame the other side: Republicans will blame Joe Biden for high gas prices on account of his nixing the Keystone XL pipeline; Democrats will blame Donald Trump’s trade war with China for higher consumer goods prices -- a recent essay in Foreign Affairs on the overuse and ineffectiveness of sanctions cited a Moody’s study showing that 93% of the added costs of tariffs that resulted from the trade war with China were paid for by US importers and passed on to US consumers in the form of higher prices.

This tit-for-tat blame game misses the bigger picture: there are two primary factors at work here, one more temporary than the other. First, the more temporary of the two factors is the intersection of Covid-related supply chain constraints and free money-related increased demand. The second, less temporary of the two factors is the ongoing zero interest-rate policy (ZIRP) engineered jointly by the by the Federal Reserve and the US Treasury Department. In short, the Federal Reserve buys Treasurys (and other assets) in whatever quantities are required to suppress interest rates and keep asset prices inflated.

Inflated asset prices, in turn, keep voters happy and support the value of Treasurys to finance deficit spending. (Note: freespending, financially speculating voters who finance asset purchases with debt no doubt have been happier for many years than “responsible” voters who earn next to nothing on their savings and do not spend beyond their means.)

Because they have been the architects of the longer-term inflation-inducing ZIRP and Quantitative Easing (QE) and other policies that have been in effect in some form or fashion since 2008, through Democratic and Republican administrations and congresses alike, the technocrats who begat ZIRP and QE prefer to focus on the exogenous, Covid-related supply and demand imbalances.

In two gems that may come back to haunt her, Treasury Secretary (and former Federal Reserve Chairman) Janet Yellen spoke once in May and again in June on what she perceived to be fleeting inflation, noting in May, “My judgment right now is that the recent inflation that we have seen will be temporary. It’s not something that’s endemic.” Then, in June, “We have in recent months seen some inflation… But I personally believe that this represents transitory factors.”

Such statements should ring alarm bells for the seasoned observer of political poppycock, and while I concede the jury is still out on Yellen’s proclamations, I believe she will come to regret having spoken these words. While the most glaring December CPI reading is for used cars and trucks, the prices for which increased 37% in a year, this particular inflationary burst probably can be attributed to the temporary factor politicians and technocrats would prefer to focus on, but the more insidious and dominant factor at work in any pent-up inflation is the artificially low interest rate regime that pleases politicians.

Like the guy who overindulges at the dinner table every night, things seem to be going well and he’s happy almost all the way ‘til the end, when, after a few warning signals, he dies “suddenly” of a heart attack. Inflation strikes in a similar way: the US economy has been eating at a monetary and fiscal all-you-can-eat buffet ever since the Great Recession. The 7% CPI reading in December may be a warning signal, a high cholesterol, blood pressure, or triglycerides reading for the US economy.

I have far more faith in our own technocrats and even our own politicians than in the relatives and sycophants surrounding Turkey’s president Erdogan who are executing his crackpot economic fantasies, but let’s look at a current example of what can go awry when interest rates are kept artificially suppressed for political purposes. The Turkish lira has been on a long slide against the US dollar, but just to take the point in time on July 9, 2018 when President Erdogan installed his son-in-law (who has since resigned) as Minister of Finance and Treasury, the lira has collapsed by 2/3 against the dollar. Erdogan incorrectly believes that high interest rates cause inflation, so he has ordered them to be kept artificially low. Erdogan’s reward for his trailblazing economic thought has been inflation in 2021 of 36%.

Our own economists in the US do not believe in Erdogan’s nonsense interest rate theory, but the technocrats in the Federal Reserve and the political appointees in the US Treasury are effectively implementing the same inflation-inducing low-interest-rate policies, just for different reasons.

Either the recent CPI readings presage a prolonged period of inflation brought about by artificially low interest rates, or they do not, but it is worth considering that the QE and ZIRP chickens are coming home to roost, and when you get a lot of chickens together, they leave a lot of poop that will need to be cleaned up.

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