Only a Recession Can Kill Accelerating Inflation

Dr Ivanovitch - MSI Global
Dr. Michael Ivanovitch

The U.S. Federal Reserve (the Fed) is misleading the public with statements that sharply accelerating price increases (aka price inflation) in the American economy are due to temporary and reversible external shocks. The subtext here is that this undeclared form of taxation is not caused by serious errors of the Fed’s monetary policy.

Don’t believe a word of it.

Even inflation measures where the government excluded allegedly “volatile” consumer basket components, such as food and energy, show that there is nothing temporary and reversible in the current assault on households’ real purchasing power.

What we now see is the old axiom that “inflation is always, and everywhere, a monetary phenomenon.”

And that axiom is directly derived from the fundamental law of demand and supply that has governed all human activity since time immemorial.

Old story: Demand exceeding supply

My former Fed colleagues know all that. But their attempts to talk down inflation dangers show how much they are scared of the problem they have created, and how desperately they want to deflect the responsibility for more than a decade of mistakenly loose credit policies.

They are, however, fighting a losing battle against unimpeachable evidence.

Consumer prices in the U.S. rose 5.4% in the year to June, an eight-fold increase from the same month of last year, and the highest reading since August 2008, when years of loose money policies had already pushed the U.S. economy into a financial crisis, followed by the Great Recession.

The same picture emerges when one looks at the measure of consumer prices less food and energy – i.e. the core rate of inflation. That indicator shows an annual growth rate of 4.5% in June, a four-fold increase from the year earlier, and the highest reading since November 1991.

That core rate of inflation is clearly at odds with Fed’s assertions that accelerating price increases will subside and reverse in the months ahead.

The only issue now is to estimate how far the underlying forces of demand and supply will take rising cost and price pressures in America’s labor and product markets.

Sadly, that trend is simple and obvious: An estimated average GDP growth rate of 5.5% for this year and next is three times above the physical limits to America’s noninflationary economic growth, based on the current stock and quality of the human and physical capital.

We currently have an excessive fiscal and monetary stimulation driving rising demand against the physical limits of available supply. Prices, therefore, are bound to keep rising in step with soaring trade deficits, because the excess demand will be partly met through imports of foreign goods and services.

Here are some numbers.

The U.S. wages in the first quarter of this year were 8.3% above the same period of 2020. Business complaints about labor shortages, unwittingly amplified by the same White House comments, simply mean that America has run against the limits of available and qualified manpower -- despite the fact that more than 100 million of its people remain a wasted and virtually unemployable labor force.

Gold bugs may have a point

Wages, therefore, will continue to rise. They will be partly offset by productivity gains (a ratio of increasing output divided by stable, or declining, labor input), but the resulting unit labor costs will keep growing in the 4.5% to 6% range.

And those labor costs always put the floor below any future inflation rate.

That ominous trend is also foreshadowed by a 7.3% annual increase of U.S. producer prices in June, from a decline of minus 0.7% a year earlier.

On the trade side, the Chinese and the Europeans are the main beneficiaries of America’s strongly growing economy. In the first half of this year, Europe and China accounted for nearly two-thirds of the U.S. merchandise trade deficit – which is 25 percent above its year earlier level.

What will Washington do about all that?

The answer is: More of the same; fiscal and monetary policies will remain expansionary.

That’s because the governing Democrats are fighting the battle of their lifetime to hold on to the legislative power in next year’s Congressional elections that could seal their faith for general elections in 2024. As always, monetary and fiscal policies are geared to those do-or-die events.

Wall Street is riding on that, on an ocean of liquidity, on some profitable segments of the economy, and, above all, on the famous “Fed put” -- a sure bet that the Fed will bail out everybody.

The Fed is doing some of that already by driving bond yields down with massive purchases of Treasury’s debt. Private investors would do that only on expectations of a crashing economy. Under those circumstances, bond vigilantes would finance Uncle Sam without any inflation premium.

Gold bugs are playing that sad coda to a Gargantuan feast. While inflation kept exploding over the last twelve months, the price of the yellow stuff fell 8%. The gold market apparently sees a recession-induced deflationary spiral.

The legendary Friedrich von Hayek defined inflation as “overeating and indigestion.”