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A headline in the Financial Times on June 15, 2022, announced, “Fed raises benchmark rate by 0.75 percentage points to tame scorching inflation.” Inflation reached 8.6%, was decimating family budgets, and had become the number-one concern among U.S. households.
Some fear inflation more than any other economic woe, in part from the view that its causes are mysterious and can’t be controlled. And now it is raging.
Brutal as inflation is, it’s been an infrequent visitor in the U.S. and has usually departed quickly. Only four episodes of high inflation have occurred since 1900 – two of which came from the supply depletion and decimation on the battlefields of our two world wars. Put simply, if wheat fields are destroyed in those battles, the price of wheat will go up until those fields are restored.
Our most recent episode came in the 1970s as OPEC throttled oil production in retaliation for the U.S. position on the Yom Kippur War, and as production was choked by the Iranian Revolution. This drove the price of oil from $4 to $39 a barrel, a 10-fold increase, which pushed inflation to 13.5%. Its defeat came not from high interest rates, as many believe, but from domestic oil price deregulation. This spurred a massive boost in production that brought the price down to $11 by 1986 and sent inflation tumbling down to 2%.
Although supply constraints and depletion brought these bouts of inflation, there’s a universal conviction that government spending and the massive “printing” of money is the culprit, and that the only solution is to raise interest rates.
Three simple points contradict this conventional wisdom:
1. Inflation is a result of the pandemic and the Ukraine war
This is another case of inflation caused by supply depletion and restriction. The pandemic kept workers away from their jobs and decimated supplies. Progress against the pandemic was restoring production and distribution and increasing supplies, and inflation was destined to abate – probably quickly – once those causes had receded or we had otherwise come to grips with them.
But in February 2022, Russia launched a new invasion of Ukraine. Since Russia is a key supplier of the world’s oil and wheat, and Ukraine is among the world’s leading suppliers of wheat, the prices of those two commodities leapt. The war-related price increase pushed inflation higher.
2. Inflation is nota monetary phenomenon
Inflation is not a function of the Fed “printing” copious amounts of money.
Our best evidence comes from history. From 1994 to 1999, then again from 2011 to 2018, the Bank of Japan – Japan’s equivalent to the Fed – doubled and tripled its balance sheet, flooding the country with money. Yet inflation remained at zero. Japan is just now showing slight inflation, but its cause is the same supply depletion affecting the entire world.
Further proof comes from the U.S., where Fed actions from 2009 to 2013 to counter the great financial crisis flooded the market with money, and yet inflation stayed stuck at a low 2%.
In fact, when we scour all the major countries of the world, we find that high money supply growth is often not followed by high inflation, and high inflation is often not preceded by high money supply growth. And of further note, if inflation were simply a monetary phenomenon, all prices would increase by roughly the same percentage, and that’s not the case.
3. Inflation has normally been resolved by addressing the underlying causes withoutresorting to high interest rates
Although raising interest rates will help tame inflation, they’ll do so only by suppressing demand and bringing harm to the economy. They won’t, however, repair supply chains or end the Ukraine War.
As with all our other bouts of high inflation, we’ll defeat it by addressing the real cause, which is the restoration of COVID-impaired supplies and distribution and a resolution to the Ukraine war. Pandemic production and supply disruption will take longer to untangle given the global complications brought by this war.
Unfortunately, the war in Ukraine may last years. And if it escalates – if a Russian tanker delivering oil to Asia should be destroyed – it could get much worse. Our current inflation will most likely persist for a time.
The U.S. must cope with this inflation, and it must do so while trying to fend off an economic slowdown that could become a recession. Fasten your seatbelts!
Richard Vague was managing partner of Gabriel Investments. Previously, he was co-founder, chairman and CEO of Energy Plus, an electricity and natural gas company. Vague was also co-founder and CEO of two banks and founder of the economic data service Tychos. He currently chairs The Governor’s Woods Foundation, a nonprofit philanthropic organization. His new book is The Case for a Debt Jubilee (Polity Press, Nov. 22, 2021). Learn more at richardvague.com.
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
