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EricN Publications by Eric Niewoehner
EricNPublications by Eric Niewoehner

Where Does Inflation Come From?

July 7, 2022

 

For most Americans, inflation is something that is always around, but not disruptive. Everyone likes to see the value of their house go up, although they lament the increased property taxes that follow. Everyone seems to keep a subconscious budget in their heads and they sense when costs are rising faster than their incomes. But generally, people get paid more over time and usually advance in their careers. As long as folks can keep ahead of the bills, inflation is nearly invisible.

 

 

But lately that has changed. The official figures are even laughable to most Americans. They know when fuel is rapidly rising and they know quite specifically what items in the grocery store are significantly higher. To tell them inflation is at 8% is just so much baloney. Fuel is up more than 100% and the price of many items in the food market are up 15-100%. People are now making lifestyle decisions, changing what they eat, whether they travel, even where they work.

 

So what causes inflation? One thing is certain, the crowd that is hanging around the White House is either intentionally a new breed of economist or the President is simply not listening to them. What occasional glimpses we get of the economists seems to demonstrate a lamentable lack of traditional economic perspectives. They tag the future course of economic evolution as one of a carbon free energy sector, electric cars and the benevolent direction of government technocrats. From them I seriously doubt you will get an honest answer regarding the cause of inflation.

 

First and foremost, inflation is rarely a “temporary” thing, as Janet Yellen once inferred. An explanation of inflation usually contains the word “momentum.” In essence, something causes prices to rise beyond normal growth over a long period of time. The inflation that beleaguered the Carter administration, for example, had contributing factors that went all the way back to the Johnson administration. The same can be said for our current experience. The causes can actually go back to the George W. Bush administration. And just as it took Reagan almost the entire eight years of his presidency to bring inflation down, it will take this administration and the next president to control this beast.

 

Second, it is important for the reader to understand that inflation is not just a rise in prices. It is also a metric of a drop in productivity. The current surge in our inflation is definitely that. And it is not that people are not working hard enough. It is more on how our resources are best being used. Just “follow the money,” and you can judge for yourself whether the money goes where you would think it best. I will explain later below because this problem became especially acute due to our reaction to COVID.

 

 

 

Keep Throwing Money Into the Economy

 

The last federal budget surplus we ever had was under, of all people, Bill Clinton. It was the strange alchemy of a liberal agenda running headlong into a grass-roots reaction that elected a Republican-controlled Congress. Fortunately for Americans, there were enough adults in the room to hammer out a budget solution that generated a budget surplus. Since then, it has been one deficit budget after another.

 

Under Keynesian economics, budget deficits make sense if you want to stimulate an economy. They also make sense during times of dire emergencies, such as World War II. Yet Congressmen have in their heads the idea that a “small” deficit is OK at any time. This becomes especially alluring when the interest rates on government bonds drop to near 0%, as occurred after the recovery of 2008. They gave the printing of money a new name: “quantitative easing”. It effectively printed money, but not the sort of money you and I carry around. No, this was money in the form of bonds that banks and hedge funds carry around. The result was a hyper-inflated stock market and the eventual magnification of income inequality between Americans and the reduction of the middle class. In conclusion, borrowing money all the time was sold to us as being normal. Yet what happens when we suddenly need a lot of money? Most of us, at the personal level, suffer something. If we are fortunate, we might liquidate investments, sell our expensive car or boat, or even downsize our home. But for many Americans, a sudden financial emergency is extremely difficult to match. They can’t go out and just borrow money. Well, actually they can. Twelve months later they declare bankruptcy.

 

Not so with our government for some strange reason. When a crisis occurs, they can simply print more money. Since budgets are always in deficit, the debt progressively gets larger. When a crisis occurs, the deficit balloons. The bankruptcy comes in other forms. The government does not go bankrupt, but rather what occurs is that democracy is bankrupted. The portion of the budget that is used to pay the interest costs on the debt gets larger and larger, which means the choices our elected representatives are expected to make get more restricted. Restricted, that is, unless they simply finance their initiatives by borrowing more money.

 

Eventually, that printed money gets into the day-to-day economy. But it is not in the pockets of the average working American. Rather it is elsewhere – and thus my point about productivity. When I was visiting my old home town of Columbia, Missouri recently, I noticed there was a local discussion on how to spend $25 million of leftover COVID relief money. This, mind you, for a town of 120,000 people. That is $208 per capita. Another way to look at it, what would the employers scattered around the city do if they suddenly received $25 million? They would most likely direct the money towards operations that produce income. The city? All the proposals have only one objective: to spend the money on services. The question here is not whether these services are needed or helpful. It is whether they are productive. If not productive, then you can appreciate the fact that what has happened is that the city of Columbia will have injected into its local economy $25 million on non-productive ends. That generates inflation. And it is that sort of non-productive use of our resources that will take time to bleed out of the economy.

