Editors’ Note: This article was written in late November and notes inflation in the US hit a 30 year high. Last week, it was reported that inflation is at a 40 year high. That didn’t take very long, did it?

History teaches us something important about inflation: it can spiral out of control just that fast.

The Federal Reserve began in 2020 has finally got people’s attention, and is no longer a topic for just economists and free-market advocates.

CNN last week reported that price increases recently hit a three-decade high and 25 percent of Americans say their standard of living has fallen. Speaking on CNBC’s “Squawk Box,” Home Depot founder Ken Langone noted that “inflation is a regressive tax [that] hits poor people hardest.” On CNBC’s sister network, MSNBC, host Joy Reid noted that “unless you’ve been living under a rock your money isn’t going as far as it used to, with higher prices on gas, food, and your energy bills.”

Even the late-night comedy show hosts are talking about inflation.

“Right now inflation is the one thing people hate even more than Jake Gyllenhaal,” Daily Show host Trevor Noah quipped. “It seems like everything is more expensive these days. Groceries are more expensive. Cars are more expensive.”

Noah wasn’t done.

“I went to a gas station today,” Noah joked, “and for a gallon of regular, it just said ‘kill yourself.’”

Inflation: How Worried Should We Be?

Most people understand what inflation is, but in case you don’t, let’s define it. Inflation is essentially an increase in the supply of money. That’s basically it, and this was the standard definition of inflation for centuries, economist Joseph Salerno notes. Economists later added a second definition describing inflation as “a general and sustained increase in prices.”

Polls show Americans are quite worried about these “sustained price increases.” As FiveThirtyEight recently observed, some surveys show 87 percent of registered voters are “very” or “extremely” concerned about inflation.

Some are less worried. MSNBC’s Stephanie Ruhel recently said the “dirty little secret” was that Americans can afford inflation.

“You’ve got the families of over 60 million kids on average getting $430 a month. For people on fixed incomes, older people on social security, they’re getting those fixed payments adjusted next year up 5.9 percent or inflation. And the dirty little secret here, Willie, while nobody likes to pay more, on average we have the money to do so. Household savings hit a record high over the pandemic. We didn’t have anywhere to go out and spend. And as we said a moment ago, we’re expecting retail sales this holiday season to break records. For those who own their homes and the value of our homes are up. And while the stock market isn’t the economy, you have over half of American households with some investment in the markets and the markets have hit record highs.”

Ruhel isn’t wrong that inflation impacts some more than others. Homeowners and Americans invested in other assets—stocks, land, cryptocurrencies, gold and other commodities—tend to be shielded to a degree from the most pernicious effects of inflation. But this only accentuates the truth that inflation falls hardest on lower-income Americans who rely more heavily on cash.

Importantly, history teaches us something else about inflation: it can accelerate very fast.

Hyperinflation Starts as Inflation

We’ve already tackled the definition of inflation. So what’s hyperinflation?

However, it’s also important to understand that hyperinflation is always preceded by regulation inflation. This of course doesn’t mean inflation always leads to hyperinflation, just that inflation can lead to hyperinflation if the money supply continues to expand.

One of the most famous examples of hyperinflation happened in Germany during the Weimar era. Many of us have seen the images of women carrying laundry baskets full of marks to buy bread or rooms plastered with useless money.

As Salerno notes, people often forget that Germany’s hyperinflation began following a period of sustained inflation that started in 1914, when the German government began to increase the money supply to fund the war effort. Hyperinflation didn’t begin until 1922—several years after the Versailles Treaty and the official conclusion of World War I—and it began relatively slowly (if hyperinflation can ever be described as such).

Salerno offers this example: The price of a daily newspaper was .30 marks in June 1921. By May the following year the price had risen to 1 mark. Just five months later, a daily newspaper cost 8 marks. The following February, 100 marks. In September 1,000.

It was in October 1923 that things really got crazy. When the month began, a daily newspaper cost 2,000 marks—2,000x higher than a year and a half earlier. By October 15, the price had increased to 20,000—a ten-fold increase in two weeks. And by the end of the month? Germans were paying 1 million marks for a newspaper.

