Is inflation really a problem?

Prices are up, in some cases by a lot. These include food, gas, rent, rental cars, and airline tickets, to name a few. Why is this? Is it going to be a lasting thing? What does it all mean?

I ask the latter question because most Americans have never had to deal with significant inflation. You have to be an oldster like me growing up in the 60s and 70s to remember significant inflation. The funny thing is that it seemed kind of normal at the time. Generally wages kept up with inflation and even home mortgage rates close to twenty percent didn’t seem to deter too many home buyers. Yes, there were periodic gas lines that no one liked, but while inflation seemed pretty bad, at least assets tended to keep up with inflation. I remember renting a room in a house in 1979. Its absentee owner lived across the river in Leesburg, Virginia. The house was an investment and something of a hedge against inflation.

Something like that is underway right now, as real estate prices are one of the leading signs of inflation. Stocks too, although yesterday’s two percent selloff in the markets may indicate the days of double-digit stock growth are over. Prices are up, but wages are often up too, certainly on the low end. The federal minimum wage may be $7.25/hour, but almost no employers are paying it.

These days, the effective minimum wage is closer to $15/hour because if you want to hire workers that’s about the wage floor that employees will accept. Arguably though $15/hour is not what its proponents once hoped it would be: a living wage. In part because food and rent cost more, the price of a real living wage just keeps going up. On average, you would need to make $20.40/hour to be able to afford a one bedroom apartment in this country, assuming you have only one full-time job.

The premise is that inflation is bad. By that logic, deflation is good, but no economist I know of wants deflation. For one thing, in a deflationary period there is no incentive to spend as your money tomorrow will buy more than it will today. What economists really mean is that significant inflation is bad. Ideally they want to see it in the 2% – 3% per year range.

Right now prices are up 5.4% compared to June 2020. Obviously certain costs, like rent and rental cars are up a whole lot more than that, but there are other costs that have risen a lot less than that. Assuming your income grows by at least this amount too, you are at least treading water. A year ago it was pretty hard to find a job if you needed one. Now it isn’t and at least on the lower end of the wage scale you may be better off. “Better off” though is pretty relative. Things likely sucked terribly a year ago, if you remain employed and worked a low wage job. So with rising wages and more jobs available, they are likely to suck less today. It may feel like a skinnier elephant has decided to sit on you.

Low inflation though tends to mask other problems. If wages creep up 2% – 3% a year, who is better off? Probably not you, as it keeps you in pace with inflation so your standard of living doesn’t really increase. The Federal Reserve has the primary tools to manage the inflation rate. It does this principally by setting benchmark interest rates banks use to borrow money from each other.

The practical effect though is to keep the economy from growing too quickly, so if they judge inflation is becoming a problem they will raise interest rates. Higher than usual economic growth though should raise wages if the labor pool is relatively stable. In short, whoever is on the Federal Reserve and the interest rates they set have a huge impact on your life and standard of living. But the Fed is independent from the federal government. In effect, Congress has delegated a lot of its powers to a bunch of unelected people.

Some have argued that the Fed has done a lot of money printing during the latest recession and that’s the cause of the inflation. The Fed is the sole institution charged with creating new dollars and it’s been liberal in its money creation. It hasn’t been using its ability to impact your bottom line, at least not directly. One unique action it has taken this time is that it has been buying corporate bonds with money it’s created. This stabilized financial markets and allowed my portfolio to grow by about twenty percent last year. But arguably its policies have also created the inflation now increasingly seen as a problem. Low Fed rates have spurred low mortgage rates, which helped spur the huge rise in real estate prices.

I’m betting most of you reading this don’t have much in the way of a portfolio and live paycheck to paycheck. In which case, these actions by the Fed don’t mean a whole lot, except maybe it helped the country get out of a recession faster than it would have otherwise. Federal government spending in the form of one-time payments and expanded unemployment benefits likely had more of an effect on most of my readers. In most case, the effect was to keep a lot of people from descending into poverty, which was only partially successful.

For relatively rich people like me with portfolios, the recession was in many ways great! We got a lot of unearned income that significantly padded our already pretty sizable wealth. All these actions then had the effect of further widening the wealth gap, marginally helping those who needed it most while greatly enriching those of us who were already very comfortable.

What may actually help are temporarily child tax credits, $300 per child per month, passed as part of the American Rescue Plan. These credits are now starting to go out. If you have two kids, that’s $7200 more a year in income than your family had before, assuming these credits become permanent benefits. That’s the proposal now in front of Congress which looks likely to pass as part of a budget reconciliation package in the Senate. How would it be paid for? The proposal is to raise taxes on the wealthy, essentially redirecting income from the wealthy to those who actually need it. It’s old fashioned income redistribution, something we haven’t seen changed in a long time. The trend has been to end or cap benefits like these.

