Inflation’s Other Causes

Yes, Putin did play a small role; but there are myriad other causes, including Biden's response to Putin

President Joe Biden speaks about inflation and the economy in the South Court Auditorium on the White House campus in Washington on May 10, 2022. (Drew Angerer/Getty Images)

Commentary

NEW YORK—The biggest economic news of the year, so far, has been inflation—the highest in 40 years—and the Federal Reserve’s (Fed’s) efforts to fight it. And while there have been lots of finger-pointing at causes—from President Joe Biden’s fossil fuel policies to the war in Ukraine—all of which are at least somewhat true—there are myriad other causes that the media tends to ignore and that we need to address to tamp down the current inflation and avoid it in the future.

Even Fed Chair Jerome Powell dismissed Biden’s claims of “Putin’s Price Hike,” pointing out that inflation was well underway before Putin’s invasion of Ukraine. But that war is an element of the current inflation, albeit because of the West’s sanctions on Russia, particularly on the costs of oil and natural gas prices and the staggeringly high cost of fertilizer, much of which comes from Russia.

But there are other causes of inflation that are pernicious and are rarely discussed in the media, even in the business media. So, let’s take a look at some of those.

The Federal Reserve Balance Sheet Is Way Too Big

The foremost issue driving inflation is the enormous growth in the Fed balance sheet. We have simply produced far too much money, which has caused asset inflation in everything from real estate to equities to silly, one-of-a-kind, photos of monkeys (so-called “Non-Fungible Tokens,“ or ”NFTs").

There have been three major tranches of Fed money creation that have expanded it to ten times the size it was in 2008:

^{Federal Reserve assets in millions of dollars. (Federal Reserve/Screenshot via The Epoch Times)}

• In the fall of 2008, to maintain market liquidity with Quantitative Easing (QE) for the September 2008 Lehman Brothers collapse housing crisis (from $905 billion to $2.2 trillion);
• In December 2012, when the Fed gradually expanded its balance sheet in a slowing economy (from $2.9 trillion to $4.5 trillion);
• To address the CCP virus in 2020 and, again, to fulfill Biden administration fiscal policy, like the American Rescue Plan Act of 2021 that added $1.9 trillion, to an already recovering economy. All told, the Fed balance sheet went from just under a trillion dollars (from $4.2 in March 2020 to $7.2 trillion in June); then, again, to today as the Fed balance approaches $9 trillion.

Prior to 2021, inflation was, likely, reasonably well-contained by the Fed paying interest on excess deposits, the deposits above Fed member banks are required to hold. While this practice was intended to maintain a floor on the federal funds rate (i.e., the rate banks charge other banks), it also kept excess cash out of the economy. But the onset of COVID crippled the “Q” and inflation became inevitable.

As I’ve written previously, the Fed blew up its balance sheet and created far too much money since 2008. It made inflation inevitable, given the Quantity Theory of Money. (MV=PQ, which I discussed at some length here.)

There’s Not Enough ‘Stuff’ in US Markets...

A glance at GDP shows the trajectory of GDP growth was considerably disrupted by the CCP virus. It is only now commencing a return to its pre-pandemic trajectory. Had GDP growth continued unabated, there would be more goods and services (the “Q” in the formula aforementioned) to “sop up” the excess money that’s in the system.

... and It Costs More to Get Stuff Here

As the European Central Bank (ECB) wrote in its March 2021 Economic Bulletin, costs for container ships had increased dramatically, even by the second half of 2021. “Reportedly, ports in Europe and the United States are congested amid logistics disruptions related to the coronavirus (COVID-19) pandemic and idle containers remain in several ports on the back of the uneven recovery of trade,” the ECB wrote.

Freightos Baltic Index; USD per 40-foot equivalent unit shipping container, contributions of sub-indices. (ECB)

But costs to customers are not only exacerbated by costs of leasing containers and moving them across the seas, but also by demurrage and detention charges.

