Inflation: what’s next?
In the last two decades alone, Congress and several administrations, with the full support of the Federal Reserve, have let our budget deficits soar to over 130 percent of GDP with no end in sight. This surge has put the US in the top 10 worst deficits in the world, alongside Greece and Italy. According to the US Treasury Department’s most recent US government financial report, “current US fiscal policy is unsustainable.”
It cannot go on like this and the Federal Reserve must stop supporting and supporting them immediately. The scourge of inflation is upon us again. For a textbook on how we might deal with it, we can look to the period from the late 1970s to the 1980s when we dealt with it successfully, albeit with extreme pain and disruption.
The cause of inflation in the 1970s is simple. President Kennedy was assassinated in 1964 and Vice President Lyndon Johnson became President. Johnson decided to greatly expand an already costly and hugely unpopular war in Vietnam without raising taxes to pay for it. He then declared a very costly war on poverty by instituting extremely costly welfare programs, again without raising taxes to pay for them.
The Federal Reserve expanded the money supply to offset massive deficit spending and kept interest rates moderate. President Nixon inherited both the war in Vietnam and the growing deficits, but was so weakened by the Watergate scandal that he had little political capital left to fight inflation and was eventually forced to leave office.
When President Carter was elected in 1976, rapidly rising prices, particularly for petroleum, which is used to heat homes and fuel cars, became a major political issue. The effects were felt in the financial world, putting pressure on interest rates and threatening banks and thrifts, particularly those that lend long-term, fixed-rate loans.
Carter approached Paul Volcker, then President of the Federal Reserve Bank of New York, and appointed him Chairman of the Federal Reserve Board in 1979 with a mandate to do whatever was necessary to eradicate inflation. Volcker responded with zeal, boldness and determination, eventually raising interest rates to an unprecedented 21.5 percent.
This in turn led to two recessions, an agricultural depression, a collapse in energy prices, massive corporate and personal bankruptcies, and over 3,000 bank and thrift bankruptcies, including some of the country’s largest banks. The situation was so serious that the Fed and the Federal Deposit Insurance Corporation (FDIC) planned a possible nationalization of the country’s largest banks if their loans to Third World countries defaulted.
Everyone involved in implementing this policy believed that we had no realistic choice. The longer inflation took to eradicate, the more pain and hardship it would inflict, especially for our middle- and low-income Americans.
Alongside monetary policy, fiscal policy is far looser today than it was in the 1970s. At the end of the Clinton administration in 2000, the national debt was $5.5 trillion, or around 55 percent of GDP. A little over 20 years after Clinton left office, the federal deficit had increased nearly six-fold, much of it even being monetized by the Fed.
President BidenJoe Biden Jan. Defendant #6 asks Trump be summoned as witness. On The Money – Breakdown of January’s job boom Photos of the week: Joe Biden, Punxsutawney Phil and Sarah Palin MORE shows no signs of willingness to pressure the Fed chair Jerome PowellJerome PowellBalance/Sustainability – Beijing pollution halved since last Olympics Biden Fed pick faces GOP fire on climate stances The Hill’s Morning Report – Dems juggle priorities amid new challenges MORE to follow in Volcker’s footsteps. Powell, like his two immediate predecessors, shows no willingness to do so. There doesn’t seem to be much appetite among convention leaders to go that route, either. The COVID-19 pandemic took center stage about two years ago. Congress, backed by two governments, has thrown trillions of dollars at it with a seemingly insatiable desire to spend even more – damn the inflationary consequences.
The Volcker playbook that defeated inflation in the 1980s may not work this time. Monetary policy has been completely out of control for far too long and the Fed has carved out such a massive role in funding the government’s huge deficit spending (in addition to supporting housing markets) that we could get hooked and unable to get out of the high – at least not without more pain than our current leaders can endure.
We have previously criticized the Fed’s obsession with raising inflation to 2 percent and urged the Fed to start normalizing/raising market interest rates immediately. We observed that the Fed’s ultra-low interest rates “benefited mostly the wealthy, with meager income growth for middle- and low-income Americans, including retirees trying to live on pensions.”
We continued to urge the Fed to “start winding down… its oversized balance sheet and let the markets start to function properly.” We noted that the Fed’s balance sheet “never reached $1 trillion” in recent years, but in 2017 “stands at more than $4 trillion, or nearly 25 percent of the federal government’s total debt.”
We also noted that the Fed’s “eight-year intervention in the markets [had] helped push asset prices to “bubble-like” levels, including the stock market, long-dated bonds, at least some commercial real estate and other assets, [which are now] starting to show signs of stress… [while the] The incomes of a significant and growing number of Americans are stagnant or declining, and still too many people who want to work cannot find decent jobs.”
Ironically, today we find ourselves in the opposite situation, with twice as many jobs available as unemployed people on government grants without having to look for a job.
Our calls – and those of the former Volcker during the same period – for sound monetary and fiscal policies went unheeded. It’s time to put an end to reckless spending and the monetary policies that make it possible.
William M. Isaac is a past chairman of FDIC and Fifth Third Bancorp and is currently chairman of Secura/Isaac Group and Blue SaaS Solutions.
Richard M. Kovacevich is retired Chairman and CEO of Wells Fargo & Company.