The Solution to Inflation

President Biden and his cohorts in Congress and at the Federal Reserve have delivered an early Christmas present.  They’ve given Americans the gift of raging price inflation.  The cost of just about everything has gone through the roof.

Consumer prices, as measured by the consumer price index (CPI), have increased 6.8 percent over the last year.  This marks the largest 12 month surge since the period ending June 1982.  In truth, the CPI is rising at more than double the rate of what’s officially reported.

Can the Fed stop raging price inflation without triggering a deep recession?

Former U.S. Treasury Secretary Larry Summers doesn’t think so.

Summers, if you didn’t know, has an axe to grind.  He always fancied he’d be Federal Reserve chairman one day.  But he’s too much of a dirty fellow to ever get the job.

Summers is better suited to the ivory tower of Harvard academia.  There, sequestered from public life, he can play Fed chairman from the ease of his lounger.  He’s good at it.

Summers is also a paid contributor to Bloomberg.  For entertainment purposes, Bloomberg makes a habit of dripping out utterance from Summers when the time is right.

Last week, for example, in anticipation of this week’s Federal Open Market Committee (FOMC) meeting, Bloomberg treated the world to Summers’ tedium.  From Bloomberg:

“Former U.S. Treasury Secretary Larry Summers said inflation has become entrenched, lowering the probability that the Federal Reserve will be able to tame price increases without causing a recession.

“Summers now sees 30 percent to 40 percent chances for a recession over the next 24 months.  The Harvard University economist also estimates that the odds of a so-called soft landing, in which tighter monetary policy doesn’t sharply constrict economic growth, at 20 percent to 25 percent.”

How Summers came up with these odds was not disclosed.  We put the odds of a recession much higher and the likelihood of a soft landing much lower.

By our back of the napkin calculations we estimate a 100 percent chance of a recession over the next 24 months.  We also put the odds of a soft landing at 0 percent.

We’ll have more on why we’re headed for an epic crash and burn scenario in just a moment.  But first, some context is in order…

The Legend of Casey Jones

When Casey Jones took the engineer controls of Locomotive No. 382 his orders were clear.  Go fast.  Apply a heavy hand on the throttle.

This was just the job for Jones.  He loved to go fast.  In fact, during his career he’d been fined nine times and suspended for a total of 145 days because of speeding violations.

On the early morning of April 30, 1900, Jones was supposed to be off the clock.  He and his fireman, Sim Webb, were filling in for a sick crew that had caused a 75 minute delay on the Cannonball Express from Chicago to New Orleans.

When Jones pulled the Cannonball Express out of the Memphis, Tennessee, station at 12:50 am he was determined to do everything he could to make up time.  His passengers were counting on him.  So was his boss.

The journey started off well enough.  Jones did what he loved to do.  He went fast.

By the second water stop in Grenada, he’d made up  55 minutes of the 75 minute delay.  Then he made up another 15 minutes in the 25 mile stretch from Grenada to Winona.

The following 30 mile stretch to Durant was a breeze.  And by the time he got to Durant, he was almost on schedule.  But at Durant Jones received new orders to take to the siding (side track) at Goodman, Mississippi, and wait for the No. 2 passenger train to pass, and then continue to Vaughan.

Vaughn was 15 miles south of Goodman and 10 miles away from his destination.  The Cannonball Express would be on time after all.  Or would it?

As the train rounded the curve near Vaughn, Jones was greeted with something unexpected.

“There’s a freight train on the siding,” Jones yelled across to Webb.

The freight train crews figured the Cannonball Express could ‘saw by’; where as soon as the passenger train passed the front part of the first train, it would move forward and the rear freight would move up, thus clearing the track.  But Jones was going way to fast to execute this maneuver.

In a flash of doom, Jones and Webb beheld the looming shape of several boxcars in motion, swinging across the side-track.  There was no earthly way of preventing a smashup.

“Jump, Sim, and save yourself!,” was Jones’s last order to his fireman.

Jones remained on board and made a valiant effort to slow the train.  He saved all his passengers…however, it was at the price of his own life.

His watch stopped at the time of impact, 3:52 am on April 30, 1900.  Popular legend holds that when his body was pulled from the wreckage, one hand was still clutching the train’s whistle cord and the other hand its brake.

The Solution to Inflation

Yesterday, following the FOMC meeting, Fed Chair Jay Powell simultaneously pulled the whistle cord and applied the brake of monetary policy.  The Fed had been going too fast – for too long.  Now, with inflation raging out of control, Powell is determined to stop it.

Here’s CNBC’s account:

“The Federal Reserve provided multiple indications Wednesday that its run of ultra-easy policy since the beginning of the COVID pandemic is coming to a close, making aggressive policy moves in response to rising inflation.

“For one, the central bank said it will accelerate the reduction of its monthly bond purchases.

“The Fed will be buying $60 billion of bonds each month starting in January, half the level prior to the November taper and $30 billion less than it had been buying in December.  The Fed was tapering by $15 billion a month in November, doubled that in December, then will accelerate the reduction further come 2022.

“After that wraps up, in late winter or early spring, the central bank expects to start raising interest rates, which were held steady at this week’s meeting.

“Projections released Wednesday indicate that Fed officials see as many as three rate hikes coming in 2022, with two in the following year and two more in 2024.”

This all sounds well and good.  The Fed certainly can stop inflation.  But does Powell have the intestinal fortitude?

We doubt it.

You see, in the early 2000s, following the dot com bust and the conclusion of Alan Greenspan’s goldilocks economy, the Fed was fretting over deflation.  Former Fed Chairman, then a Fed Governor, came up with a solution.  He laid it out very clearly in his November 21, 2002 speech, Deflation: Making Sure “It” Doesn’t Happen Here:

“The U.S. Government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.  By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. Government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the price in dollars of those goods and services.”

The Fed’s solution to deflation, as outlined by Bernanke, is inflation.

At the time of this speech, the Fed’s balance sheet was around $800 billion.  Today, after nearly two decades of non-stop money printing, the Fed’s balance sheet is over $8.6 trillion.  And inflation is now raging out of control.

Thus, the solution to inflation must be deflation.

The problem for the Fed, however, is that it despises deflation.  Deflation destroys over indebted economies, producing mass personal bankruptcies and corporate defaults.  Deflation also destroys overindebted governments, which depend on printing press money to pay their bills.

The task at hand for the Fed is to somehow control inflation without triggering a depression.  But after two decades of non-stop money printing the economy and government has come to depend on it.

What happens when the Treasury issues debt and the Fed doesn’t buy it?  What happens when interest rates rise in earnest?  What happens when the DOW falls below 15,000?

Will the Fed reverse course?  Does it really matter, either way?

Like Casey Jones barreling down the tracks, there’s no earthly way of preventing a smashup.  This is the ultimate crash and burn scenario.  Inflation?  Deflation?  You can count on both…

…we’re in for the ride of a lifetime.

Sincerely,

MN Gordon
for Economic Prism

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