Demurrage charges are for holding a container at dockside beyond an allowable time; essentially using it as storage. Detention charges are for not returning the container on time because the port has no appointments available for the port to receive it. (As one writer elsewhere put it, “Imagine you want to return your Hertz rent-a-car and Hertz tells you, ‘We’re too busy to take it back,’ but then keeps charging you the daily rental fee!”) Significant backlogs at the ports have added considerable costs to both those charges. And all those charges get passed on to consumers.

‘Weaponizing’ the Dollar Over Ukraine Has Harmed Us

Foreign demand for US Dollars (USD) helps to retain its value relative to other currencies in our free-floating exchange system. “King Dollar,” meaning a strong USD relative to other currencies, and a frequent refrain of financial commentator Larry Kudlow, helps U.S. consumers buy goods, particularly imports, more cheaply.

Much of the reason the USD is strong, though, is because we have the world’s largest economy and a reliable “rule of law” society. As a result, the USD is the world’s leading reserve currency.

The Biden administration’s decision to attempt to “weaponize” the USD as part of its sanction campaign against Russia over Ukraine shook foreign central bankers’ confidence in the USD to some extent. A number of entities divested of dollar holdings, starting in March and accelerating in April, for fear that what the United States did to Russia’s reserves could happen to their reserves as well if they ran afoul of the United States. (See this chart from TradingEconomics.com based on Federal Reserve data for a graphic representation.)

The divestment reduced the demand for USD and, thereby, its purchasing power. It made things cost more. While we have imposed economic sanctions in prior conflicts, we have never before weaponized the USD to destroy another nation’s currency—not even against the Nazis.

Lessons for Now and for Future Policy

Prospectively, we should recognize that there is a risk of expanding the Fed balance sheet and should keep it tied to GDP to make sure there is not “too much money chasing too few goods (and services).” I continue to maintain the Fed should sell off the Treasurys and MBS it acquired in the pandemic.

Supply chains need to be made far more robust. Ideally, much of what we need (and particularly carbon-based fuels) should be sourced from the United States. But certain manufactured goods must come from overseas; making them here simply isn’t profitable. We should work with our North American trading partners to build out additional ports and port capacity along the Pacific Coast. On the Atlantic Coast, we should dredge ports to accommodate larger container ships. We should also have the Army Corps of Engineers perform a survey of the nation’s inland waterways with a view toward extending barge shipping along inland waterways. We should better integrate national rail lines with port operations to take the stress off the trucking industry. Truckers should be shipping the last few hundred miles, not coast-to-coast. And while we do that, let’s look at using GPS technology to maybe make trucking a “Pony Express” type of industry, with truckers driving a load outbound from their homes for four hours and then inbound for four, so that truckers can work as near as possible a regular work day and have dinner with their families. (Retiring “baby boomer” truckers have caused a shortage in the industry. Making the job less stressful and family-friendly might help add more workers.)

We should lead a movement among our major trading partners and the International Monetary Fund to swear off ever again using currency sanctions to wage economic warfare. The Biden administration used it for the first time in U.S. history in the Ukraine war and it failed miserably. (After a brief decline from mid-February to mid-April, the ruble recovered and is now at its highest USD value since 2015, as seen in this chart.)

We should admit that such tactics were and are a huge mistake and, as this author at Foreign Affairs opines, “policymakers must accept the material reality that an all-out economic offensive will introduce considerable new strains into the world economy.” For now, the best way forward is to seek peace in the Ukraine war; instead, the Biden administration keeps escalating.

We’ve had experience dealing with inflation and we need to be extraordinarily wary of it. Biden’s oft-repeated cliche of, essentially, “I feel your pain,” does little for consumers deciding whether to choose to bypass their child’s dentist’s appointment or their car payment. Americans need solutions, not sympathy, from their government.

Future policymakers should be wiser in managing inflation than we have been the last several years. And take lessons from our shortcomings.