 

COVID relief amounted to trillions of dollars of debt-financed income support being directed to working Americans during a critical time in our history when the economy was in lockdown. Additional money was directed to businesses and governments to help deflect the effect of the pandemic. It is, in theory, what government deficit spending is supposed to accomplish. But, as noted above, it is not how it is supposed to be operated. If a government is economically rational, it will not be borrowing money to operate during good times. It will only reach to the well during bad times. As noted above, our government borrows all the time.

 

The end result of the sudden infusion of income that paid Americans not to work only exacerbated the productivity drop off. Here we were paying Americans not to work. They were producing nothing but added subscription revenue to Netflix. The infusion, over time, also had the result of affecting incentive. People simply were slow to return to work and also more critical of where they worked. Normal patterns of employment were significantly disrupted. Add to that the ramifications of firing people who refused to be vaccinated, it is no surprise that there was a sudden shortage of critically needed labor in specific sectors of the economy. The truckers’ protest in Canada was highly indicative of that disruption.

 

So where does inflation come from today?

  • It is the culmination of nearly 22 years of highly irresponsible spending by Congress and our presidents.

  • It is the infusion of trillions of dollars to pay Americans not to work

  • It is the insertion of trillions of dollars into highly non-productive uses

What About Energy?

 

The elephant in the room is that of energy. All of what I shared above could cause inflation without disruptions in the market. But this is where the Biden administration is 100% responsible. Immediately upon taking office, the Biden administration disrupted the energy market. Biden canceled the Keystone Pipeline project which resulted in as many as 11,000 workers losing their jobs and the dead-panning of $15 billion of investment. This was followed by the suspension of leases of drilling rights on federal lands and certain off-shore sites. For Alaska, it meant suspending drilling in ANWR, a wild-life reserve that is roughly the size of the state of South Carolina. Added to this disruption was the obstruction to pipeline development in norther Michigan that would affect access to energy for customers in eastern Canada and New England.

 

The climate change policies advanced by the Biden administration had a derivative effect which was to stymie investment in fossil fuel extraction and in gasoline-powered engines. Energy companies took that signal. They curtailed investments in refineries. Refining capacity in the US is currently reduced.

 

This needs to reintroduce the factor of time. As noted above, inflation just doesn’t suddenly happen. It is generated over time. In the case of energy, the inflation we are seeing is not just because of current supply-demand factors, but because of future considerations. In stock market parlance, “expected earnings.” For the oil industry, you are usually looking at fifteen years! The Keystone Pipeline, for example, was being built to resolve market demand for the next twenty to thirty years, at least. It would have transported production from western Canada and the Dakotas to the refineries in Texas. If that oil had been expected to flow to Texas, then the refineries would have been maintained and modernized. Without that expected oil deliveries, there is no economic reason to invest in added capacity, if not even for maintaining current capacity. After all, isn’t all of America supposed to be driving electric cars?

 

Another aspect of this equation is that energy is foundational. In other words, when the price of energy goes up, it affects the costs of every aspect of the economy. A blight may significantly reduce coffee production in South America, and the price of coffee will go up. But aside from affecting Starbucks, what else is affected? But fuel? Fertilizer? Plastics? Medical Technology? The list goes on and on. The Biden administration’s climate change policy disrupted a foundational component of our national economy.

 

So it can be argued that a fourth cause is political disruption. Nowhere is this demonstrated more than in Cuba and Venezuela. In both of those states, relatively vibrant and prosperous economies were transformed into extreme poverty and stagnation because socialist politicians were ideologically convinced that government experts could determine what was produced or not produced. It was the ultimate inflation. It is no different in the US when the government injects itself into any market, whether it be energy or baby formula. No matter how well-intended, the placement of decisions that are made by countless thousands of individuals into the hands of a room full of bureaucratic technicians results in non-productivity. And that generates inflation.

 

Energy also demonstrates something that most pundits fail to mention – globalization. The energy market is global. The Biden administration has demonstrated this fact by repeatedly blaming the inflation on Vladimir Putin, or the Saudis because they happen to have a fifty-year outlook on the value of their oil reserve. Yet what happens to the price for a barrel of oil when the United States under-produces? Oil prices were at rock-bottom prices during the Trump administration for one main reason – the US was exporting oil rather than importing. That has now been reversed and the price has rationally risen. The lesson we must learn from this is that the decisions we make as citizens impacts the world, and we should not be surprised if that bites us on the foot in the form of inflation.

 

I encourage you to listen to Senator Rand Paul. He provides in the video below a good explanation of what is contributing to inflation.

Rand Paul Explaining Inflation

Resources

 

FRED, St. Louis Federal Reserve -- This the source of the data for the official inflation rate and various price indexes.

 

Trading Economics, United States Inflation Rate -- This source provides a less complex presentation.  It has an informative table of how the inflation rate is measured in different sectors of the economy.

 

By Eric Niewoehner

© Copyright 2022 to Eric Niewoehner.

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