We are in a depression and do not even know it
We are in a depression and do not even know it.
In a recent Harvard Business Review (HBR) article, “What Causes Inflation,” Walter Frick describes some of the economic forces that often create sustained inflation.
It can happen when a critical supply becomes suddenly scarce, such as the Arab oil embargo of 1973. Prices advanced, limits were placed on the amount of gas you could purchase, and lines of cars formed around all gas stations. We were beset with inflation exceeding 18% at times, and it took a decade for inflation to subside.
It can happen when economic expectations do not meet reality or when economic shock occurs. The 2007–2010 Great Recession is a prime example. The trading of mortgage-backed securities (MBS) became extremely popular on Wall Street during the late 1990s and early 2000s. These securities were originally rated AAA by the bond rating agencies, and their popularity increased. Gradually, however, to earn higher yields, a portion of the MBS packages would contain a few subprime home loans. This practice grew until soon Wall Street had grievous amounts of MBS, not rated, on their books and with clients. A small and intelligent group of individuals spotted this financial weakness and “shorted” the MBS market. This immediately created the largest financial crisis ever on Wall Street. Because the investment banks were “too big to fail,” it took monumental giveaways from Uncle Sam — some say $12 trillion over a decade — to put the banking system back on its feet.
It can happen when a sudden increase in the supply of money occurs. Did anyone give thought to what might happen when Uncle Sam printed and dumped $6 trillion into the economy during COVID? With a $15-trillion money stock before printing COVID checks, this $6 trillion represented a 40% increase in the total money supply. It peaked at $21.7 trillion during July 2022, the highest ever, before beginning a slight decline to $20.9 trillion at the end of this past December.
To counter inflation, in March 2021, the Fed started increasing interest charged to member banks (rediscount rate) to its current rate of 5.5%. It also instituted Quantitative Tightening by selling treasury bills from its portfolio. Most alarming is the fact that the Fed’s actions have been negated by continued government overspending. The current money supply is only $979 million less than it was at its highest level in July 2022.
Uncle Sam is now telling us inflation is under control and we are headed for a soft landing. Balderdash!
According to the Bureau of Labor Statistics (BLS), the Consumer Price Index (CPI) for 2023 was 3.4% year over year. Not horrible. But do not forget that 6.5% occurred in 2022, and 7% in 2021. That is a total of 16.9% in three years. You are paying at least 17% more than at the start of this decade. Regardless of what the BLS would like you to believe, prior year inflation does not go back to zero with the beginning of each new year.
BLS uses a sampling approach to determine the CPI. This does not work well with large, infrequent purchases such as home mortgages. You cannot replace these purchases any time you feel like it. During the two years following 2020, interest on home mortgages doubled. So if you are a first-time buyer in 2024, you will be paying 100% more in interest than your next-door neighbor, who purchased 20 months earlier. So how does BLS determine the CPI for “long-term purchases”?
According to BLS, real GDP (adjusted for inflation) increased 3.3% and 1.9% in 2023 and 2022, respectively, for a rather anemic 2.6% per year. We may not be in a recession, but we are real close to it.
So what is next? The Fed has painted itself into a corner. There is little it can do. Congress could balance our current-year budget by $2 trillion and soak up that much excess cash, but it will not. We could increase taxes by several trillion, but that is not going to happen. Or the government could try to recapture from states amounts of leftover COVID cash. Raise your hand, City of Chicago! Or we can wait until something breaks, as something surely will.
We have all suspected that the day would arrive when we would no longer be like kids and kick responsibility down the road. I think that day has arrived!
Image via Picryl.