This week I read a very interesting op-ed in the Wall Street Journal by Donald Luskin, “Inflation Has Peaked—Get Ready for Deflation.” He basically argued the Fed is making the mistaking of treating as a monetary phenomenon what is in fact, a fiscal phenomenon. Noting that what really triggered high inflation was excessive federal spending during the pandemic, which I have long agreed with, (and the Economist a couple weeks also concluded, Biden’s disastrous “American Rescue Plan” was “the spark that lit the match”)— he says the Fed now risks draining the broader economy of all liquidity with too aggressive interest rate hikes.
At first after I read this editorial, for a couple days, I had my fist in my mouth, having championed in one long blog post after SVB and Signature failed, somewhat bombastically perhaps, for a monetary campaign of continued impactful hikes—against the estimated $1 trillion of pandemic relief still in circulation and against the prospect of continued airlifts of Bidenian helicopter money.
Where I work at a grocery store, I see firsthand 5 days a week, all the middle and lower middle classes, struggling to afford their basic needs. Considering that year-on-year Core CPI, is still 5% over double the Fed’s target of 2%, notwithstanding their steady quarter point increases of the Federal Funds Rate, leery in the beginning of the campaign, I have become gradually more and more of an agitator. Especially since the FDIC started guaranteeing all the deposits over $250,000 in the midsize banks, and the Fed established a lending facility, and then seemed to waver on rate hikes to hedge against the contagion of a sustained national series of bank runs—it seemed ridiculous to me that the Fed should forget inflation all the sudden to virtually nationalize the banking sector by propping up a few well-capitalized, unusually exposed banks most frequented by cryptospeculators and venture capitalists, banks that indeed deserved to fail, declining to heed all the warnings they were given.
So since I read Luskind’s thought-provoking alarmist oped in the Journal, as you can imagine, I was loth to make myself anxious now about deflation. Deflation would be very very bad. If inflation punishes savings, real wages and incomes, deflation punishes spending power. Deflation makes money worthless. Indeed during the depression, the central bank for some reason I don’t remember, started hiking rates, and it led to deflation in the middle of a global recession, and eventually dollars became so worthless, many ordinary citizens even pioneered their own currency with which to trade.
Deflation would accompany if not precipitate a recession, making it extra difficult for consumers and businesses to consume and invest. In fact, during the 90s or early 2000s supply side boom, because the Fed became so fearful of deflation, that was the original reason they cut interest rates, leading to disinflation, and we correspondingly enjoyed two decades of zero rates thereafter which we all, with good justification, regret nowadays. It was zero interest rates, the dawn of quantitative easing as well as the Fed’s mortgage lending program moreover, that led to the series of asset bubbles which have given us such financial instability over the last couple decades. The lesson however, is for the sake of stability, the Fed should refrain from engaging in overzealous, vaulting macroeconomic endeavors in way of central planning, like mortgage lending. That means the hitherto protean Fed needs to reclaim the purpose for which it was created which is: to maintain price stability and to be the lender of last, not first, resort.
That is to say after the economy crashed in 2008, there is no question some quantitative easing—the process by which the Fed adds liquidity to the economy by buying government bonds in exchange for selling securities to lenders— was good, because on that occasion, it was acting as a lender during a time of actual emergency. Hiking rates to fight inflation now is also good. However, blanket deposit guarantees and foregoing the task of price stability to stabilize the presumed contagion of banks deemed a systemic risk, is not what we have the fed for. I’m digressing from the point I’m trying to make.
The point is with inflation this high and this sticky, the Fed is supposed to be working to stop it. And given the circumstances that the other day consumer spending actually increased again, it seems a little premature to worry about deflation. Luskin claims the reason the Fed’s policies haven’t worked is, since inflation was provoked by Bidenomics, all we need is for the money in circulation to dissipate on its own before things ideally return to normal; but the Fed meanwhile risks tipping us into deflation by sucking up too much of the money supply. It’s about 1 trillion of pandemic relief still out there. That’s quite a bit. And there is a real possibility the Fed can overdo it. But here’s the issue with Luskin’s critique.
He fails entirely to take account of the super hot jobs market, due to worker’s retiring and quitting, decreased immigration, and large welfare rolls. It’s not pandemic relief keeping prices up but that worker’s wages are rising like hell, along with corporate profit margins, because we have too many jobs but not enough people to fill them. Employers are overpaying and consumers in turn are overspending, and so wages and prices will keep rising, irrespective of consumers’ pandemic savings, however much they still have. And Fed can raise or lower rates, but it can’t fix the labor shortage. So I think inflation will remain high as the federal spending that started this conflagration becomes entrenched, as economist are already arguing it has.
Therefore I agree with Luskin that the cause of this inflation is fiscal—Bidenary— not monetary. But since I don’t think pandemic relief but job vacancies: is why inflation is proving so stubborn, I am decidedly not inclined to worry about deflation. I actually think, at this rate without supply side changes, unfortunately we’re justified to worry about inflation for a while to come.
— Jay