The Politics of Inflation

“Bankers Uneasy on Inflation” was the Wall St. Journal’s above the fold headline on Monday October 16, 2017 in its story summarizing recently concluded meetings of the International Monetary Fund and the World Bank in Washington D.C.  Wages and consumer prices in the US remain stubbornly stagnant after close to a decade now of aggressively low interest rates ostensibly intended to stimulate economic growth.

According to the official unemployment rate determined by the Bureau of Labor Statistics, unemployment has been safely below 5.00% for well over a year now, indicating that the economy is at full employment.  Full employment would trigger wage and price increases and inflation as people increasingly bid up scarce labor, services and material.  In anticipation of this happening, the Fed has raised interest rates five times since 2015.

Yet inflation as measured by traditional indicia has remained low.  There are several reasons for this, which include that the indicia used are flawed and narrow.

The current low level of inflation is strong evidence that the economy is not actually at full employment.  Rather, as many critics have contended for years, it seems that the Bureau of Labor Statistics has for many years under-reported unemployment by being quick to categorize large numbers of unemployed people as ‘not participating’ in the workforce and thus not officially unemployed.  The BLS has also inflated the number of employed people by categorizing people with two jobs as two separate people, each employed.  Critics contend that the BLS engages in this behavior for political reasons, to make the economy seem better than it really is and to thus reflect well on the economic policies of the government.

Another aspect of the Fed’s flawed means of measuring inflation is that those assets whose value is most easily inflated with easy credit, real estate and equities through margin debt are not considered by the Fed.  The result of this is that people with those types of assets benefit from the Fed’s myopia, while poorer people in need of simple employment suffer from the Fed’s endorsement of the BLS’s obviously flawed statistics.

An even more problematic issue that low inflation presents is that as a nation we are obviously well past the point of diminishing returns with respect to the economic stimulus effect of marginal increases in the money supply.  After almost ten years of aggressive fiscal and monetary expansion, prosperity, as measured by increasing wages, remains elusive.  This should not be surprising when one considers the tremendous growth in the money supply since the US went off the gold standard in 1971.  In 1971, the amount of credit outstanding in the US was about $1 trillion.  Today outstanding credit in the US today is approximately $58 trillion.

The US economy is akin to a man who eats three apple pies a day and does not gain weight, simply because he is already dangerously overweight.

America’s fiscal over-indulgence and the questionable integrity of our currency is readily apparent when one considers the enormous unfunded liabilities (especially pension liabilities) of our state and federal governments.  U.S. citizens in Puerto Rico are currently suffering through the epic mismanagement of their Commonwealth’s affairs.  Detroit went bankrupt a few years ago.  The City of Chicago’s debt is now junk rated, indicating that it has a very high risk of following Detroit’s path into bankruptcy.  Even New York and California, with their skyrocketing property tax base, are almost hopelessly behind with respect to their pension liabilities.

The ultra low interest rate policies pursued by the Fed are exacerbating the problems of government entities with respect to unfunded pension liabilities.  Most of these plans assume that investment returns on conservative fixed income investments will be close to historical norms.  Ultra low interest rates are helping to cause these plans to fall further and further behind their goals.

If America was a small Caribbean country, and not the world’s most politically powerful country with the world’s biggest economy, our woeful balance sheet denial would not be tolerated by prospective creditors and we would have a much weaker currency than we have now.  As thing stand now though, we have the power to define away inflation, with a wink and a nod to the other first world countries issuing their own fiat currencies of dubious value, and kick the problem of hopeless indebtedness down the road.

Polticians who both appoint Central Bankers and run debtor countries  have self-serving interests to keep interest rates low, so as to ease the budgetary concerns of their own administrations.  Decades of disastrous fiscal practices and an inherently undisciplined fiat currency system are, at this point, beyond the power of Central Bankers to fix on their own.  Given that most of these bankers grew up professionally in this system, candor and responsibility from them is probably too much to expect.  They worked too hard and too long to become the celebrated person who gets to feed the fat man the beloved apple pies that are hastening his demise.

About Chris Donnelly

Christopher J. Donnelly, is an experienced attorney, bond analyst and fixed income strategist, with years of experience in structured finance, distressed bonds and bond related litigation in a variety of industries and the emerging markets. He is a graduate of Rutgers University (BA), The University of Pennsylvania (JD) and New York University, (LLM in Taxation). Chris is a Managing Director of Straacom, LLC and can be contacted at cdonnelly@straacom.com. Straacom provides strategic research, analysis and communications for publication and on assignment for private clients.

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