Written by Jeff Mount
September 03, 2020
Federal Reserve Chairman Jay Powell recently announced a policy for tolerance of higher than average inflation rates for short periods of time. Although the language has changed, the actions really haven’t changed.
The Fed has kept rates near zero for quite some time. What has changed is this language around being “flexible” about one of the two mandates for the Federal Reserve. There was a time when managing inflation was the only real mandate of the Federal Reserve.
I recognize Mr. Powell suggested they would only tolerate heightened levels of inflation for a short period of time, but it seems rather arrogant to me that these economists think it is easy to control inflation once that genie is out of the bottle.
There was also no clarification as to how long they would tolerate inflation or how high they would let inflation climb in order to achieve an “average” inflation rate of around 2%.
Perfect Storm Swells Debt
To be fair, the country is in one of the most incredible periods it has ever seen. People were forced to stay home, not work, not generate revenue to support their businesses or families, and in return, the U.S. government gave many people money through one program or another. The U.S. government had no choice but to do what it did. The challenge is that the country already had an excessive amount of debt and now our debt/GDP is 136% as of July 30, 2020. Our nation’s debt has swollen to heights we have never seen before. As of July 30, 2020, we have $26.5 trillion in debt. Our GDP is only at $19.4 trillion. The question is, how are we going to normalize the economy, minimize the economic pain of this debt, and how can families prepare for the potential consequences of all of this?
We have two possible directions after the November elections. If the Democrats take control of the White House and both houses of Congress, we will most certainly see an increase in taxes that will hit the upper and middle classes. The justification for these taxes will be to help us recover from this economic situation we are currently in, but those dollars will most certainly go towards social programs for the lower class, rather than to pay down this exorbitant amount of debt. If the Republicans do well in the election it is unlikely we will see a tax increase.
The last time a Republican raised taxes was after campaigning with a slogan that read, “Read my lips, no new taxes!” President George H.W. Bush never recovered from that and served only one term in the White House as a consequence. What is the consequence of doing nothing? With a debt/GDP ratio of 136%, the U.S. government will see interest payments on this debt become one of the highest budget costs moving forward. This is the trap we are in. If the Federal Reserve raises rates in the future to combat inflation, they will be raising the interest payments on this debt as well. That would be political suicide.
There is an urban legend about what life was like in post-World War 1 Germany. The German government had an enormous amount of reparations to pay the Allies and turned towards runaway inflation as an exit strategy. By allowing inflation to take hold at a very high rate, it naturally reduced the economic significance of the reparations. The legend refers to a shepherd. Legend has it that the largest farm in that country sought a large loan to expand their operations. This large loan had a long maturity and a manageable interest rate. Rapid inflation occurred shortly after that period and the entire loan was paid off with the sale of one sheep in just four years. I’m not sure if this urban legend has any truth to it, but it clearly demonstrates how a country can manipulate the economic consequences of debt. What real cost is felt by the citizens, however?