Live by the Fed, Die by the Fed
Biden shuffled the inflation problem off on the Fed and got what he deserved. We didn't.
Attracting much merited attention is a recent paper from former U.S. Treasury Secretary and President of Harvard Larry Summers and several colleagues arguing consumers are right to be unhappy with the economy, even though unemployment is low and official inflation is back down to circa 3%.
Nope, say Summers and colleagues, consumers are right because the inflation numbers are wrong and not just a little bit. The authors argue that in November 2022 prices rises peaked not at 8%, but 18%, a positively Jimmy-Carterish number. As late as November 2023, the cost of living was rising not at the 3% reported for the official ConsumerPrice Index (CPI) but almost 9%.
The discrepancy comes because since 1983 the official cost of living figures have not included interest rates, the cost of money. For most of the years since, interest rates have been low, so their exclusion had little impact. Yet lately, with the Federal Reserve trying to thwart inflation by raising interest rates, rates have reached a 20-year high.
Since the monthly mortgage payment is the single-biggest expense for most Americans, this is a huge miss.
The authors note that, with “higher rates, mortgage payments, car payments and other credit payments required to finance, everyday purchases have risen.” The combination of home prices rising “almost 50% since the start of the pandemic, while the 30-year mortgage rate has tripled since the historic lows of 2021,” means “the interest payment on a new 30-year mortgage for the average house has increased more than threefold since 2021.”
They add that the “interest payment on a new car loan has increased more than 80% since the start of the pandemic,” noting that at some $1.6 trillion, U.S. automotive debt is roughly equal to U.S. college debt.
Wryly, the authors note it “is not surprising that” these costs “would affect how consumers feel about the economy.”
Apart from the delicious irony that the Fed’s main tool for allegedly fighting inflation is causing most of the rise in inflation, there is a deeper point here.
We have said all along that the rise in prices since 2021 is not mostly the result of “inflation,” which can only mean a devaluation of the dollar. Rising prices are being caused by a shortage in the supply of goods.
This has been obvious since the onset of the pandemic and the deliberate ravages of the U.S. and global economies we now know to have been pointless. As we have argued previously, prices did not rise much early in the pandemic because most Americans were economizing. Despite the government throwing money at us, we saved and the velocity of money slowed markedly. (Even so, we yearn for an academic to examine prices in the black market for toilet paper in spring 2020).
When folks finally loosened up a bit and went back to the stores, supply chains remained tangled. Since then, we’ve suffered under an administration that uses the regulatory apparatus to thwart production, misallocates capital via subsidies for products people don’t want and taxes on things they do want.
The regime George calls “emergency socialism” in Life After Capitalism is even more deleterious than usual run-of-the-mill socialism that stops short of rain dances and other costly sacrifices to weather deities and diversity cults.
It is unfortunately difficult to quantify the impact of all this. And contrary positive forces, mostly technology, continue to bolster the economy.
Still, if Biden gets the tax increases he wants, expect those contrary forces to fall short (even with the thousand-fold rise in computing efficiencies over eight years heralded by Nvidia Chief Jensen Huang). Progressives may finally get the low-growth economy to which they aspire.
Misunderstanding the real source of rising prices, the Biden administration has ignored the 43-year record of high growth with low inflation since President Reagan. Attributing the current inflation to monetarist mumbo jumbo rather than substantive inhibitors of enterprise it has abandoned responsibility to the Fed. The Fed has acted on its traditional theory that the way to fight inflation is to raise unemployment and “cool” off the economy, just the opposite of what was needed.
Underlying all this confusion is the bizarre notion that it costs less to live in a poor country than a rich one, where prices supposedly rise with prosperity. Time prices—the only accurate way to measure the cost of living—tell us just the opposite. It may cost only pennies to buy a portion of rice in some poor corner of Asia, but those pennies cost hours of labor. In the United States, a cup of dry rice costs a blue-collar worker about 50 seconds of his time.
We’ve never thought that raising interest rates (to the extent that is in the Fed’s power) and suppressing production made any sense as a way to restrain prices. Now we know it doesn’t work even in the most nominal sense. Raise the price of money and the price of the biggest items in a household budget goes up as well.
I've been screaming this for years, but nobody will listen. You don't fix inflation by making yet ANOTHER thing more expensive, particularly when that thing--capital--is a basic economic input just like fuel, steel, etc. They have the causal relationship backward. Inflation CAUSES higher interest rates, since I'll demand more return if I know the dollars I'll eventually be paid back in will be worth a lot less than the dollars I lent out. This is so simple only highly credentialed economists seem capable of misunderstanding it.