On the menu today: This newsletter will dip its toe into waters it rarely explores — interest rates and inflation. The guys at Capital Matters know more about this stuff than I’m ever going to — but I have the advantage in explaining it to a layman because I’m a layman.
Fighting Inflation: An Explainer
What causes inflation? Too much money chasing too few goods. Think back to the old Duck Tales episode. If you had a form of currency that magically replicated itself every few minutes, then not only would you quickly become a millionaire, but everyone else would quickly become a millionaire. And when everyone is a millionaire, the value of a particular dollar or currency declines rapidly. Suddenly, the cost of everything would go up, because the amount of goods — cups of coffee, sandwiches, or gallons of gas — hasn’t increased at the same rate that the amount of money increased. A vendor who kept goods at the pre-inflation price would quickly sell out — and then face trouble when they tried to restock supplies and faced the increased costs of the store’s suppliers, to say nothing of the difficulty to motivating employees to work who suddenly found themselves millionaires, too.
If everyone in town suddenly became a millionaire overnight, it would likely set off a race to see who could purchase the most from the same limited supply of highly desired goods. If you’re a millionaire, you can head over to the nearest Lamborghini dealership and plunk down the $200,000 or so to purchase a new sports car. Lamborghini only makes about 8,400 cars per year. By comparison, Toyota makes more than 9 million cars per year. If everyone in a town became a millionaire, the nearest Lamborghini dealership would sell out quickly — and those last few models would rapidly increase in price, because demand had exploded (from the town’s previously wealthy to now everyone) while the supply had remained the same.
The Biden administration and its like-minded allies are fond of inane arguments that inflation is high because corporations aren’t taxed enough or are greedy. But the thing is, every person and institution who sells you something first has to buy that something from someone else. Let’s say you go to the grocery store to buy orange juice, and it’s more expensive than it was a few months ago. It’s not because the grocery store suddenly became greedy. The grocery store bought it from, say, Tropicana Brands Group. The Tropicana Brands Group buys oranges from roughly 400 Florida orange groves. To grow the oranges, the grove owner and operator purchases fertilizers, as well as water if it isn’t raining enough. The fertilizer company buys phosphates from . . . er, Russian suppliers, and well, that sort of thing got a lot more complicated recently.
Once a particular commonly used good gets more expensive — say, refined fuels, because six oil refineries shut down in 2019 and 2020, as discussed yesterday — then those costs keep getting passed from institution to institution. Your grocer is likely paying more to get the orange juice shipped from Tropicana. Tropicana is paying more to get the oranges transported from the groves to the processing plant. The orange-grove owner is paying more to get his fertilizer brought to his groves. And so on. No one in this process rubbed their hands together, twirled their mustache like Snidely Whiplash, and cackled with glee at the thought of raising prices. In fact, everyone in this process probably worried that their consumers would buy fewer of their products because prices were higher.
This weekend, our Kevin Williamson had a good column in the New York Post laying out that, while Joe Biden didn’t single-handedly create our current high inflation, he significantly exacerbated it by making the wrong decision at just about every step of the way. Kevin wrote that our current mess is “what you get when you combine the wrong monetary policy with the wrong fiscal policy, the wrong trade policy, the wrong regulatory policy, and the wrong energy policy.”
We were probably destined to have supply-chain issues and other economic hiccups as the country emerged from the Covid-19 pandemic. But our government worsened the problem by throwing gobs and gobs of new money into the economy, much faster than the country could produce goods.
In March 2020, as the Covid-19 pandemic hit, the national unemployment rate spiked to 14.8 percent. But by October of that year, unemployment was down to 6.9 percent, and by March 2021, it was down to 6 percent. The U.S. gross domestic product had crashed in the second quarter of 2020, rebounded dramatically in the third, and returned to regular growth in the fourth. On December 21, 2020, Congress approved a $2.3 trillion funding package consisting of a $900 billion end-of-the-year Covid-19 stimulus bill attached to a $1.4 trillion omnibus spending bill to fund the government through September 30, 2021. In other words, by March 2021, as the vaccines were rolling out, the U.S. economy was well along the road to returning to normal.
But then, once President Biden took office, Democrats in Congress passed, and Biden signed, another $1.9 trillion package of “pandemic relief” in March atop the $900 billion they had spent four months earlier. And by November, Biden had signed a $1.2 trillion infrastructure bill on top of that. And then this March, he signed a $1.5 trillion omnibus bill.
