As cliche as it may sound, economist Milton Friedman is correct in observing that Inflation is a monetary phenomenon. Namely, it’s the result of excessive expansions in the money supply. America itself is beginning to experience its most recent bout of inflation as the government has embarked on a massive spending binge, a loose monetary policy, and lockdowns that have significantly disrupted business operations nationwide.
All told, America is about to experience a significant economic upheaval. With the economy in such a dire situation, one has to wonder what path policymakers will choose to confront this dilemma. Against this backdrop, America’s national debt currently stands at nearly $29 trillion, which will tempt many pro-easy money politicians to consider doubling down on money printing.
Generally speaking, inflation allows debtors to pay off their debt with depreciated dollars. The national debt is becoming a major problem with speculation of the US defaulting or going into a sovereign debt crisis in the next decade or so. This will make inflating the debt away a tantalizing proposition for some of the ruling class.
However, American Institute for Economic Research Senior Fellow Richard Ebeling, poured cold water on this concept in a piece for AIER earlier this month. The current Biden administration is proposing a vast infrastructure program coupled with expansions in the welfare state through the establishment of a federally-managed paid leave program.
The million dollar question with regards to this spending binge is: How is the US government going to finance it?
Generally speaking, politicians turn to heavy taxation to finance generous welfare programs. In developed countries with progressive income taxes, jacking up taxes on the rich to finance social welfare programs makes for great politics. However, it’s terrible for economic development.
Contrary to popular belief, tax hikes don’t necessarily translate into increased tax revenues if the taxes are so high that it stifles economic activity, thereby leading to less activity to tax. All the while, the US government’s deficits will continue to balloon, further adding to the national debt. According to certain projections, the national debt is expected to reach $42 trillion by 2031.
Obviously, there are questions as to how the US government will pay off this debt, on top of the interest payments that have accrued on top of this debt. The latter case is particularly frightening when looking at projections.
According to estimations from the Congressional Budget Office’s most recent long-term budgetary report, “An Overview of the 2021 Long-Term Budget Outlook”, nearly half of the money the government borrowed in fiscal year 2031 will solely be used to pay the interest owed on the national debt at that point in time.
In essence, as Ebeling noted “over the next decade the government will be borrowing huge sums of money merely to stay current with the interest payments due on all the years of past deficit spending.”
With the very real risk of the US not being able to pay off its debt in its current state, some elites will consider using inflation as a way to effectively reduce the US government’s overall debt burden. This is a short-sighted way to tackle the debt problem, since the “solution” consists of using a flawed means (inflation) to battle the lingering problem of the national debt. This is the equivalent of putting a diseased-infected band-aid on a bullet wound.
So far, In the US’s case, the country does enjoy several disinflationary trends that generally cushion the blows from money printing. As a whole, globalization and technological innovation function as disinflationary forces that keep inflation in check for the most part. Though these factors may not fully protect the US in the long-term, as inflation eventually asserts itself.
Americans should prepare themselves for the inevitable inflationary episode that’s right around the corner. One facet of the inflation question that Ebeling is correct in talking about is how inflation does not happen immediately, nor does it impact people equally:
But it needs to be recalled that price inflations never bring about rises in all prices at the same rate and at the same time. Monetary expansions are non-neutral in their impact affect due to the temporal-sequence of how new money is injected into the economy and how that money is spent and then received as higher revenues due to the patterns of the resulting increasing demands for different goods and services in different amounts, at different times, and different places in the economy in the process.
A solid grasp of economic history would have us become weary about the prospects of stagflation – the increase in prices combined with a stagnant job market. This is the product of easy money coupled with a regulatory environment that stifles economic activity. The result of this nasty cocktail of misguided economic policies is stagflation which kills people’s savings while depriving countless others of economic opportunities.
Like all forms of government policies, inflation does have its winners and its inevitable losers. Inflation disproportionately benefits debtors at the expense of lenders and hard-working savers. The latter folks who have their money deposited in banks get hurt the most as the nominal interest rates do not catch up with the overall rise in prices.
It’s no secret that the US has chronic spending problems. As a result, there will always be an allurement for policy makers to inflate it away. The logic is, as Ebeling outlined, that through monetary debasement “nominal dollars paid back to creditors in depreciated units of money makes its real burden just go away.” At the end of the day, inflation functions as a tax, which Ebeling firmly spells out below:
It has long been understood that price inflation is a form of tax, under which portions of the citizenry’s income and wealth is taken from them through reducing the real buying power of the nominal sums of money held by all those in the private sector and the general public. But, as has also been pointed out many times, while actual taxation is targeted in various ways at defined groups in society, price inflation is indiscriminate in negatively affecting the real incomes earned by various segments of the overall population. It is far more arbitrary and deleterious in its effects on people.
Ultimately, the question of handling the national debt is one of cutting spending. That means defense spending to spending on America’s bloated welfare services should be subject to cuts. However, using inflation to reduce the debt burden is a complete non-starter due to inflation’s deleterious side effects — the destruction of savings, rising prices, etc. This suggestion is the textbook example of a “solution” that creates even bigger problems further down the line.