This is just one illustration of hyperinflation, of course. But the lesson of each remains the same: inflation can spiral into hyperinflation just that fast.

The Only Path to Sound Money?

In one of his less-known works—Denationalisation of Money—the Nobel Prize-winning economist F.A. Hayek noted that perhaps the greatest lesson of human history is that governments debase currencies. From Diocletian in Ancient Rome to Weimar Germany and beyond, Hayek saw that great powers, almost without exception, manipulated currencies and eroded the value of money.

This is why Hayek believed the only way to have sound money again was to take it “out of the hands of government.”

“[S]ince the function of government in issuing money is no longer one of merely certifying the weight and fineness of a certain piece of metal, but involves a deliberate determination of the quantity of money to be issued, governments have become wholly inadequate for the task and, it can be said without qualifications, have incessantly and everywhere abused their trust to defraud the people,” Hayek wrote.

Twice in its history, the United States has killed its central banks. The first national bank of the United States, signed into law in February 1791, died in 1811 when its charter expired. The second national bank, created five years later, was effectively killed by President Andrew Jackson in 1833 when he removed all federal deposits and let its charter eventually expire. Not until the twentieth century, following the Panic of 1907, was a third central bank created, which culminated in the Federal Reserve System we have to this day.

Considering the nation’s soaring inflation, $29 trillion debt, and rampant spending—all of which spawn from the Fed’s reckless monetary policies—it may be time to take Hayek’s advice.

*****

This article was published on November 24, 2021, and is reprinted with permission from FEE, Foundation for Economic Education.

“One of the biggest taxes is one that is not even called a tax–inflation. When the government spends money that it creates, it is transferring part of the value of your money to themselves.”  Thomas Sowell

“The cure for inflation is simple to state but hard to implement.  Just as an excessive increase in the quantity of money is the one and only important cause of inflation, so a reduction in the rate of monetary growth is the one and only cure for inflation… The problem is having the political will to take the necessary measures.” Milton Friedman

“Milton Friedman is no longer running the show anymore.” President Joe Biden

The politics of deficit hysteria, embraced by both sides for decades, served as an even bigger impediment.  ….This book aims to drive the number of people who believe the deficit is a problem closer to zero.” Stephanie Kelton, Advisor to Senate Democrats, Bernie Sanders, and the author of The Deficit Myth.

“To overcome its policy mistake, the Fed has to detail how it got the call wrong on inflation for so long, and then quickly wind down asset purchases.” Market Watch

US inflation jumps 6.8% in November — fastest rate in 39 years- Yahoo Finance.

We read the headlines just like you do. But does the CPI really measure inflation for most of us? Here is a different take from economist Vince Ginn, with the Texas Public Policy Foundation. Our government likes to “adjust” inflation for quality differences so-called hedonic adjustments. What is interesting about this list is its clarity. There is no real “qualitative” difference in say uncooked beef roasts, or gasoline over time. Beef is not that different from last year nor is gasoline.

• Food: 6.1%
• Flour: 6.2%
• Uncooked beef roasts: 26.4%
• Bacon: 21.0%
• Chicken parts: 10.7%
• Eggs: 8.0%
• Pork roasts, steaks, ribs: 22.9%
• Whole milk: 6.6%
• Apples: 7.4%
• Canned vegetables: 6.5%
• Dried beans, peas, lentils: 8.6%
• Coffee: 7.5%
• Peanut butter: 6.8%
• Baby food: 6.7%

Home:

• Utility gas service (natural gas)  25.1%
• Home heating oil  59.3%
• Furniture and bedding: 11.8%
• Laundry appliances: 9.2%

Travel:

• Tires: 11.1%
• Energy: 33.3%
• Gasoline: 58.1%
• Used vehicles: 31.4%
• Hotels: 25.5%
• Rental vehicle: 37.2%

Other:

• Clothing: 5.0%
• Tobacco and smoking products: 8.9%
• Banking services: 9.9%

Some would suggest some of this is caused by supply chain issues. OK, who screwed up the supply chain by shutting the economy down, thinking they could throw a switch and turn it back on? And which political party has been most eager to shut the economy down? Any difference between Florida and New York?

