If you listen to economists and those watching the wave of inflation sweeping over us, you will hear many of these people predicting that it will soon subside. Much of their argument being the the best cure for high prices is high prices. Indeed, high prices lead to a destruction of demand. To take it to the next level, some envision an economic slowdown, recession or worse.
Yet, with so much money hidden away and so few tangible real assets, there is no guarantee that inflation will slow or that we will see deflation. For years, central banks around the world have claimed that the absence of inflation was the key that allowed them to adopt and deploy their QE policy. It was at the heart of their ability to stimulate. By the time inflation started to take hold, much of their flexibility was lost. Already, much of the inflation has been baked into our future.
We must not be deceived or led to believe that falling oil and commodity prices will in themselves lead to deflation. Often, falling prices for commodities and goods reflect a lack of demand or a temporary imbalance in supply that will correct itself. When this happens, prices tend to adjust quickly to reflect the “new day reality”. In this case, it is very likely that the higher prices are here to stay, and even increase. While inflation is painful, one could argue that stagflation is even worse.
Inflation is not limited to manufactured consumer goods. Currently, prices are rising in the service sector along with fees, tolls and taxes. People tend to forget how much government spending is done at the local and state level. For these entities, simply printing more money is not an option to eliminate shortfalls. This translates into a slew of income-driven programs coming from the local level that come back to drive up the cost of living.
The large number of people working for government or in quasi-government positions who will never take a pay cut creates a floor under income. Add to that supply chain disruptions that lead to lower productivity and a struggling energy sector, and you have a recipe for soaring prices. Of course, much will depend on where the wealth that escapes the expected stock market crash will flow to. I expect this amount to be substantial.
A number of people are predicting that this money will go into bonds, which will cause bond yields to fall. Although it can happen, it is possible that much of this money will be invested in tangible assets that increase in value during times of inflation. It is important to remember that inflation is not just about interest rates. Much of Fed policy is rooted in quantitative easing and tightening. Asset valuation growth is highly dependent on liquidity resulting from the unlimited flow of new money and credit. Ultimately, liquidity and money supply matter much more than interest rates.
Going back to the idea that there is no guarantee that a slowing economy will slow inflation, part of the problem is that fees, tolls and taxes could increase. When we look at where inflation has occurred over the past decade, we find it centered in areas where government has extended its influence. Inflation is not only prevalent in manufactured consumer goods. Two areas where inflation has been rampant and that come quickly to mind are health and education. A less often noticed area that has massive implications over time is the failing legal system, but that’s its own story.
Other areas where the government is raising prices are utility bills, new construction and the cost of providing local services such as police and fire protection. That’s why the next spurt of inflation or rising costs to consumers, regardless of the pace of economic growth, may well come from huge increases in fees and taxes. An example I’ve used in the past of skyrocketing tolls was highlighted in a Philadelphia plaintiff editorial. In 2008 it only cost $15.25 to travel across the state from New Jersey to Ohio, over the years that amount has risen to $61.20.
People tend to forget how much government spending is done at the local and state level, where simply printing more money is not an option to eliminate shortfalls. The theory is based on the fact that local and state governments have been hiding and masking the size of their growth and financial promises from the public. One factor that many people fail to grasp is how much government has grown over the years. Governments mask growth by “outsourcing” much of the work done by their workers. Another place where this goes unnoticed is the huge growth of “quasi-governmental” entities such as airport authorities and downtown improvement districts that are able to levy special taxes.
Since state and local governments lack the ability of the federal government to print money and buy back their own debt, they have to pay higher interest based on their credit rating. As a state or local government’s debt increases, so does the amount of interest it must offer to sell its bonds.
The average Joe or Jo may not see many of these revenue-enhancing fee and tax increases because they are not personally measured against them. Yet they directly affect businesses and homeowners, who are forced to eventually pass on the extra cost to consumers. Often, this means higher prices. Another way to do this is to shift responsibilities, limit warranties, or reduce goods and services that were previously provided.
Ultimately, tolls, taxes, rising permit costs, declining productivity, and fines trickle back into society and our economy in complex ways with complex ramifications on America’s ability to be competitive in the future. Inefficient and wasteful government has a cost and it must be paid for. As I stated above, it will come in many forms. Don’t be surprised if these additional costs really start to weigh on brick-and-mortar retailers as well as commercial real estate across America. If so, we will all be forced to pay the price of this “cost shifting” through inflation and lower living standards.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.