February 10, 2022
Not learning from the stagflationary past may lead to a stagflationary future.
With winter in full swing across the Northern Hemisphere, the prices for energy and most other commodities in America and Western Europe are soaring. Meteorologists can tell us much about the weather ahead, but economists seem to be stuck in a rut.
Having assured us that inflation is not something to be feared, and then later labeling the inflation that followed as “transitory,” many of these same economists have also looked at Europe and the U.S. and concluded that these economies are not only recovering but will also enjoy decent growth in the years to come. Unfortunately, they have proven to be consistently wrong on the effect of “pandemic” economics.
The comparison to the 1970s is a useful one. Just as excessive growth in the money supply fueled that era’s inflation — now the consensus among economic historians — so too is our current inflation fueled by the extraordinary growth in the money supply over the past two years.
Money is one of the more poorly defined concepts in economics, but if you choose the simple M2 measure, money growth has exceeded 50 percent over the past two years while the growth in nearly everything else in the economy has grown by 6 to 7 percent. If the supply of one economic good increases eight times faster than the supply of most other economic goods, what is the logical expectation of the relative value of the good whose supply is exploding? A loss.
Economists in the Biden administration and elsewhere focused their main attention on developments in the labor market and consistently ignored the impact of the dramatic acceleration in money growth. There were some dissenters, notably Larry Summers, but in the main, academic economists had their heads solidly buried in the sand.
Treasury Secretary Janet Yellen, perhaps the best of the Biden-administration economists, said in a March 2021 interview on MSNBC, when asked about the prospects of higher inflation ahead: “I really don’t think that is going to happen. We had a 3.5 percent unemployment rate before the pandemic and there was no sign of inflation increasing.” But, as prices surged, Yellen backed away from this complacency about future inflation. The facts on the ground left her no choice.
Economists have spent a lot of time and ink discussing supply-chain disruptions in the wake of the spread of Covid-19 as causes of inflation. This discussion is mostly beside the point and is focused on the symptoms of the inflation disease. The root cause of our current inflation and the growing inflation that lies ahead is the excessive growth in the money supply.
Milton Friedman, perhaps the greatest monetary economist in history, once said: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than output.” This straightforward Friedman dictum is certainly borne out by the data available to us over the past two years.
Meanwhile, it is becoming clear that real output growth in Western economies is falling and likely to turn negative in the near future. Already, Germany’s economic growth rate slipped into negative territory in the final quarter of 2021. Any recovery, as in other Western economies, is likely to be short-lived, meaning a rough ride ahead. Look for negative growth in real output to spread to all or most of the major Western economies. The low rates on ten-year and 30-year Treasuries provide a key market signal to our dismal future economic growth.
Ultimately, the inflation of the 1970s was broken by the courageous actions of Federal Reserve chairman Paul Volcker, who first halted and then reversed the growth in the money supply. First appointed by President Carter in 1979 and then reappointed by President Reagan in 1983, Volcker had the political cover of President Reagan to do what was necessary to halt inflation and put an end to the inflationary spiral of the 1970s. The reward? Decades of low inflation. The price paid, however, was painful: the worst recession since the Second World War and an unemployment rate of 10.8 percent that has not been exceeded since.
There are differences between the 1970s and today. The size of the national debt in the U.S. is 30 times what it was when President Reagan was sworn into office. Interest rates were in the double digits then and are minuscule today. A modern-day Volcker would not be able to enjoy seeing the boost from dramatically falling interest rates once policies began to gain ground against inflation. We already have low rates. They can’t fall more than 1,000 basis points from today’s levels, as they did as the 1980s wore on.
As rates inevitably rise, they will exacerbate Treasury debt-servicing and likely call forth more monetization of the debt, which will promote more inflation, not reduce it. It will take very severe measures to break the back of inflation. Meanwhile, sluggish Western economies, hobbled by climate-change transition policies, will produce little or even negative real growth for years to come.
This is the perfect storm — weakening real economies in the Western world and growing inflation. Policy-makers are faced with an almost insuperable task of curbing inflationary pressures while attempting to entice real economic growth. Meteorologists often warn us of bad weather ahead, but economists can sometimes be oddly reluctant to do so. The results can be disastrous.