Those who follow the news about the economy and finance are no doubt aware just a year or so ago, the “authorities” were worried about disinflation. They were worried that bad demographics (little growth in the population), too much debt, and disruptive new technologies like the internet and globalization, had the world locked in a deflationary spiral. Or, so they believed. Because of that fear, we have run a long regime of zero interest rates and very large budget deficits. Then along came the Chinese virus, and the government responded by shutting down the economy, quarantining the healthy, and jamming the vulnerable elderly into crowded nursing homes, where they died like flies.

The economy tanked so the government poured on more stimulus. As the economy started to recover, the government poured on more stimulus.

Their policy response was huge spending and gigantic deficits all while, they held interest rates near zero and pumped trillions into the system by the FED buying treasury bonds and mortgages and adding them to the FED’s balance sheet. Where did the FED get the money to buy all the government debt? They created it out of thin air.

The theory was that much of this newly created money would stay largely within the financial system, inflating the value of financial assets.

Then came along Covid relief policies, that sent checks directly to consumers, making a monetary end-run around the constipated banks. As a result, the M2 money supply grew in the first half of the year around 25%, and has now backed off to around 12-14%, still way above the rate of economic growth.

The Federal Reserve said it would respond to the threat of disinflation, by actually promoting inflation, with a target of exceeding 2%. Critics at the time pointed out that such policies are like “being a little bit pregnant.”  You can’t start an inflationary spiral and be certain you can control the whole process. We now have inflation at more than three times that rate and the FED is now only rhetorically stirring itself, but terribly worried about “tapering” or reducing the FED’s balance sheet lest we repeat the stock meltdown of 2018. You might recall that in late 2018, the FED started to unwind its balance sheet and raise rates only to abort quickly after the stock market sold off 20%. They have not attempted a “taper ” since.

As inflation has increased, the FED publicly stated that it was “transitory”, although they never defined what transitory meant in the real world, nor did they explain why a high rate of inflation is good, even if it be temporary.

Meanwhile, politicians noticed they were able to run huge deficits, have them financed by the FED, and there was seemingly little inflation. Critics pointed out there was inflation, but that it was largely confined to asset prices (stocks, bonds, real estate) and the new ways hedonic accounting was used to hide the real inflation rate in the inflation indices. But Congress wanted to take advantage of the virus crisis to advance its goals of socializing the economy and destroying fossil fuels.

Moreover, politicians felt new principles were at work. As President Biden bragged, “Milton Friedman is not in charge”. That was another way of saying the growth of deficits, debt, and money supply, would not create inflation. And they had the new ideas of Modern Monetary Theory to assure them of this new benign relationship. They could run up monstrous deficits, increase bank reserves, and increase the money supply, and unlike previous eras, inflation would not interrupt their plans to convert the United States to a socialist system.

Well, it hasn’t worked out all that well, has it. Inflation is now at a forty-year high. But unlike the 1970s, we have much higher debt in the Federal Government, state and local governments, and among corporations and individuals. The one thing that is dramatically lower, is interest rates. By shoving rates down, they shoved bond values to the ionosphere. Bonds move opposite of the interest rate. Thus, rates near zero create by mathematical law, a bubble in bond prices.

Meanwhile, with no yield in bonds or bank deposits, the public has stormed into stocks as the only alternative. Already this year, the flow of money into equities exceeds the combined total of the past 12 years!

Certainly, in the US, and in other countries, aggressive central banks have facilitated wild spending by their respective legislatures. Central banks have enthusiastically enabled at every turn, the legislative monetary drunks that want to binge on more spending.

Many believe central banks are at fault. Yes, they are. However, they would not be monetizing a lot of debt if the government was running a balanced budget. Central banks carry “independence” largely as a fig leaf. In the end, they are very political and often do what their legislative masters or the President want them to do. Our point though is this:  you can’t monetize excessive debt if there isn’t any. Debt is a creation of Congress, not the FED. The FED just makes it easy so Congress can continue wild spending.

