Inflation is a grave economic and social illness. The policymakers and central bankers who might have been praying for higher inflation rates for quite some time are finally getting their wish – but for the rest of us, this is terrible news.
Ernest Hemingway, the famous American writer, was a keen observer of society. In “Notes on the Next War,” he makes this striking observation: “The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”
Fear of inflation is spreading globally. After an extended period of asset price inflation (during which the concern for general inflation was downplayed), now consumer price inflation is hitting 4 percent in Europe and 5 percent in the United States. A normal monetary policy reaction would be to take liquidity out of the system. Central banks would increase interest rates and minimum reserves. Since the European Central Bank (ECB) and the U.S. Federal Reserve (Fed) are currently financing governments directly by purchasing their bonds – a risky move that is against their statutes – the central bankers could, in theory, also reduce these purchases, which is called “tapering.”
Raising interest rates increases the debt-servicing burden of the overextended countries. But what about tapering? Last week, ECB President Christine Lagarde expressed the policy wryly and clearly: “The Lady is not for tapering.” So, inflation will rise further, fueled by the irresponsible policies of governments running deficits and central banks pumping more and more money into both the economy and governments. This vicious circle also allows the public sector to expand further.
The cost of an expanding head count must be passed on to clients and consumers.
Expansive monetary policy has been maintained for several years now. Politically, it is motivated on both sides of the Atlantic by the desire to avoid natural downward shifts in the economy and populist politicians’ unsatiated need for money to satisfy their clientele with handouts. As a result, the public sector’s spread has no end. This nefarious process is combined with hectic regulatory work at the national and supranational levels. The rising wave of regulations and legislation generates the need for more staff to administer, control and enforce. In this context, enterprises big and small must allocate ever more resources to comply with the new rules, not all of them productive, but all of them increasing the cost of doing business. Firms’ productivity is reduced, and the cost of an expanding head count must be passed on to clients and, ultimately, all consumers. Prices then increase.
Endlessly growing state
Classical economics posits that inflation occurs when aggregate demand is higher than supply. There is already concern about who will pick up the tab for the massive coronavirus-relief programs, the empty cash boxes of the social systems, and the tremendous resources being spent on attempts to create a state- and technocrat-controlled green economy. Also, we are witnessing an insufficient supply of goods and services as consumer demand has exploded after the Covid recession. The problem is made worse by the money handed out in the social programs.
What are the reasons for this insufficient supply? A classical explanation is supply-chain problems. And indeed, we see raw material shortages on the one hand, and bottlenecks in logistics – like Covid flare-ups in China’s ports – and political and regulatory obstacles on the other hand. Generous unemployment benefits in the U.S., for example, discourage returning to work. Such a policy curbs labor supply while increasing spending.
Another important reason is the misallocation of human resources. As more and more people perform unproductive functions in government and supranational sectors, their skills do not contribute to the productive sector of the economy. Increases in national overheads reduce productivity.
Inflation is likely to spiral out of control.
The phenomenon of the growing state has been with us for a long time. However, businesses in many countries have been doing a tremendous job innovating and increasing productivity. That had a positive deflationary effect, compensating for the inflationary activities of governments and central banks. Now, it seems that a tipping point has been reached. The economy’s strength is no longer sufficient to outweigh the proliferation of the public sphere and its associated costs, as well as the burden of expansionary monetary policies.
Until recently, policymakers frivolously lamented that inflation rates were below 2 percent, the magic formula for healthy growth. Well, 2 percent has been reached, and surpassed, over the last three months. Inflation is likely to keep on rising out of control. Rather than help expand the economy in the medium and long term, it gives rise to the worst, which is stagflation: persistent high inflation combined with high unemployment and stagnant demand.
The Hemingway quote obviously applies here: “The first panacea for a mismanaged nation is inflation of the currency …” The situation we are in today is, most emphatically, a result of gross mismanagement. Geopolitical Intelligence Services has warned in many reports and comments of the danger, but policymakers have treated inflation as a solution; “Honi soit qui mal y pense” (shamed be whoever thinks ill of it). Economists on supranational and national levels may not be unhappy, as the responsibility for the disaster will become unclear. But the consequences will be dire: savers will lose their money without seeing the political leadership taking it in obvious ways. Prosperity will be rolled back; social problems will grow. But, as the cynical reasoning goes, so will the power of the state and the political establishment.
The lower-income groups might be kept loyal to the bankrupt system through further handouts and blaming the rich.
However, the technocrats may miscalculate. Citizens have ample reasons to rebel and bring drastic changes in the political systems. This ill-advised journey propelled by cynical, self-serving policies, technocratic arrogance and populist lies can end in turmoil.
The first victim of inflation is the middle class. At this point, it looks likely that the inflationary policies will continue, and the lower-income groups will be kept loyal to the bankrupt system through further handouts and propaganda blaming the rich. Wealth and inheritance taxes are likely to rise in this context, even though we know empirically that these are detrimental to the overall economy and prosperity. The end result is social and political trouble.
People are beginning to realize that problems are looming. In Germany, for example, the growing concern is not over climate change or Covid, but tax increases followed by inflation and the huge cost of the EU debt crisis to the taxpayer.
As Hemingway pointed out, inflation brings temporary prosperity (unfortunately, we are most likely past this phase) but permanent ruin. “It is the refuge of political and economic opportunists.” Political classes, opinionated technocrats and some economists have taken this refuge for more than a decade now. Today, the dilemma is how can one make governments, administration and supranational organizations leaner and return more workforce talent to the productive side. This is one of the daunting socioeconomic challenges of our time.