Riders on the Storm: Inflation Nation

"Inflation may have become the oldest form of government finance. It may also have been the oldest form of a political confidence game used by leaders to exact tribute from constituents, older even than taxes, and inflation has kept those honored places in human affairs to this day."
Jens O. Parsson, Dying Of Money

"In this world, nothing can be said to be certain except death and taxes." Benjamin Franklin

To that last quote, I would add another certainty—inflation. The government just reported the CPI for the month of May. Instead of declining as anticipated, it rose to the highest level in over 40 years. It was expected that inflation had peaked. Rather than peaking, it accelerated to 8.6%. As usual our politicians blame oil companies, food producers, or the Russians. Absent is any discussion of their own policies.

The root causes of the inflation we are now experiencing are years of extremely loose monetary and fiscal policies. Modern Monetary Theory (MMT) has taken hold over Washington with both parties adhering to its philosophical tenets. MMT basically says that as long as debt is issued in your own currency, there are no limits to the amount of debt issued or the money printed to pay for that debt. As a result, what we now have is the classic definition of inflation: too much money chasing too few goods.

Inflation is now running rampant, and you are experiencing it from goods to services. You see it at the gas pump, the grocery store, your utility bill, insurance premiums, cell phone charges, restaurant menus, service charges, and from garbage collection to haircuts. The cost of just about everything is going up as you see the signs of inflation everywhere you look.

I highlighted in my first article in this series why I believed inflation would persist. What I want to discuss here is the issue that no one in Washington seems to understand. Rather than looking at spending money, issuing debt, and printing money to pay for it, Washington and the financial press look at inflation through the myopic lens of its symptoms: rising prices. If oil and gas prices are going up, it is the greedy oil companies. If food prices are rising, it is food and grocery store companies gouging consumers. If we have wage inflation, it is employees and unions demanding higher wages to compensate for rising prices. This makes it easier to shift the blame to producers or wage earners rather than the fiscal and monetary policies that produce inflation.

The great majority of professional economists and the mainstream media define inflation as merely rising prices. However, this definition says absolutely nothing about any specific cause of rising prices. It implies that inflation can be caused by anything that causes prices to rise. By defining inflation as a result of its symptoms, it leads most people to see it as something caused by the evil of private individuals, especially greedy businessmen, labor unions demanding higher wages, or acts of God. Therefore, by defining inflation in terms of rising prices, it leads to the logical conclusion of wage and price controls. The government and the media present inflation as a causeless phenomenon born of ill will, so price controls are levied to correct symptoms, but never the source.

As Thoreau noted many years ago, "There are a thousand hacking at the branches of evil to one who is striking at the root."

On the day this is being written, Senator Wyden from Oregon is proposing a windfall profits tax on oil companies, and a 25% tax on companies buying back their own shares. Others such as Elizabeth Warren, a possible presidential candidate in 2024, wants to cap oil company profits with higher taxes. Senator Wyden, as mentioned above, wants a 25% surtax on any company buying back its shares.

Unless the political environment changes, we are looking at wage and price controls and much higher taxes in the years ahead. This is not just the Democrats. Republicans have been profligate spenders as well. President Trump gave us trillion-dollar deficits at a time the economy was booming. It is just a matter of spending priorities between both parties.

More demand or less supply are the only conceivable proximate or direct causes of a higher price level. The quantity theory of money connects the increase in the quantity of money to the rise in prices by way of establishing a connection to more demand. A growing supply of money raises the demand for consumer goods through the new additional money being spent and re-spent as its rate of growth becomes more substantial. As an example, think of the pandemic. The government shut down supply through lockdowns and at the same time they were shoveling money into the hands of consumers through helicopter drops of money. More money chasing fewer goods. The result is rising prices.

To illustrate this point, look directly at the graphs below of the Fed’s balance sheet and the government’s budget deficits. As shown in the graph below, the Fed more than doubled its balance sheet from $4 trillion to $8.918 trillion as of May of this year, an increase of over 120% in just two years. Looking at our national debt, it rose from $22.719 trillion at the end of Q3 of 2019, the end of the government’s fiscal year, to $30.4 trillion at the end of Q1 of this year—an increase of 85% in just two years. If you want to know why inflation is the highest it has been in over four decades, look no further than the exploding balance sheet of the US government and Federal Reserve.

Source: Bloomberg, Financial Sense Wealth Management
Source: Bloomberg, Financial Sense Wealth Management

An increase in spending by the government of $7.7 trillion and an expansion of the Fed’s balance sheet of over $4.9 trillion is why we are experiencing the highest inflation rates in over four decades. To make matters worse, at the same time the government was spending and printing money, its policies were shutting down supply through lockdowns, while giving people more money to spend.

Wall Street is hoping the Fed’s rate tightening will tame the inflation dragon and bring down the cost of energy. It will fail. The Fed cannot create more barrels of oil. All that it can do is kill off demand by plunging the economy into a recession. This will be followed by more money printing and spending by government.

Four Stages of Inflation

Stage 1: The first stage is the price manufacturers pay for raw materials, i.e. producer prices up 11%.

Source: Bloomberg, Financial Sense Wealth Management

Stage 2: The second stage is the price manufacturers charge middlemen, i.e. wholesalers, retailers and distributers. These are the prices now being reflected in a rising CPI.

Source: Bloomberg, Financial Sense Wealth Management

Stage 3: Prices now trickle down to consumers as we are now seeing everywhere from goods to services.

Terminal stage 4: This is the stage when people no longer want to hold on to cash and spend money as soon as they get it for fear of rising prices. This is when money velocity increases. Think Venezuela and Argentina. This is when central bankers lose control and the loss of confidence in the currency. Think OPEC in the 1970s and 14.5% inflation.

There are three outlets for money: the financial markets, the economy (goods & services), and in cash. Right now, people are frightened by falling asset prices, but that will not be for long. The Fed will eventually pivot and go back to money printing along with increased government spending. The terminal phase is a few years off, perhaps mid to late decade, which will result in a devaluation of the US dollar against gold.

As I wrote in March of 2020 (see The End of Money), this is going to be an inflationary decade. It is one reason why we own hard assets from commodities, real estate, precious metals, to dividend paying stocks. The point I want to make here is we are not going back to the way things were before the pandemic. We are more than likely to see higher energy prices, scarcity of goods, and unfortunately a shortage of food in many places around the world.

For an outlook of what is ahead, I recommend reading Peter Zeihan’s just-released book, “The End Of The World Is Just the Beginning: Mapping the Collapse of Globalization”. Peter comes to the same conclusion as we do, but from the perspective of demography, geography, and geopolitics. I had the privilege of interviewing Peter last month. It can be partially listened to by going to our weekend Financial Sense Newshour podcast of May 27th or the full one-hour interview aired on May 24th.

Coming up next, The Next Big Thing: The Commodity Bull Market of the Century.

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Copyright © 2022 Jim Puplava

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