That’s a lot of money being borrowed and thrown into the U.S. economy in a short period of time — about $5.9 trillion in a 16-month span. In other words, a whole lot of money is chasing too few goods.
On paper, the playbook for a state, central bank, or banking system to fight inflation is simple: Raise interest rates. Low interest rates make it easy to borrow money; high interest rates make it more expensive and more difficult to borrow money. When interest rates go up, it becomes more expensive for individuals or couples to get a mortgage or a car loan, and it becomes more expensive for businesses that want to borrow to finance expenses or expand operations. A higher interest rate can also make saving money seem more appealing — keeping money sitting in bank accounts paying interest, instead of being spent and flowing through the economy.
Few people enjoy the consequences of raising interest rates, but the move forces consumer spending down. As consumer demand decreases, producers can’t raise prices at the same rate, or they simply won’t sell any goods.
So, earlier this month, the Federal Reserve announced that it was raising the federal rate to between 0.75 and 1 percent, up from .25 to .5 percent. The thing is, by historical standards, interest rates are still pretty darn low, and the expectation is that they will rise to 2 percent by the end of 2022 and 3 percent by the end of 2023.
Earlier this week, I joined Brady Leonard’s podcast, and Brady observed that the Fed’s decision to raise interest rates by half a percentage point was enough to send already-jittery stock markets plunging — the Standard and Poor’s 500, which measures 500 large companies listed on stock exchanges, has dropped 20 percent since the start of the year. Some of that excess money floating around the economy ended up increasing the prices of stocks higher than their likely actual worth, and reality is setting in. Investors are realizing that they’re holding stocks that are likely to lose value in the near-to-medium future, and they’re looking to sell those stocks.
It’s likely going to take more increases in interest rates to get inflation back down to its historically normal levels, but the markets hate that, and continued rate hikes exacerbate the already fairly high odds of a recession. So the question may be: Would America prefer the pain of a recession that increases unemployment but brings down inflation, or the pain of an extended period of jaw-droppingly high inflation? Is it better to rip off the band-aid quickly, or slowly?
In an interview with the Wall Street Journal published this morning, Federal Reserve chairman Jerome Powell said that, “The central bank’s resolve in combating the highest inflation in 40 years shouldn’t be questioned, even if it requires pushing up unemployment. . . . He said that it seemed the unemployment rate consistent with stable inflation ‘is probably well above 3.6 percent.’”
On paper, the chairman of the federal reserve is supposed to be able to make the hard choices that create short-term pain in exchange for long-term gain. Former Fed chairman William McChesney Martin famously said that the job of the Federal Reserve is “to take away the punch bowl just as the party gets going” — that is, raise interest rates just when the economy reaches peak activity after a recession. Raising interest rates leaves less money churning around in the economy, but it also prevents the economy from “overheating” or getting caught in speculative bubbles.
You may have noticed that elected officials are not well-known for their long-term thinking, nor their ability to defer gratification — particularly in an election year. And politicians love to scapegoat others for bad economic news.
I suspect that if unemployment rises or there are other signs of a recession between now and Election Day, many, many Democrats will eagerly demonize Chairman Powell. Never mind the fact that the Fed is trying to clean up a mess left by a Democratic Congress throwing way too much money into the economy, way too quickly.
And Democrats are likely to need scapegoats. President Biden is underwater by eleven points – meaning that his disapproval is stuck around 52 percent and his job approval is only around 41 percent. In the most recent NBC poll, just 16 percent of respondents said the country was on the right track, and 75 percent said the country was headed in the wrong direction.
This morning brings word that the Democratic Congressional Campaign Committee’s internal polling “finds that in battleground districts, the generic Republican is beating the generic Democrat, 47 percent to 39 percent, according to lawmakers, multiple party officials and the DCCC.” That is a formula for not just getting wiped out in the battleground districts, but probably seeing at least one seemingly safe House Democratic incumbent ousted in some D+5 or D+6 district.
ADDENDUM: Two days ago, the editors of NR declared that, “Madison Cawthorn doesn’t belong in Congress.” Last night, the Republican primary voters of North Carolina’s eleventh district concurred.