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The Coming Financial Vise No One Will Talk About

Every day, Americans are experiencing rapid inflation. And if their guts tell them it is much higher than the official 7.1 percent of the Consumer Price Index, their guts are right. 

That official rate is the highest since 1982, when we were coming down from the disastrous Jimmy Carter years. At the time, the Federal Reserve under Chairman Paul Volcker, with the support of President Ronald Reagan, aggressively pursued defeating the inflation monster by using all of its tools, including increasing interest rates and reducing the money supply. It worked. The moves caused a short, sharp recession, but the country was better off for a long time afterward. Good policies matter. 

We have been blissfully enacting awful policies for decades now, however, and the Fed is continuing in its share of that. It simply has no intention of following in Volcker’s successful footsteps, for reasons that will become painfully clear. The only thing surprising about the growing wave of price inflation we are seeing now is that it did not arrive sooner. 

The Fed gushed cash into the American system by increasing the money supply by about 40 percent over the past two years. Much of that money went to American consumers via the overly large stimulus payments so many received, encouraging Americans to keep spending like drunken sailors on leave. We did. And yet with inflation taking off, the Fed is continuing to pump more money into a glutted money supply. 

At the very same time, governments throughout the United States and much of Europe and Asia shut down vast swathes of their economies for months on end, and when they reopened it was tentative and slow. The forehead-slapping obvious result of this was that production fell off a cliff, because the simplest explanation of the cause of inflation is too much money chasing too few goods, causing prices to rise. The government in two moves created the perfect storm for inflation to swirl into action. 

The shutdowns also created supply-side carnage. Modern Western economies are built on just-on-time production methods, where parts arrive at factories and are installed with little and sometimes no storage time at all. Just-in-time delivery also is used in the retail business. This saved on costs by eliminating the need for massive warehouses. But now, after shutting down modern economies in a doomed attempt to stop a virus, catching up on the supply chain is proving very difficult—which continues to restrict the supply and pushes the imbalance further toward inflation. 

And we’ve seen the result of these foolish policies in rapidly rising prices, with no end in sight. 

What You’re Hearing Isn’t Real

Back to the American gut on inflation. For the average American, it is indeed much higher than 7.1 percent because the government keeps changing how the CPI is measured and—who’s surprised?—it always lowers the official metric of inflation. The biggest changes came in 1998, when the Bureau of Labor Statistics accepted the recommendations of what was called the Boskin Commission. Even the BLS called these changes “sweeping,” and indeed they instantly lowered official inflation by 1.3 percentage points. 

But the basket of goods and services in the CPI is constantly being changed, ostensibly to reflect changes in consumer-buying habits. That makes sense, but we see throughout the decades that every change has worked to lower the official inflation rate, an outcome in which the government has a vested interest. That does not make sense. Economist Peter Schiff estimates that if the same CPI was used today as in the 1970s—not the same basket of goods, but the same weighting and categories in general—our inflation would be as high as 15 percent. And this is why Americans know that 7.1 percent is not right. Because it’s not real. 

“The government always makes changes to their methods of measuring things, whether it’s GDP, or inflation, or unemployment,” Schiff says. “And they always tweak the numbers to produce a better result as a report card.” 

Why does the government do this? In short, because lower inflation means less pressure on interest rates, which saves the government billions of dollars on its debt. This is part of why inflation will be so painful and difficult to combat, and will make much of the economy and the federal financial mess so much worse. 

Traditionally, as in the case of Paul Volcker in 1982, the Fed pursues a tightening monetary policy, in which it reduces the amount of the money supply circulating and it increases interest rates. This two-punch method would work, and current Federal Reserve Chairman Jerome Powell has tip-toed around the idea. But even then it is laughably too little, and only a possibility. 

Again using 1982 as the model, Volcker raised interest rates an eye-popping amount. As the Washington Post reported in his obituary two years ago:  

When he took the reins of the central bank, the nation was mired in a decade-long period of rapidly rising prices and weak economic growth. Mr. Volcker, overcoming the objections of many of his colleagues, raised interest rates to an unprecedented 20 percent, drastically reducing the supply of money and credit.

But Powell is only talking about raising interest rates from the current level of 0.25 percent to 0.50 or 0.75 percent. And not doing it until next spring. In the meantime, the Fed will keep inserting even more money into the economy, continuing the quantitative easing that has been going on for years. If this strikes you as unserious, you’re right. 