So, we are left with inflation raging, central bank balance sheets bloated to record levels, high levels of debt in government and society, and negative interest rates.

If Professor Friedman is correct, the ONLY way to tame inflation is to reduce money growth, which will require substantially higher interest rates, as we saw with Reagan and Volker in the early 1980s. But like Reagan and Volker, that takes political courage. Does the current crop of politicians look like they have both the understanding and the courage to act?

It would be hard to emphasize how dangerous this policy conundrum has now become. We literally have little choice to either let inflation rage on the one hand or take the painful steps to cut it off. However, increasing interest rates against a financial asset bubble comes with huge risks. For example, margin debt in stock lending is at all-time highs, and that does not even include “security-based lending”, which has become all the rage at brokerage houses. This is an extension of loans for non-stock purposes (typically to buy real estate, cars, and large ticket items) using your stock account as collateral.

Do you see a problem? If rising rates were to prick the asset bubble, both stocks and those things financed by stocks could fall in value, risking that they will fall below the value of the loans they collateralize, triggering a system-wide call to pay down the loans. If you read any of the better histories of financial crashes, financial leverage achieved through excessive lending, has always been a feature of financial crashes.

That is only one area of debt excess. It is present in housing and in government and corporate finance. It will take a genius and incredible luck to guide us to a soft landing with the debt and valuation extremes in so many markets.

Yet to do nothing about raging inflation contains its own serious risk. Inflation is particularly hard on those of lower incomes because they can’t afford big stock portfolios or real estate holdings. While bemoaning economic inequality, progressive economic policies exacerbate economic inequality because inflation helps the rich and hurts the poor. Many people are on fixed incomes in retirement, and others live on wages that typically lag inflation.

It not only directly hurts people but also distorts accounting rules and causes a huge misallocation of capital. Inflation often causes booms that go well beyond their economic justification, resulting in a corrective phase called a bust. Inflation pushes people into higher tax brackets, even though they are not really making any more money in real terms than before. It blows up the strategy of deferring taxes, so popular with the public in IRAs and 401Ks. Instead of deferring taxes to a lower tax rate upon retirement, you may well be deferring to a higher bracket.

Serious inflations have often been associated with political and social upheaval and there are many historical examples. Perhaps the most graphic was the wiping out of the German middle class in the great inflation of the 1920s, paving the way for the National Socialists and Adolph Hitler.

Who put us into such a box where there are only dangerous and painful alternatives? Remember their names.

It would not be fair to single out only Democrats, although they bear the majority of the blame. But many Republicans that don’t believe anymore in sound money and limited government also deserve our condemnation.  They have either played along, offered a feeble defence of limited government, or have been bought by special interests that favour big government.

They have created a situation of elevated systemic financial risk. That leaves us all vulnerable to a policy error, a lack of policy action, a foreign policy event, an overreaction to a pandemic; all of which could play a role as a possible triggering event sending us into a financial maelstrom.

And to some extent, the American people are to blame. They have elected people who told them there is a free lunch,  that the government can give you everything you want, and it won’t cost anything. It is delusional to believe that, but sadly it seems attractive to many people.

Knowing when this precarious situation will start to shift is almost impossible to know and thus to time.

If inflation is left to rage, or definitive steps are taken to put out the fire before it becomes an uncontrollable conflagration, there will be hell to pay in either case.

We all in our hearts know there is no free lunch and that you can’t borrow or print your way to prosperity. If that were true, then Argentina would be the world’s dominant economic power.

We need to remember what leaders and which party maneuvered us into a situation where there are no good alternatives. These are the people that injected huge monetary stimulus while simultaneously constraining supply through pandemic lockdowns. That gave us a lot of money chasing a diminished supply of goods.

The only true way to stop inflation is to so thoroughly trounce at the polls those that advocate inflation, that the memory of their demise lasts several generations. And then, we need to put in institutional safeguards so that we don’t face this no-win situation again.