UNDERSTANDING INFLATION

Welcome to the discouraging world of high inflation. The headlines scream,

“Inflation hits 40 year high at 8.6%.” Food and fuel prices are the number

one concern of most Americans. Observers blame the Federal Reserve for

misreading the economic tealeaves. Fox News gleefully attacks the Biden

administration for causing an “economic catastrophe.” Even loyal

Democrats are asking what is going on and how do we fix it?

I am not an economist and have little background in the aptly called “dismal

science.” However, I have studied the subject enough to understand that

most of the accusations being hurled at policy makers and energy

producers are at best superficial and at worst pure nonsense. This

commentary will attempt to bring some common sense to our present

inflation crisis.

The economy is complicated. Rarely is a single factor responsible for an

economic outcome. All economists would agree that the overriding goal is

to avoid an overheated economy/inflation on the one hand and

recession/high unemployment on the other. Nevertheless, there are many

competing theories on how to keep the economy in the Goldilocks zone of

“not too hot – not too cold.”

Financial pundits are expert at using hindsight to assess an economic

crisis. Politicians have used unpredictable, unforeseen economic calamities

since the beginning of recorded history to unseat incumbents and gain

power. Such was the case for the Roman Empire with grain, the French

monarchy in 1789 with bread and now the Biden administration with oil.

There are four issues to consider in understanding our present high

inflation. The first is “core inflation” which excludes transitory or temporary

price fluctuations. Volatile commodities such as food items and energy are

excluded from core inflation. Annual core inflation rate in the US slowed for

a second month to 6% in May of 2022. It is the lowest reading in four

months. Because of high food and gas prices, no one talks about core

inflation, which is actually the more important long-term threat to a

balanced economy.

There is evidence that core inflation will continue to moderate. Housing

costs should come down as interest rates rise and lumber prices fall. New

and used vehicles should become less expensive as the shortage of chips

brought on by pandemic backlogs is reversed. Retailers like Target and

Walmart have recently announced anti-inflation fire sales to reduce

inventory surpluses in a variety of goods.

The second concern is gas/food prices, the focus of much of the boisterous

political debate. The irony is that most economists agree, of all the price

increases making up inflation, the two over which the Biden administration

has least control are gas and food. Of course, these items are also the two

items, which most concern angry voters heading into the midterm elections.

Larry Summers is an economist who has heavily criticized the Biden

administration and the Federal Reserve for waiting too long to tackle

inflation. However, when it comes to gas and food prices he believes that

these items have been influenced by geopolitical events not domestic

policy. On the Sunday talk shows, Mr. Summer announced his disbelief in

Republican hypocrisy for supporting the Ukraine conflict while blaming

Biden for high gas and food prices.

NATO imposed sanctions against Russia have taken between 3.5 and 4

million barrels of oil off the market, increasing the price of gas by $1.74 per

gallon. A perfect storm was created with low supply at a time when world

demand for oil increased following the pandemic. Regarding food

shortages, there is gridlock due to a Russian blockade of Black Sea ports.

Between 20 and 25 million tons of wheat are stuck in Ukraine while global

grain prices spiral upwards.

The third issue is “price gouging,” the go-to issue for Democrats as they

seek to push back against consumer anger at high gas prices. A bill backed

by House Democrats would give President Biden authority to declare an

energy emergency. The bill directs the Federal Trade Commission to

punish companies that engage in price gouging.

The bill has little chance of passing the Senate. It is pure political theater to

place blame on the oil companies because they made record profits over

the past six months. A detailed analysis by Barron’s (Why is Gas so

Expensive; June 10, 2022) shows that the profits of gas stations (now all

franchised) are actually down this year. Struggling customers are buying

less gas, coffee and snacks.

Refiners are the main reason that domestic supply of gas is low. Due to

decreased demand before and during the pandemic, the refining industry

contracted over the last decade shutting down 10 refineries. Now, supply is

low, and demand/profits are high, as one would expect.

The last issue is recession. With the Federal Reserve reversing its

quantitative easing policy and raising interest rates into a normal range, the

economy should slow down for at least several quarters. My guess is that

there will be a mild recession. The downturn should not be severe due to

our low unemployment rate, high level of consumer saving and low level of

consumer debt.

The takeaway from this commentary should be that economic cycles are

largely beyond the control of lawmakers. It is better to evaluate the

performance of elected officials on issues that they can control but often

choose to ignore. These would include important topics like preserving our

democracy, gun control, a women’s right to choose and voters’ rights.