The Battle Over U.S. Inflation and Its Real Cause

Mark my words: The upcoming U.S. presidential election will likely be won or lost on the issue of inflation.

Blame game under way

Given that, it is unsurprising that a big blame game is under way among Democrats and Republicans.

Of course, the Republicans point out that the cost of food and lodging, which is what most voters care about daily, has gone up by at least 30% over the past three years. They say it’s Joe Biden’s fault.

For their part, the Democrats say that inflation has been a global phenomenon. Indeed, inflationary pressures got out of control in every country of the world during the recovery from the Covid 19 pandemic and after Russia invaded Ukraine.

In any case, they argue, inflation has declined – and the U.S. Federal Reserve is poised to start cutting interest rates.

The true cause of the cost-of-living crisis

However, there is one factor neither party addresses: The debasement of the U.S. currency. It is the true cause of the current U.S. cost of living crisis.

Currency debasement was common when money consisted of gold and silver coins. When monarchs needed to raise funds, they resorted to reducing the amount of the precious metal in their coins. You would still get the same gold sovereign from the mint, but it would contain 20% less gold.

The dangerous temptations of fiat money

Later on, when fiat money – i.e., paper currency not backed by any tangible asset – came about, the idea was that money would be issued strictly in proportion to economic growth.

Thus, if the economy produced 5% more goods and services in a given year, it was assumed that the monetary base would be expanded by the same 5%.

However, fiat money was also an open invitation to abuse. If a government wanted to give tax cuts to voters, for example, or import oodles of cheap Chinese consumer goods, or finance a tech revolution, it could just print more money.

Then, once you ran into a financial crisis because plenty of money encouraged dangerous speculation and created financial bubbles – just turn on the printing press and drown the system in even more money.

No free lunch for the U.S. forever

Other countries play this game at their peril – because eventually foreigners will refuse to accept their currencies or give them loans. This is what regularly happens to Argentina, Brazil and other profligate countries.

But the United States has the almighty dollar, which is the international reserve currency and the lynchpin of the global financial system.

And so it went. Ronald Reagan, while railing against “tax and spend Democrats,” spent lavishly on the military, while his Federal Reserve Chairman Alan Greenspan obligingly opened the monetary spigot.

When Reagan assumed office in January 1981, U.S. government debt amounted to around 30% of GDP. When he left, it was 50%.

Monetary vodka for U.S. financial markets

More important, Reagan and Greenspan created a dangerous pattern: The government would prime the fiscal pump and the Fed would loosen monetary policy to accommodate extra government spending.

William McChesney Martin, who had been the Fed president during the age of American prosperity from 1951 to 1960, famously said that the Fed’s job was “to take away the punch bowl just as the party gets going.” In other words, the Fed was supposed to raise interest rates to prevent economic overheating and financial excesses.

Starting with Greenspan, the Fed has been plying financial markets with monetary vodka.

The big-spending Bushes

During his one term in the Oval Office, George Bush, Sr. – another Republican – boosted U.S. debt to 62% of GDP.

After him, Bill Clinton, a Democrat, was able to reduce U.S. debt to 54% by the start of the new century. But with the arrival of George W. Bush the true monetary orgy began. It has not stopped since.

Having implemented a massive tax cut at the start of his administration, Bush Jr. invaded Afghanistan and Iraq without bothering to raise money for his military adventures. He promptly ran up U.S. debt back to where his father had left off.

Worse, the plethora of cheap money created a real estate bubble which blew up in 2008, the last year of Bush Jr.’s presidency, triggering a disastrous financial crisis and a global economic downturn.

Barack Obama was faced with the possibility of another economic Depression, which was avoided when he and Ben Bernanke, his Fed president, started, to use Bernanke’s phrase, to drop money out of helicopters. They did right the economic ship but raised U.S. public debt to 100% of GDP.

Crossing the 100% threshold

By the time Donald Trump was elected, the cooperation of the profligate government with the profligate Fed was well established. The cost of Trump’s tax cut, estimated at $1.7 trillion, pushed the U.S. debt-to-GDP ratio to 105% by the end of 2018.

Curiously, Trump followed directly in Bush’s policy footsteps. He slashed government revenues with a tax cut at the start of his presidency and ran into a major crisis at the end, when his administration mismanaged the Covid 19 pandemic.

By the time Joe Biden alleviated the resulting economic crisis, U.S. debt amounted to 125% of GDP.

A study by the Center for American Progress found that without the tax cuts by Bush and Trump, the U.S. public debt ratio would have continued to fall as it did under the Clinton administration.

And even though, due to pressing economic circumstances, money had to be printed lavishly under the Obama and Biden administrations, it was largely the response to the mess their Republican predecessors had left them.

Beyond partisan angles

The result of all this is that the U.S. currency has become debased. The old compliment — “you look like a million dollars” — now sounds more like an insult.

Successive U.S. administrations and Fed presidents have turned the dollar into a commodity. Its value depends on a supply-demand relationship, which means that the more dollars are printed, the less valuable they become.

How the U.S. is like Russia and Saudi Arabia

This makes the United States a massive producer of the commodity called the dollar – in much the same way that Saudi Arabia or Russia pump oil out of the ground.

But most oil producers also have corrupt governments and have huge wealth disparities — grotesquely enriching some, while everyone else is pauperized.

Given the fact that the U.S. commodity is money, the consequences of this commodity economy are clear for all to see. Those who are active in financial markets — either as finance professionals or those who monetize their businesses in the stock market — have become the superrich, while much of the rest of the country is having trouble making ends meet.

A different kind of inflation

The United States had high inflation in the 1970s, but it was a different kind of inflation. Prices went up and triggered wage increases in their wake, even though there was no offsetting increase in productivity. More money was chasing the same quantity of goods and services, creating a vicious cycle.

Inflation which results from the debasement of currency is different. Those lucky enough to find themselves near the financial trough can make money at will.

Only the top benefits

They are the beneficiaries of the debasement process. Even though prices of yachts, vineyards, private planes, Maseratis, Swiss watches and works of art, along with tuition at top-flight colleges and universities and other luxury goods, are rising much faster than the overall inflation level, they have been more than compensated by their rising wealth.

Reaganomics postulated a “trickle-down” effect for wealth creation. Under this concept, more money for the rich would translate into higher incomes for everyone else.

The reality has been quite different. What has trickled down is the rising cost of living for ordinary consumers who are being paid with debased dollars.

Conclusion

Donald Trump has no plans to change this. He will actually exacerbate the situation.

But the Democrats will also have trouble solving the cost of living crisis – unless they are able to reverse the nearly half-century of fiscal and monetary profligacy and restore the trust in paper currency.