“When you got money,
you got lots of friends...
crowdin’ round your door;
When the money’s gone… spendin’ ends...
They won’t be round no more.”
”God Bless the Child” as performed by Billie Holiday
Should we be worried that inflation will rise significantly as trillions of dollars are printed and pushed into the financial system?
Inflation is defined as a sustained increase in the general price level of goods and services in an economy over a period of time. The prices of some goods and services have been on the rise for years, particularly food and healthcare costs. But generally, our recent financial problems have not included significant overall inflation. The cost of money itself, expressed in interest rates, is close to all-time lows. Low or declining interest rates are a classic indicator that inflation is not a pressing economic issue.
How much money the government prints by itself does not actually cause inflation. What matters is how much of that money, after it is created, finds its way into the real economy. People or businesses who receive government money but tuck it under the mattress and don’t spend it do not add to the inflation index.
Inflation is also a psychological phenomenon. If people expect higher prices, they’ll buy more products today, while prices are lower, and this in turn drives up prices. If people expect TVs, for example, to go on sale next week, they may hold off buying a new one, which causes retailers to cut prices over time to attract buyers. So there’s a human element involved, one that can be self-reinforcing, and it makes inflation difficult to predict.
Over the last decade, inflation has hovered around 2% per year. That’s far below what we remember from decades past. The early 1970s marked the beginning of one of the worst bouts of inflation in American history. Rising prices continued through the late ‘70s and peaked at over 13% in the early ‘80s. It was only when Federal Reserve Chairman Paul Volcker promised to defeat inflation, no matter what, that it was tamed.
We’ve already spent trillions of dollars just in the last six weeks fighting the economic downturn caused by COVID-19, and we’re probably not close to the end of the government expenditures that will be directed toward this crisis.
That amount of spending worries many investors, but should it? Let’s get the global perspective.
The Bank of Japan and the European Central Bank, the Fed’s largest equivalent institutions, have been priming the pump with yen and euros for years, yet they are both fighting deflation rather than inflation.
What most governments desire, ultimately, is for their economy to experience some inflation, but not too much. One could say they desire a “Goldilocks” level of inflation, not too hot and not too cold.
But how much inflation is enough? And how do we successfully stimulate the economy with fresh dollars without causing goods and services to become unaffordable?
Next week: Paying down the national debt with devalued dollars.