Why You Should Worry about Inflation

By Kevin D. Williamson

Friday, June 11, 2021

 

In the 1990s, Alan Greenspan dwelt somewhere between Olympus and Delphi — godlike in his power and prone to handing down cryptic pronouncements. Bob Woodward lionized him as the “Maestro” in a book that was published, unfortunately, right as the wheels were coming off, with Greenspan taking much of the blame for inflating the dumb-money dot-com bubble in the late 1990s and subsequently provoking the recession that began in March of 2001. The best and brightest had thought of Greenspan as something like Zeus moving around figurines in his little amphitheater in Clash of the Titans. Instead, he turned out to be not a titan at all, but another bureaucrat — without doubt a gifted and exceptional one — just doing the best he could.

 

You heard the word “hubris” a lot on the cable shows around that time.

 

Before the recession, Greenspan was worried about inflation, as we are now. He had good reason to be worried, as we do now. The main tool he had for counteracting inflation was raising interest rates, and the same is true of us now.

 

The short-term reason to worry about inflation is the obvious one: higher prices. We are in a very risky spot for higher prices right now, because of three mutually reinforcing factors: monetary stimulus (“quantitative easing”), fiscal stimulus (trillions in spending prompted by the coronavirus emergency), and — sometimes overlooked in the policy debate — the interruption of the actual production of goods and services during the epidemic, exacerbated by supply-chain disruptions and higher costs for some raw materials resulting in part from Donald Trump’s misguided trade war with the nefarious, scheming Canadians (among others).

 

The disruption of production has contributed to higher housing prices (lumber prices hit an all-time high last month, with mills unable to keep up with demand) and an enormous run-up in the prices of some goods, notably vehicles and luxury items, as well as shortages in other goods (such as firearms ammunition) that can be difficult to lay hands on at any price. When that gets sorted out, it should — should — take the pressure off some prices, including in such important sectors as houses and cars.

 

But that may not be enough to lower the current momentum toward higher prices. As economists sometimes put it, the question before policy-makers is whether the inflation we are seeing is sticky, meaning that higher prices are likely to stay with us for a long time rather than being a short-lived blip. Sticky inflation is a problem because it can stick around even when economic growth slows or stagnates, a condition that persisted in the 1970s and gave us the term “stagflation.” Nobody much enjoyed stagflation.

 

Some people did enjoy the countermeasures that were deployed against stagflation — sky-high interest rates. There are still among us people of a certain age who fondly remember getting 14 percent on their Treasuries back in the 1980s. It was a good deal if you were rich and neither working nor looking for a mortgage.

 

And that’s the long-term reason to worry about inflation. When the Fed drives up interest rates to slow down inflation, it generally raises borrowing costs throughout the credit markets — including, ultimately, the cost of financing our national debt. Debt service will cost the U.S. government about $380 billion this year, accounting for 8 percent of all federal spending. For perspective, that is about what is spent on undergraduate instruction at all of the nation’s public colleges and universities combined. It’s a big chunk of change — and it’s big with interest rates that are very, very low by historical standards. If the cost of financing the debt goes up, it could easily blow a Pentagon-sized hole in the federal budget. Money that gets spent on debt service is money that isn’t available for other things, whether that’s the ordinary heavy expenditure for Social Security and Medicare or emergency measures in the face of some unknown future crisis. The more you owe, the fewer options you have.

 

U.S. government debt is financed through a variety of different securities with a variety of different lengths of maturity. About a quarter of all federal debt is financed with Treasury bills, which are securities that have a maturity of one year or less. That means that the interest rates on this debt are locked in for a maximum of one year, after which it is rolled over and has to be refinanced. A little more than half of the debt is financed with Treasury notes, which run from two years to ten years, while only about 14 percent of the debt is financed with bonds having a maturity of ten years or more. (The small remaining share of the debt is mostly financed by inflation-indexed bonds that mature in five to 30 years and by short-term notes with an interest rate that changes quarterly.) That means that a big chunk of our national debt has to be refinanced on a relatively short timeline — months and years, not decades.

 

The worrisome, if not quite worst-case, scenario is this: We start to suffer genuinely problematic inflation, the Fed jacks up interest rates to stabilize prices, the cost of borrowing for the U.S. government goes up substantially, the cost of financing the debt rises from 8 percent of the budget to 12 percent of the budget and then appears set to keep on marching up from there, the economy goes into recession, and Washington has a choice — it can cut back spending during a recession, thereby almost certainly deepening that recession, or it can go even more deeply into debt at a time when the cost of debt service already is climbing, thereby making both the total debt and the cost of financing it that much worse.

 

This is where fiscal crises and sovereign-debt crises come from.

 

Inflation is destructive in and of itself — but it also is a trigger that brings into play other economic forces that can bring with them unpredictable and at times destructive outcomes. The 2001 recession was an unintended consequence of policies meant to stabilize the economy. The financial crisis and the Great Recession were, at least in part, the unintended consequences of policies meant to make it easier to buy a house and to make mortgage-lending less risky for financial institutions.

 

Things don’t necessarily have to shake out that way. And there are plenty of people who will tell you that it is unlikely that things will shake out that way. Some of those people thought Alan Greenspan had it all figured out back in ’97, too. Libertarians and conservative deficit hawks (a migratory species that goes south for Republican presidencies) can be absolute cranks about hyperinflation and the threat of financial Armageddon, and it’s fair to point that out. But it is irresponsible to take on heavy risk when we don’t have to, and it is wildly irresponsible to fail to made adequate provisions against eventualities that are entirely foreseeable — including bills that are coming due on a fixed schedule.

 

Our position is less secure than it should be, and we have presidents and Congresses of both parties, from the early 1990s onward, to blame for that. Adding the threat of destructive inflation to the mix means that instead of juggling or walking a tightrope, Washington is going to have to juggle while walking a tightrope.

 

There might have been some excuse for that back in the 1990s. But we should have learned our lesson by now.