The Simple Solution to Inflation No One is Talking About
03:03 GMT 15.07.2022 (Updated: 09:22 GMT 09.08.2022)
© AP Photo / Rick Bowmer
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Inflation has hit a 41-year high, currently sitting at 9.1%, forcing Treasury Secretary Janet Yellen to admit that the rate “remains unacceptably high” and it is the president’s top priority to “bring it down.”
There are many theories about why inflation has spiked out of control. Most economists point to a few factors: increased spending, mainly through economic stimulus, decreased supply due to pandemic-related supply chain issues, and increased production costs, mostly due to increased energy costs.
Those factors undoubtedly played a big role in contributing to inflation, but it could be argued that some of them, like economic stimulus during a pandemic, were necessary, while others, such as supply chain issues, were beyond the control of the US government and that gas prices, while certainly a result of policy, have proven resistant to attempts to address the issue.
So far, the Federal Reserve’s plan of action is to raise interest rates, decrease wages for workers, and risk a recession. That may slow inflation somewhat, though their first attempt did not seem to have the effect they wanted, and decreasing wages is probably not the solution most Americans want.
14 July 2022, 18:40 GMT
But there are some things we can do, things that do not involve adversely affect the lives of most Americans and that would restore purchasing power and possibly bring us back from the brink: reduce military spending and take a softer economic and militaristic stance with nations around the globe. First, it is important to remember how we got here and how the people in charge were consistently incorrect in their predictions on how the economy would respond to their actions.
When President Biden took office in 2021, inflation stood at 1.4%. By the time he signed the third coronavirus stimulus bill in March of that year, inflation had risen to a still acceptable 2.6%. That $1.9 trillion spending package came after the Trump administration had injected $3.1 trillion into the economy in 2020.
While some, like Obama’s Treasury Secretary Larry Summers, predicted that such stimulus would lead to massive inflation, Yellen disagreed: “Is there a risk of inflation? I think there’s a small risk and I think it’s manageable.” She would go on to blame inflation on prices falling during the pandemic and predicted that there would only be “a temporary movement in prices.”
By June of that year, inflation had risen to 5% and the situation was beginning to concern economists. Federal Reserve Chairman Jerome Powell started to see the cracks. “Inflation could turn out to be higher and more persistent than we expect,” he said that month. But Yellen remained undeterred, calling the inflation temporary.
In July, with inflation at 5.4%, Biden doubled down, echoing Yellen’s words by saying the increase was temporary and blaming supply chain issues. But by November, with inflation at a 30-year high of 6.2%, he had to admit it was becoming a problem and called it a “top priority” to fix. Powell likewise had to admit that the inflation the US was experiencing was not transitory.
Then in February, Russia began its special military operation in Ukraine, and in response, the United States and European countries imposed sanctions on Russia and removed them from the SWIFT network. This led to an increase in the price of food and energy, directly contributing to inflation. It also encouraged countries, including Russia, China, India, and others to move away from using the dollar for international business. How that move relates to inflation will be explained later.
12 July 2022, 22:19 GMT
In June, the Federal Reserve increased interest rates by 0.75%, the largest increase since 1994. This attempt to curb inflation was long called for by many mainstream economists, and though just about everyone agreed it would slow economic growth, the hope was that the effect on inflation would be greater.
Yet here America stands in July and inflation rates are now at a 41-year high of 9.1%, and the only thing the Federal Reserve can think to do is increase rates further, with insiders saying the next increase could be an additional 1% or higher. The Department of Labor’s most recent Real Earning Summary indicated that while there was an increase in wages during the past year, that has been wiped out by inflation, and then some. Real wages are down 3.9% in average weekly earnings.
But is slowing the economy, thereby decreasing wages, the only tool the Federal Reserve has in its playbook to combat inflation? Must the American worker always be the one to take the consequences of bad policy on the chin? The Federal Reserve may not have any other moves to make, but the government does, if only we can gather the political will.
5 July 2022, 22:51 GMT
It is worth looking back at the last time we experienced inflation this high and what economists were worried about then. In the 1970s, the US experienced historic inflation rates. President Lyndon Johnson’s dual expenditures of the war in Vietnam and his “Great Society” anti-poverty plan led to record high deficits and inflation. The agenda was a failure and the saying at the time was “You can have guns or butter, not both.” After both the Vietnam War and the Great Society fizzled out, the US economy started growing again and things were looking up. But Reagan had a plan to once again increase the military budget and it started a debate among economists: “Will an increase in military spending lead to a rise in inflation?”
In 1984, economists Harvey Starr, Francis W. Hoole, Jeffrey A. Hart, and John R. Freeman wrote an article titled “The Relationship between Defense Spending and Inflation” in The Journal of Conflict Resolution, which looked at arguments, both for and against, from previous academic studies and then attempted to apply a custom made formula using empirical data to find out if inflation was affected by military spending and vice versa.
The argument that military spending does affect inflation is that it is a government expenditure that does not increase supply but does increase demand. When the government orders a hundred new cruise missiles, someone has to make those missiles and they must be paid for their labor. But consumers do not buy cruise missiles. Either they are purchased by an allied state, sit in a warehouse somewhere, or are blown up either in training exercises or actual warfare. Untold trillions of dollars have been pumped into the economy through military spending over the last century, with hardly any of that going to increase supply.
