Like a fire bell in the night, inflation threat should fill us with dread

By James McCusker

Humans have the capacity to think ahead. We can see consequences — things that haven’t happened yet, but probably will.

We know what is likely to happen when the baker carrying a tray of pies blunders into a restaurant brawl.

But seeing consequences is something that individuals do. When we act as a group somehow some of that is lost. Congress is no exception to this pattern and is notorious for inaction, even when the evidence is clear and a problem’s trajectory is visible.

For economists, this can present a problem, especially in the case of the threat of inflation. It is extremely difficult to get the public interested in something that hasn’t happened yet, and getting members of Congress interested in inflation right now is nearly impossible.

In one sense it is hard to blame them.

Each day, it seems, we see another report indicating that our economic recovery is moving forward. Unfortunately, the economic storm is gathering, whether we can see it or not.

The most recent U.S. Department of Labor report on the Consumer Price Index certainly encourages a carefree attitude about inflation. It paints a price picture that seems to be a pretty flat landscape. In fact, because some consumer prices are declining, it even has some analysts worried about deflation. Economist Rebecca Wilder, for example, expressed concern about the report and the Federal Reserve’s decision to raise the discount rate, writing that, “There’s just no support for price action at this time — the Fed can’t pull back … it probably should be putting more in.”

She is certainly right about how fragile the recovery is, and how some sectors, especially housing and banking, are still weak and in need of assistance. While home prices are recovering in parts of the country, mortgage delinquencies still spell trouble for banks. Soon, though, those issues will disappear, housing and banking will recover, employment will grow and we will be looking at a robust, growing economy — and its increasing aggregate demand will create an irresistible upward force on prices.

What will happen then?

As former Texas football coach Darrell Royal once said of the forward pass, “There are only three things that can happen … and two of them are bad.”

In the best possible outcome, somehow everything comes together perfectly, all economic sectors expand symmetrically, productivity increases are synchronized with growth and employment, and the economy grows fast enough to absorb the government deficits. It is a dream devoutly to be wished, certainly, but still a dream. We still have the two other possibilities to consider, and they aren’t pretty.

The second possibility is that financing the deficit is internalized within the U.S. capital markets. Treasury bills, bonds, and other federal government debt obligations are so huge that they crowd out private investment, slowing growth to a crawl and putting downward pressure on jobs. Unemployment levels would remain high, and even grow, encouraging the government to spend ever more to relieve the economic pain.

The third possibility is that as the U.S. and the global economies recover, the Treasury Department has to compete with private sectors and other governments for the financing needed to support the growing debt. This would mean sharply higher interest rates, setting off a price-wage spiral that could quickly spin out of control. And there are limitations to what the Federal Reserve can do to prevent it even if it makes every decision, every move, perfectly.

Possibility No. 1 would be sweet, but unlikely — leaving possibilities Nos. 2 and 3 to duke it out. What is most likely is a combination, with an initial phase marked by only a gradual crowding out of private investment. This would be followed in phase two by a chase scene with accelerating interest rates pursuing prices all over the economy … and a thud-bang crash at the end.

The absence of alarm bells right now when combined with a bias toward inaction makes it very unlikely that Congress will face up to the threat that inflation poses for us all. When inflation will hit is not date-certain, but, as Humphrey Bogart put it in the movie “Casablanca” it “May not today. Maybe not tomorrow, but soon…” He would have been a heck of an economist.

James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Snohomish County Business Journal.