Inflationary damage will not be repaired

News analysis

Public hatred for the current price increases cuts across all parties and demographics. Many people express the same desire: “These prices must return to normal. It kills me. Things will surely calm down.

It is a widespread hope born out of disbelief at what has happened in such a short time. Clearly, this cannot last!

Bad news: there will be no turning back. Yes, some price increases will roll back and some will go up, but consider this a ship with a leak in the hull. Even if it’s clogged, the boat will still be full of water and it will forever splash from one part to another.

That is, unless it is bailed out. In the case of current inflation, the only hope is to clog. There will be no bailout.

This simple point is often lost under an avalanche of data that most people can’t begin to track. At some point in the future – anyone guesses it – the media will triumphantly announce that inflation is down. Currently, the consumer price index stands at 8.6% year-on-year. If that rate of increase drops to 8%, talking heads will say Biden is taming inflation.

This is seriously misleading. A drop in the rate of increase is still an increase. Everything will get even worse, but at a slower pace. The language here really matters: it’s not about lower inflation if prices keep rising.

That’s what’s so absurd about the Federal Reserve’s supposed 2% target. If the Fed succeeds, it will do nothing to repair the existing damage. It would only mean that the aggravation of the real declines in purchasing power will take place more slowly. For prices to be frozen at their current levels, whether at the wholesale or retail level, the rate of increase would have to fall to zero.

Just to be clear, because it’s not entirely obvious to most people, an inflation rate of zero would mean that all the price increases you see around you would, in general, stay in place, even if some prices go up and others go down.

Here is a picture of the purchasing power of the dollar since the shutdowns began in March 2020. This is by far the biggest decline in the domestic value of the dollar in 40 years.

The value of the dollar at the start of Reagan’s second term is now only 34 cents. This damage is done. If the Fed magically hits its target, current realities will persist and only worsen at a slower pace.

We have already discussed at length precisely why this happened. Congress, over two years, authorized some $6 trillion in payments to individuals and businesses, all of which were funded by debt securities created by the US Treasury and purchased by the Fed with newly printed money . To simplify a two-year process, we woke up with new money in our bank accounts, but when we went to spend it, we found that prices had risen enough to make our newfound wealth meaningless.

Let’s play a simulation game and imagine a world in which things really go back to where they were in 2019, as many people hope. This would require a 15% drop in real prices across the board to fix the problem. There is simply no scenario in which this would happen. It is truly inconceivable.

To be sure, it should happen. There is nothing inherently wrong with falling prices, the reverse of which is an increase in the value of money. Under normal market conditions with sound currency, this would be expected and good because it rewards savers and fuels long-term investment. For strange reasons, however – and this has been true since the 1930s – the Fed thinks that would be the worst possible fate. Institutionally, the Fed will fuel inflation at all costs to avoid this scenario.

The Fed is completely wrong on this point. Falling prices – rising purchasing power – should be the norm. During the five years between 1872 and 1877, consumer prices fell 12.3%. Between 1882 and 1885, prices fell another 13.8%. From 1892 to 1894, prices fell another 3.6%. This whole period is known as the golden age of American economic growth as the dollar rose in value, which was a victory for consumers and producers.

It was during this same period that life in the United States was transformed, with the arrival of the airplane, internal combustion cars, and the massive availability of steel to build skyscrapers and long bridges, not to mention indoor plumbing, electricity, fossil fuel boom and new communication technologies.

The handmaiden of all this was sound money.

A striking case of an economic crisis that did not involve Fed intervention with “quantitative easing” was 1920–22. In just two years, prices have fallen by 17.8%. The result was a fabulous economic recovery. This “deflation” was not harmful, but curative.

I cite these cases just to emphasize that it would not be unprecedented for the Fed to get to work trying to undo the damage it has already done. And really today, prices would have to drop about 15% to restore the status quo ante.

It won’t happen just because the Fed is still spooked from the experience of 1930 to 1933, when prices fell 28%. At the same time, a new economic theory took hold, claiming that falling prices were a cause of the crisis rather than a blessed symptom that the crisis was resolving itself. Since that time, monetary policy has been conducted on the assumption that falling prices would be a disaster.

All this to say: there will be no turning back. Even if the Fed hits its target, the damage is done. This is your new world. The prices you see today will persist on average, and this is the best-case scenario for possible results. Worst of all, inflation is getting worse, and that’s a more likely scenario.

Everyone is now looking to the Fed to solve the inflation problem, but that can’t happen even under the best possible conditions. This is because the problem goes far beyond printing money. We have all experienced the great economic shock in world history with massive global blockages and blackouts in supply chains, and the resulting loss of business confidence and massive demoralization of workers.

It’s not easy to fix. This requires huge institutional changes.

Remember that the heyday of the 1980s was not entirely prepared by Paul Volcker at the Fed. Yes, he cracked down on the loose money policy of the Fed and that was essential. But just as important were major changes in industrial regulatory policy and major tax cuts that inspired investment. The media at the time never wanted to attribute anything to the Reagan administration, but the truth is that the economic boom of the 1980s would not have happened without these revolutionary changes in policy.

Today, we suffer under the yoke of an administration that calls and works almost daily for an end to fossil fuels, which provide 85% of America’s energy needs. It is hard to imagine a more irresponsible and destructive policy. It’s like aiming for prosperity itself and repeatedly pulling the trigger. And they wonder why we are on the brink of recession alongside terrible inflation!

Getting back on track will be a colossal undertaking, something that seems impossible under the current regime. We need a Fed that lets go of its phobia of falling prices, an end to corporate attacks, a business-friendly tax environment again, a restoration of the rule of law and a drastic reduction in the discretionary power of the administrative state.

This is the only way out of this crisis.

Jeffrey A. Tucker

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Jeffrey Tucker is founder and president of the Brownstone Institute. He is the author of five books, including “Right-Wing Collectivism: The Other Threat to Liberty”.

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