The COVID-19 Stimulus Measures Risk Great Inflation

Recently, there have been large waves of optimism building up regarding a return to normalcy in a post-pandemic world. Some of this optimism is justified. In less than one year, scientists and drug manufacturers were able to develop, test and distribute numerous effective vaccines for the disease. Currently, three such vaccines have been authorized for use by the United States Food and Drug Administration (FDA) with many more in the works. In the United States, 106 million doses have been delivered, representing 11.25% of the population. In terms of confirmed cases, the 7-day average in the United States has fallen to 55,215 per day, a substantial decrease from the January peak of 300,619 per day, according to data from The New York Times. In addition, the 14-day change in deaths and hospitalizations resulting from COVID-19 have fallen 31% and 25%, respectively. After looking at this data, many people have deduced that the future prospects of the economy and financial system are incredibly bright. However, if one digs deeper, they will discover an ominous threat that, if exacerbated, could wreak havoc on the United States, as well the global economy more broadly. That is the threat of runaway inflation.

In simple terms, inflation refers to the general rise in prices — as well as the fall in purchasing power of money — in a given economy. In the United States, the average inflation rate from 1913 to 2020 was 3.10%. In other words, goods and services cost, on average, just above 3% more than in the previous year. In terms of purchasing power, the amount of “stuff” that a single U.S. Dollar can buy this year will decrease by just above 3%, assuming the average long-term inflation rate. Contrary to the beliefs of some, appropriate amounts of inflation are healthy for a functional economy. In fact, moderate levels of inflation help yield economic growth, enable the fluid adjustment of prices and allow wages to be adjusted more regularly.

However, too much inflation can be catastrophic to an economy, not to mention extremely difficult to control. When prices rise and purchasing power falls in rapid fashion together, panic quickly ensues. Suddenly, real wages fall, investment confidence plummets and long-term economic growth prospects dissipate. As this cycle progresses, a country can enter a period of hyperinflation, which describes excessive and out-of-control bouts of inflation. One of the most famous examples of hyperinflation took place in Weimar Germany during the early 20th century. In order to finance the cost of World War I, Germany’s central bank, the Reichsbank began accumulating enormous levels of debt. After losing the war, Germany was left humiliated on a global scale with no economy. However, the large debt pile remained in place. In an attempt to pay off the debt, Germany began to print seemingly endless amounts of its currency, the German Mark. But, as economic and social conditions deteriorated, the currency became increasingly worthless and prices skyrocketed. During its sixteen-month period of hyperinflation, prices in Germany increased at a rate of 322% per month! In essence, the amount of German currency in circulation far outweighed the economic capacity of the country, which in turn resulted in an incredible depreciation of the Mark. In fact, depreciation was occurring so rapidly that citizens actually used the currency as wallpaper in their homes, as opposed to spending it on goods and services.

In my opinion, the United States — through both excessive fiscal and monetary policy — has paved the way for extreme inflation in the near future. Since the Global Financial Crisis of 2008, the U.S. National Debt has exploded. However, the rise has been especially pronounced since the pandemic began last year. In Q1 2020, the National Debt stood at around $23.2 trillion. Today, the National Debt is over $28 trillion. In less than one fiscal year, the National Debt has increased by almost five trillion dollars, or more than 20%. Following a review of the $1.9 trillion American Rescue Plan (ARP), which was passed by Congress and signed into law by President Biden last week, Fitch Ratings pointed out that the bill will cause government debt to reach 127% of GDP in 2021, while surpassing 130% by 2023. In other words, by 2023, for every one dollar the United States economy produces, the federal government will be borrowing one dollar. According to data from Forbes, prior to the passage of the most recent bill, the United States had spent $2.6 trillion on stimulus relief. With new rounds of stimulus already being administered, that number has increased to $4.5 trillion. This is equivalent to over 20% of total U.S. GDP from 2020.

However, Congress is not the only entity that has contributed to the Great Inflation Risk. The Federal Reserve Bank of the United States (FED) has also contributed its fair share. Two of the chief responsibilities of the Fed are to control the money supply and adjust interest rates. Ever since the United States increased its debt burden, the Federal Reserve has made it a priority to provide seemingly limitless amounts of liquidity into both the economy and the financial system. It has accomplished this by means of printing additional currency and keeping interest rates artificially low. By doing so, money in the economy has become more plentiful and cheaper. Since the pandemic began to affect the health of the U.S. economy, the Fed has increased the M2 Money Stock (money supply) from $15.5 trillion to $19.4 trillion, an increase of more than 25% in less than one year. While this took place, the Velocity of Money, which measures the rate at which currency is exchanged in an economy, fell substantially. This makes sense. As businesses and consumers experienced a dramatic spending and investment shock from the pandemic, there were far fewer transactions that took place, thus leading to a decrease in the Velocity of Money.

The previous two paragraphs act as ingredients for a “perfect storm” of profound upward inflationary pressure. Once the economy reopens, consumers who have been cooped up for almost a year will rush to purchase goods and services that they were unable to utilize during the pandemic, which will result in greater profits for businesses, which in turn will lead businesses to increase spending. Altogether, the post-pandemic boost will provide immense economic growth in the short-term. However, when coupled with the enormous sums of stimulus measures outlined above, the economy runs the very real risk of overheating. As the reopening occurs, prices will rise, which is not detrimental in and of itself. The problem is that single-minded fiscal and monetary policy prior to the reopening has paved the way for a potentially dangerous risk of runaway inflation.

In short, the United States economy is like a bonfire. Congress and the Federal Reserve wanted to start a small bonfire in the woods to enjoy a nice evening. But, instead of pouring just a small amount of lighter fluid on the timber, they decided to pour the entire bottle. After all, more is always better! However, after lighting a spark in the wood, Congress and the Fed quickly discover that the entire forest is engulfed in flames. With no tools to put out the fire, they must sit back and watch the horror unfold.