“If you could imagine dissonance assuming human form – and what else is man? – this dissonance would need, to be able to live, a magnificent illusion which would spread a veil of beauty over its own nature.” Friedrich Nietzsche
While I have often criticized the Fed, I must admit that at least they have a firm idea of what they can and can’t do about inflation. I will differ to a later post whether the Fed has gone too far with rate hikes, so for now recognizing the enormous harm that inflation does to people, and given the Fed’s mandate under law, they are utilizing the tools available, i.e., interest rates, money supply and their balance sheet. The problem is that all that only applies on a monetary level. While their tighter policies have had some effect on inflation, that has been significantly offset by the egregious fiscal policies of the administration, which in truth is a continuation of prior administrations, only now seemingly on steroids.
While the quote by Friedrich Nietzsche is from “The Birth of Tragedy”, a work devoted to art form and not economics and politics, it captures the essence of how dissonance can be disguised. The dissonance between the Fed policies toward inflation and those of the administration expose how these incompatible policies are being disguised with an illusion of prosperity. Time will show that this dissonance, if left uncorrected, will eventually have the same effect as if both policies ignored inflation. Should the administration reverse course and show some semblance of fiscal prudence, which is highly unlikely, it would bring us sooner to the inevitable recession economists are talking about, either as a hard or soft landing, the differences being one of degree; at least we will reach the point where the potential for cleansing the distorting effects of the poor policies of the past will occur. What will happen at that point may unfortunately rely more on politics than sound economics.
The construct for the illusion is one of circumstances and consequences. The circumstances go back to the early 20th century during the Wilson administration and exacerbated by the FDR administration. Later on, and even further again with Nixon’s administration; subsequently the repetition of all those policies to more current circumstances like the endless wars, financial crises, accommodative monetary policies, irresponsible fiscal policies, all contributed to the consequences from these self-inflicted wounds. While this is not a blog post to address the history of all that, please see prior posts that do. What I want to do is focus on the construct of the illusion noted.
An instructive peak behind the veil of illusion is with the GDP. The official government report is a 5% GDP month-over-month. How this will translate on an annual basis is much debated, but what is not debatable is the huge size of government both in costs and expenditures; that this is being included in the GDP data is a distortion disguising the fact that government has no production but only consumption of the nation’s wealth; in effect the government is an example of the economic concept of a “rent seeker”, i.e., an entity that takes wealth without earning it. (This is not to be confused with rents due under a real estate lease.) We can see this in the reciprocal transactions between government and corporations through grants, subsidies, bailouts, tariff protections, political campaign donations, etc., usually practiced through the lobbying efforts of those with access to the powers that control the purse, the money in which comes from taxes, fees, and often from monetary inflation.
As acceleration is a rate of change in velocity, inflation is a rate of change in currency value. While the interest rate and money supply actions by the Fed have decelerated inflation, we still suffer the burden of decreased purchasing power until such time as we have deflation; that usually comes as part of a recession, unless of course we have a similar circumstance as we had with “Stagflation” in the 70’s and 80’s. A consequence of increased interest rates is decreasing credit availability. This primarily affects households and small/medium businesses as banks can’t attract the capital to lend; traditionally that came from savings account deposits, but now households and small/medium businesses find far better returns in stocks and bonds or rely on what used to be “disposable income” just to make ends meet.
A friend recently argued that the government’s policy of increased interest rates is intuitively illogical as it increases the interest due on its ever-growing debt. True the debt service increases, but what that friend and many Americans misunderstand is that the government doesn’t pay the debt service because the debt is ours and so we will pay it. Understanding that helps explain why there hasn’t been more of an impact on inflation; given its outsized position in the data used for GMP, and how that weight is erroneously included in that data, government has no incentive to kill the illusion created.
The consequence of such an illusion is the displacement of capital in the economy from the productive investment households and small/medium businesses require to grow, or even survive, to the nonproductive consumption of an ever-growing government behemoth; in effect it is destroying the economic backbone of a free society, and likely the very freedoms that come with it. As noted above, when we reach the end game of these inherently flawed policies, we will have the opportunity to change those policies and cleanse the distorting effects; the issue is will that be based on sound economics or more corrupt politics? That may very well depend on an election next year, which at this time appears headed for a repeat performance. While I am an eternal optimist, I am tempered by Mark Twain’s famous adage that “It is easier to fool people than to convince them they have been fooled.”
Libera Voce 