Is There an Imminent Threat of Inflation?

Concerns exist that government spending is reaching unsustainable levels. The Covid lockdowns, which have played havoc with the economy, along with the election to near dominance of the Democrat Party, with its strongly progressive orientation (and wanton fiscal irresponsibility), will lead to spiraling of federal debt, which already exceeds $23 Trillion. The only possible to way to pay for all this spending is by having the Federal Reserve buy Treasury bonds. This is tantamount to "printing" money --- although nowadays the money is not actually printed, but is created electronically. 

Supposedly 35 cents of every dollar spent in 2020 by the federal government was "printed." This has frightened some hard money advocates into predicting high inflation in the coming years. While these expectations are certainly reasonable, this doesn't mean they'll necessarily prove accurate. There is a tendency for critics of easy money policies to over-predict inflation. The Federal Reserve has actually engaged in quite a bit of easy money  (i.e., inflationary) policies over the last three decades without serious (at least in terms appearances) inflation. There are three reasons for this, which I will briefly discuss.

1. The most aggressively inflationary monetary policies in recent memory have been implemented by the Fed to counteract deflationary periods in the economy: essentially debt crises triggered by bursting bubbles in asset and housing markets. What occurred, for example, in 2008 is that the collapse of Lehman Brothers exposed the weakness of the system. An immense of bad debt had been allowed to accumulate, and its discovery led to a contraction of the money supply. This deflation is what motivated the Fed to essentially "reinflate." Under such circumstances, inflationary policies can be pursued without any great inflation, because all the monetary authorities is reinflating. This policy was recommended originally by Milton Friedman, who blamed the Great Depression on the Feds unwilling to reinflate after the great Stock Market crash. In March of 2020, with the lockdown of the economy in response to the Covid-19 crisis, we went through a similar contraction of the money supply through debt defaults, followed by aggressive reinflation by the Fed. The important lesson to draw from this is that rapid expansion of the money supply won't necessarily trigger widespread "inflation" (i.e., significant rise in the consumer price index) if the inflation occurs during a deflationary episode, since these two monetary forces more or less cancel each other (although not completely). 
2. In both 1980 and 1990, the government changed its methodology for how "inflation" (i.e., consumer price index) is measured. They did this for a number of reasons, but the most obvious was to keep social security (which is tied to inflation) from bankrupting the country. Below is a graph comparing the inflation rate according to the pre-1980 methodology for measuring CPI with the post 1990 methodology. Note that there exists about a six to eight percent difference in the two rates; and that the pre-1980 rate has been at or near ten percent since the late nineties (the main exception being the deflationary period triggered by the 2008 debt crisis). A ten percent inflation rate means that the dollar loses half its value every decade.
   
   
   
3. The computer revolution, along with other technologies, have introduced economic efficiencies that have enabled the economy to absorb a fair amount inflationary pressure. Let's say the value of the dollar has plummeted by a factor of three over the last four decades. Economic productivity has worked in the opposite direction, enabling our deflating dollars to buy more stuff, so that in some cases we have hardly notice the devaluing of the dollar. Economic innovation has thus camouflaged the debauchment of the currency by our financial elites.

It is important to keep in mind these three factors when discussing the threat of inflation. The threat of inflation is very real. There's no point in trying to minimize the threat or dismiss it out of hand because the official rate over the last twenty years has hovered around two or three percent. Even so, we also have to be careful about exaggerating the threat: inflation is not always as catastrophic as it is sometimes made out to be.  In the past, people warning about the dangers of inflation have occasionally been guilty of crying wolf. They have repeatedly warned about "inflation," and sometimes even of "hyper-inflation," yet no such inflation has thus far visited our benighted land. The reasons provided above explain why. However, just as in the story of the boy crying wolf, the wolf eventually shows up, so with warnings of inflation: someday the wolf of inflation will be at our door, ready to gobble up our savings and destroy our economy. It's not a matter of if, it's only a matter when. Do we now find ourselves on the threshold of a major inflationary episode that will gut the dollar and threaten to topple the current economic elite?

Much of this depends on who controls the financial system --- i.e., the banks, the big financial houses, and the federal reserve. In the past these institutions have been controlled by "neo-liberals," which is to say, by people who  accept free market principles and have shown a genuine concern (based on financial interests) for preventing inflation from getting too out of hand. These people will of course allow for some inflation (at least by the old pre-1980 system of measurement). A moderate amount of inflation allows for the emergence of asset bubbles that allow financial elites to rake in huge amounts of money at the expense of nearly everyone else. These elites will likely take measures to preserve the current financial regime, since it produces so much wealth for them and insures that they stay in power. Hence as long as they remain in charge, they have incentive to keep things from getting out of hand. But if the financial system has been infiltrated by radical leftists (as has happened to other institutions in our society, such as education and the Justice Department), then all bets are off. The radical left subscribes to what is called Monetary Money Theory (MMT), which is a very sophisticated rationalization supporting high government spending paid for with inflation. It is so radical that even Keynesians like Paul Krugman are opposed to it.

It's hard to know the exact character of those who make up our ruling elite, since such an elite is rarely a homogeneous body and is changing its complexion over time. Like the population in general, it is made up of various factions vying for domination in various hierarchies within the power elite. Which faction has the upper hand at any given moment in any given sector is difficult to say. The threat of inflation allows us to run a bit of experiment. If the inflation threat plays out, we must assume that radical leftists have infiltrated the financial system and are imposing their will on the weaker "neo-liberals." If forces rally against inflationary forces; if monetary policy refrains from the most dangerous type of policy excesses; if the spending of the Biden administration is somewhat held in check: then in that case the "neo-liberals" are still in charge and the days of high inflation will have been put off by at least a few years.

There exists a third possibility. It's conceivable that current financial paradigms have reached the end of their tether --- that in short it's no longer possible to keep the system going on current principles. But that is a subject that would require more treatment than we have time for in this particular post.

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