The Federal Reserve (the Fed) believe inflation is temporary because of huge obstructions to supply. E.g. lumber and microchips. Because of significant debt build-up, financial institutions have to raise rates which takes money away from driving the business economy.
The Fed believes business can pass on costs but also encourage the economy. But, there’s concern that a lot of debt in the economic system, from supporting businesses and individuals and aiding recovery, could cause stagflation.
Last experienced in the 1973 OPEC oil embargo when the 12 member countries stopped selling their oil to America. Oil prices quadrupled, drivers queued for miles to fill their tanks.
In 1971, Nixon took America off the gold standard, this affected the oil-producing OPEC member countries. They could no longer exchange their US dollars for gold. Nixon’s actions caused the price of gold to rocket, and because nobody expected it, the dollar plummeted.
The value of the dollar hurt the OPEC countries because the petrodollar also went down. As stated in their contacts, America paid for their oil supply in dollars. OPEC oil-producing members’ governments lost revenue.
The event that tipped the OPEC members over the edge happened because America supported Israel against Egypt in the Yom Kippur War. The embargo began.
Government and certain businesses, stocks and commodities may suffer from stagflation. Banks raising rates with debts spiralling at every level could cause another recession.
We could compare the similarities of the buildup to the embargo to the pandemic last year. And the tipping point to the shortage of semiconductors and the rising cost of commodities, e.g. lumber.
The Biden administration in Washington, D.C., and industry leaders implemented a plan for expanding domestic chip manufacture this year. The pandemic highlighted a major problem caused by outsourcing jobs to Asia. Microchip production will rise from 12% now to 30% by 2024. This also means more skilled jobs for Americans.
Other areas where Biden wants to see money going into the economy include the repair of bridges and infrastructure, also creating more jobs.
The president’s plan for future growth may not come into effect soon enough to stop inflation from rising this year. Higher inflation and slower economic growth could cause stagflation.
By propping up businesses and people, has the Fed helped or hindered America’s recovery?
The Fed admitted to failing on two points: stable prices and maximum employment.
However, it steadied the economy with near 0% interest rates last year. At first, you might think fantastic! Low-interest rates on mortgages and cars. Then both markets run out of stock. People still can’t take advantage of either.
When the price of lumber goes down, contractors can build more houses and folks can buy their bigger houses. When chip production catches up, automobile dealers will have new stock to sell to eager buyers. The latter will be sooner than the former. Plus rates are rising again now.
To make matters worse, businesses took advantage of the low-interest rate, buy back their stock and invest in technology to automate jobs. Reducing the number of jobs available rather than increasing them, as the Fed hoped.
Columbia University professor and Nobel Prize-winning economist Joseph Stiglitz, says:
“We’ve been through a period where low-interest rates have not stimulated the economy very much and where disproportionately [companies’ increased profits] go into automation, killing jobs, not creating jobs,”
Dion Rabouin, Axios, reported in early April a frenzy of speculative investments in Bitcoin and meme stocks, like GameStop, because of low-interest rates for saving and pumped up asset prices. He also points out the dramatic actions taken by the Fed intended to help ordinary folks, instead, created a windfall for the rich investors.
Another negative impact of the Fed’s actions resulted in unprofitable ‘zombie’ businesses being kept afloat. Without help, lively new start-ups would have pushed out the inefficient firms, which would have died and stayed dead.
A positive for those with decent-paying jobs included the Fed buying up debt so companies could weather the pandemic.
The Fed has kept inflation low by buying up bonds. It continues to do so, aware of increased sensitivity to rising rates.
The major worry of investors caused by increased labour and consumer prices is their fear of rising inflation. They want to know if this rise in inflation is temporary or permanent.
Fed Vice Chair Richard Clarida said on Wednesday 12 May, it will be “some time” before the U.S. economy is healed enough for the Fed to consider pulling back its crisis levels of support and he expects the rise in prices to be temporary. Caroline Valetkevitch, Reuters
Economist Andrew Steer explains that the rest of the world wants to hold dollar-denominated assets. Plus, the riskier the world becomes the more other countries want to increase their holdings. Most other countries have to watch their deficit and debt figures because if, for example, a pandemic hits them, buyers of their debt may disappear sharpish.
For the U.S., demand for a “safe haven” rises, and money flows in the riskier the world becomes.
According to National Affairs and Harvard economics professor Gregory Mankiw, the modern monetary theory (MMT) view is that:
“inflation gets out of control when workers and capitalists each struggle to claim a larger share of national income.”
For fans of MMT, inflation happens when there aren’t enough resources in the economy to soak up the excess money. My opinion on this might consider all the savings people have but they can’t spend because of a shortage of lumber and semiconductor microchips for cars, is causing the temporary increase in inflation.
The same proponents of MMT also say raising taxes might be a suitable method of drawing some of the excess money out of the system.
“incomes policies, such as government guidelines for wages and prices, are a solution to high inflation” Gregory Mankiw
Watch this space
Until more alarms sound, the Fed will continue buying up debt. If it needs more money, it can print more. Because the American dollar is the world’s reserve currency. It controls its own currency and can therefore pay its own debt.
There will be no stagflation for the foreseeable future. I’m an optimist. I’m looking forward to seeing the playing field of workers and capitalists duking it out. A metaphorically legitimate battle of wills rather than physical, of course.
I will also say, President Biden, by raising the minimum wage and continuing to pay benefits and stimulus checks and raising the taxes to 28% for anyone who earns over $400,000 per annum, is doing the right thing for America.