In the article, Starr et al quote a 1981 article from James Fallows arguing that military spending increases inflation: “The first principle is that defense spending is inherently more inflationary than other kinds of government spending… the problem with military spending, simply put, is that it adds to the demand of goods without adding to the supply… Military and non-military spending add to the demand; military spending does not add to the supply.”
Additionally, Fallows argued that military contractor spending is intentionally designed to maximize cost, rather than efficiency, and that in addition to the massive amounts of fraud that is typically involved, military contractor spending can have a larger impact on the deficit and spill over to civilian product pricing. If our factories are being used to build fighter jets, they cannot be used to make cars, so the price of cars should increase.
Starr et al also laid out the argument against military spending increasing inflation. The arguments made some good points. They say that there is nothing particularly special about the relationship between military spending and inflation compared to other types of government spending. That is particularly true about the stimulus package. We all got paid by the government, and like cruise missiles, it did not produce any products that would contribute to supply. But cruise missiles and wars overseas do not help Americans struggling to make ends meet, and another contract for Boeing does not help the economy outside of Boeing’s stock price and bonuses for the company’s executives.
Furthermore, the pro-military side caveated their arguments by saying that any increase in military spending should be counteracted with a decrease in domestic spending or higher taxes.
Quoting Charles L. Schultze in the Brooking Bull from 1981, the authors explain the argument: “The United States is fortunate in having an economy, that, with proper policies, can adjust to about as high or low a level of defense spending as the nation and its leaders think is appropriate.” Schultze admits that problems arise when that spending is ramped up quickly, but so long as that is kept in check, military spending is little different than other types of government spending. “In sum, government purchases do not add to market supply in the economic sense of the term. Hence taxes must be levied. But the military nature of the goods is absolutely irrelevant” [emphasis mine].
To further help the United States in its fight against inflation, the economy had a lot of “slack,” i.e. unused potential in an economy such as empty factories, excess workers, and other unutilized assets that could be used to offset the lack of supply created by military spending.
In concluding their study, Starr et al looked at empirical data of countries that increased their military budget and put it through a proprietary formula that was a modification of the Direct Granger Causality. They looked at four countries that increased their military budgets over the 1950s and 1960s and attempted to determine if military spending causes inflation. They concluded that it depends. The United States and the United Kingdom did not see inflation rise as a result of military spending, while France and West Germany did.
“[I]t seems reasonable to conjecture that in the 1950s and 1960s defense spending put a much greater strain on the industrial bases of Germany and France,” Starr et al explained. “This showed up in terms of inflation, both in the effect of defense expenditure on investment and in the lack of slack in the French and German economies compared to those of the United Kingdom and the United States. Recall that the amount of slack in the American economy was a prominent variable in several recent analyses of defense spending and the US economy.”
However, offshoring jobs and then the pandemic has done a lot to eliminate that slack in the US economy today. We are simply not able to replace that supply with an ever-growing workforce and increases in infrastructure and technology like we once were able to. But Starr et al also pointed to another key factor that applied to both the United States and the United Kingdom, the strength of their currency.
“The United States used the key currency status of the dollar to export its inflation by running balance of payment deficits in the 1950s and 1960s. Although the United States has had by far the highest defense spending as a percentage of GNP of all the countries under study, the special position of the dollar may have allowed the United States not only to use slack in its own economy to absorb possible inflationary effects of defense spending, but to use slack in the world economy as well.”
In the 1960s, the British pound was already lessening in importance, but it still had immense influence as one of the largest reserve currencies behind the US dollar. Today, the dollar remains dominant but, due to the aforementioned sanctioning of Russia, it is quickly losing that advantage.
Russia competently moved away from the SWIFT network and started selling its oil using rubles and the yuan. Meanwhile, China, India, Saudi Arabia, and Iran have all signaled interest or have taken tangible moves away from using the dollar as their reserve currency. This all means that the dollar is no longer in demand like it once was. We cannot offset our deficit by increasing global liquidity as we once did. Even before the world’s second and seventh largest economies, plus three major oil producers, started moving away from the dollar, it was already losing its prominence as the global reserve economy.
In 1999, the year the euro was introduced, the US dollar represented 71% of the global foreign-exchange reserves. In 2021, it had fallen to 59%. Most of the change was countries, like the US later forced Russia to do in 2022, switching to local currencies rather than the dollar or British pound. The trend is expected to continue.
14 July 2022, 18:39 GMT
The answer to inflation is clear when you are willing to put everything on the table. While the $5 trillion spent on three stimulus packages certainly was a big number, it is important to note that we spent at least $13.34 trillion on the military from 2000 to 2019 (adjusted for inflation) and none of that money, save for soldiers who had to kill and be killed to get a small portion of it, went to helping Americans.
The pandemic may have been unavoidable (though, it could have certainly been handled far better), and we may have already screwed the pooch when it comes to gas prices (though ending our support for Ukraine and normalizing relations with Russia would be a great first step), but what we can do is draw down our military spending and take a friendlier position with nations around the world, rather than acting like the dollar is their only choice for reserve currencies.
If you want to curb inflation while preserving the US economy, what we need to do is simple: end the war racket.
Unfortunately, no one in the federal government or mainstream media is likely to propose that.