As long as inflation is kept low, it becomes harder to address the income gap because leaders assume the economy is under relative control. It is, just not necessarily in a way that benefits the most people. The Fed’s policies in many ways exacerbates and encourages income inequality, in part because of their limited toolset.

Don’t you be fooled: the bottom line is not a low inflation rate, but who controls the wealth and whether the those with less of it have a realistic path to get more of it. The tight reins by the Fed are actually a big part of our problem.

Trade deficits don’t matter but tariffs sure do

A couple of posts ago I pointed out that trade deficits don’t really matter. This is because trade deficits merely report the difference of the value of goods exchanged between countries. A trade deficit with China demonstrates that in general we get better bargains trading with companies in China than from buying them internally or from other countries.

Tariffs on the other hand do matter, a lot. Over the weekend Donald Trump, our “very stable genius” president demonstrated how profoundly ignorant he was on how tariffs work. Trump stated that tariffs are helping to pay down the national debt.

In the sense that higher taxes make deficits lower if spending is kept constant, Trump is right. But Trump apparently thinks it’s foreign countries that are paying these tariffs, like before a freighter from China unloads its cargo in Los Angeles the government of China wires the tariff to the United States Treasury. That’s not how it works at all. Chinese manufacturers don’t pay a tariff to bring their goods into our country either.

So who is paying? You: the American consumer. Tariffs amount to tax increases, but these tax increases are sneaky. Since you don’t buy directly from companies in China, you don’t see a tariff added to your bill of sale. But when a company you shop at does, like Walmart, they send a check to the U.S. treasury for the amount of the tariff.

Companies can absorb the tariff. Being profit-making though they will almost always pass the cost on to you by raising their prices. We saw this recently when Coke announced it was raising prices, because its cost for imported aluminum used to make its cans went up.

The Coca Cola Company of course can shop around elsewhere for aluminum. It looks like there is no better deal. The kind of finished aluminum they use is either not made in the USA or is cheaper to buy from China in spite of the tariffs. This is true of lots of products in our modern economy. One way for companies to make profits is to specialize. However, the tariff system seems to assume we principally trade commodities like oil and wheat, not rolls of aluminum with the exact thickness Coke needs for its soft drink cans.

Tariffs thus amount to sneaky indirect tax increases. Unfortunately, this is just the beginning of their detrimental effect on our economy. When we have to pay more for the same goods and services, this is inflation. And inflation from tariffs is already showing up. In June 2018, prices rose .4% from May 2018, largely due to tariffs. If this continues at this rate for the next twelve months, prices will be 4.8% higher annually. This is a significant increase in inflation compared to rates we are used to of 2% per year or less. It’s likelier though that the effect of tariffs is just beginning, and that soon inflation in June will seem like one of our better months.

As long as wages keep up with inflation, then perhaps inflation doesn’t matter. Our unemployment rate may be 3.9%, but wage growth has been anemic at best. In fact, most American workers have lost money because wage growth has not kept up with inflation. Unless Americans borrow money to make up the difference, which unfortunately they are doing at record rates, then without commensurate increases in wages they will consume less, dragging down the economy.

So it’s pretty clear that the real effect of tariffs is to stifle overall economic growth. Strict tariffs caused the Great Depression. While they allowed us to do more buying local, retaliatory tariffs as we are seeing now also made it hard to export our goods. With fewer buying our products, commodity prices for things we do make tend to collapse. So when the government charges tariffs, it is playing a very dangerous game. I’d like to think our administration knows what it’s doing, but Trump’s remarks this weekend show he fundamentally misunderstands how tariffs work. Apparently his supporters don’t understand either, as they roared their approval.

In any event, with recent tax cuts that benefit primarily the very wealthy, these modest tariffs will do little to boost tax revenues; the Post article puts the effect at .1%. But even the Post article understates the true cost of tariffs. Here are some of the other direct effects:

  • It increases government spending for social security, government pensions and many entitlements that are tied to the cost of living
  • It increases the cost of medical care, including Medicare, Medicaid and health care for veterans by pushing up prices for imported goods and services like certain medicines
  • It increases the cost of borrowing, as inflation tends to raise interest rates, which means the U.S. Treasury will have to increase interest rates to attract investors
  • Subsidies already announced will cost the government, for example the $12 billion the Trump Administration wants to give farmers to offset the effects of its tariffs

And then there are the indirect costs, which include:

  • Higher prices and inflation in general
  • Reduced employment in sectors affected by counter-tariffs
  • Lower profits as fewer goods and services are bought and sold
  • Likely increases in unemployment

Try as it might, the Trump Administration’s tariffs policies won’t do much more than partially offset tariffs’ downsides. It is likely to raise prices, reduce employment, feed inflation and reduce economic activity. Quite frankly, these tariffs are a disastrous policy.

But don’t take my world for it. The wreckage is already unfolding. It’s only going to get worse and may hit a crescendo around the midterms.