A Financial and Political Buzzsaw

After decades of irresponsible, profligate federal spending by Congress and presidents, and the Federal Reserve printing money like we may run out of ink any day, our economy now has an entrenched addiction to easy money and Congress has the same addiction to spending whatever it wants, regardless of revenues. There is never even a serious discussion about living within its means. 

So any serious tightening of monetary policy, increasing interest rates, runs into a financial and political buzzsaw. To make a real attempt at taming inflation before it gets out of control, the Fed probably needs to raise interest rates to 5 or 6 percent, at least according to non-political economists using traditional measurements. While that is still below the Volker benchmark of raising rates above inflation (even the manipulated inflation of today) it would still have the effect of easing money out of the economy and slowing consumer debt spending. 

For the economy, which is to say Americans, this means reduced credit spending and constricting the money supply, triggering a sharp decline in asset prices, including stocks and possibly real estate. Rising interest rates will cause consumers to spend less and perhaps save more, restoring a closer approximation of a healthy long-term balance. 

But the drop in consumption, on which too much of our economy is built, would cause companies’ sales to decline, and they will cut capital investments and jobs. Banks and smaller companies would be very hard hit and there would be a recession—probably a sharp and long one at this point—as the economic market mechanisms work to restore the previously misallocated resources driven by easy money. 

And this will happen while the economy is already sluggish. Unfortunately, it is not a roaring economy that triggered the inflation, making the inevitable downturn more painful and probably longer. 

But that may not be the worst. Such a move would utterly ruin the federal budget that is already financially diseased. The federal government will spend around $413 billion in 2021 on debt interest alone, according to the Congressional Budget Office. Debt service was a comparably reasonable $197 billion in 2010. Even the World Bank knows that’s a problem. It figures that a country reaches a negative tipping point when the debt-to-GDP ratio hits 77 percent. The U.S. debt-to-GDP ratio today is around 125 percent and climbing. 

But remember that is at about one percent interest. Each one-percent interest-rate increase costs another $413 billion. More precisely, each one-percent interest-rate increase costs American taxpayers another $413 billion (and climbing.) If the Fed was serious and raised rates to five percent—which still may not be enough—that would be close to $2 trillion in interest the federal government would need to pay annually. That’s half of the entire federal budget. Americans will be outraged to discover that Social Security, Medicare, defense spending, infrastructure, and everything else will need deep cuts in order to pay interest on money long spent by craven, irresponsible politicians. 

But we will also be impotent to do anything short term. 

The Silent Thief That Never Sleeps

And there is another costly wrinkle very few Americans understand. The Federal Reserve is the nation’s central bank, and as a bank it must maintain balanced books. It currently has about $7 trillion in U.S. Treasury debt, according to Bankrate.com. If interest rates go up, which pushes down the value of the federal notes and bonds the Fed holds, it must raise money to balance that sheet. Guess who has to make up the difference on the Fed’s balance sheet should that come to pass? Yup, the American taxpayer. 

But given this level of pain, is inflation really that bad? Yes. Inflation is the same as Americans constantly taking pay cuts as long as it exists. Wages and salaries rarely keep up with inflation, and never come close when inflation is high. So each dollar earned buys less. And buying power is the only relevant measure of wages and salaries. We may think a 10 percent wage increase is awesome. But if inflation is 12 percent, then it is the same as a 2 percent wage cut with no inflation. Inflation is a silent thief that never sleeps. 

This is the terrible place that our political leadership has put us in, a place that the media rarely if ever has actually explained to Americans—if it even understands it—because it is too busy chasing clicks or pursuing its own political agenda. 

But we will all have to pay for this one day, and as people like me have been saying since last century, the longer we put off the reckoning on our spending, the more painful it will be. And we have put it off for a very long time.

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About Rod Thomson

Rod Thomson is a former daily newspaper reporter and columnist, former Salem radio host and ABC TV commentator, and current Founder of The Thomson Group, a Florida-based political consulting firm. He has eight children and seven grandchildren and a rapacious hunger to fight for America for them. Follow him on Twitter at @Rod_Thomson or Truth Social at @rodthomson. Email him at rod@thomsonpr.com.

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