Tag Archives: savings

Inflation!

Voters rate inflation as the most important issue in the United States today. In this article, Frugal Ron will try and explain what inflation is, how we got to where we are today, how to fix it and most important too many people, can we blame Joe Biden for all of it?

One definition of inflation is that it is a general increase in prices and a fall in the purchasing value of money. The definition Frugal Ron likes to use is “too much money chasing too few goods and services”. In other words, inflation is caused by an imbalance of too much demand and too little supply. 

We’re going to look at each side of the equation separately. First, why is there too much money in our economy? Republicans like to blame Democrats for passing the $1.9 trillion American Rescue Plan and blame our problems on that single spending item.

Federal Government Expenditures and Savings ($ trillion)
2020 2021 2022 Quarter 1
Total federal govt. expenditures 6.920 7.197 5.600
Total federal govt. savings -3.217 -2.937 -1.042
Source: Bureau Economic Analysis, Table 3.2 Federal GovernmentCurrent Receipts and Expenditures https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey    

The difference between 2020 and 2021 spending (the last year of the Trump Administration and the first year of the Biden Administration) was 4 percent. The 2022 value includes the $1.9 trillion American Rescue Plan. This 4 percent spending increase  certainly isn’t inflationary compared to the spending increases of  Republican presidents from Ronald Reagan on.

Table 1. Spending by President
Annual Federal Govt. Spending (billions)
President Year before taking office Last year in office Percent Change Annual percent change*
Ronald Reagan – Rep. 1981-1988 $645.0 $1,171.1 82% 8%
George H.W. Bush – Rep. 1989-1992 $1,171.1 $1,524.8 30% 7%
Bill Clinton – Dem. 1993-2000 $1,524.8 $1,943.6 27% 3%
George W. Bush – Rep. 2001-2008 $1,943.6 $3,383.1 86% 7%
Barack Obama – Dem. 2009-2016 $3,383.1 $4,200.4 24% 3%
Donald Trump – Rep. 2017-2020 $4,200.4 $6,932.9 65% 14%
* Calculated by averaging percent spending change of each year in office.

Source: Bureau of Economic Analysis; Table 3.2 Federal Govt. Current Receipts and Expenditures; Line 43.

Note: Bureau of Economic Analysis (BEA) calculates totals on a calendar year basis (January 1 to December 31). Quarterly data is annualized. That means that if the first quarter data continued throughout the year exactly the same, this would be the annual value. The data is also seasonally adjusted. This means we can make apples to apples comparisons when we compare 2020 and 2021 annual totals to 2022 quarterly totals.

The falling deficits in 2021 and the dramatic drop in 2022 spending and deficits are because of the impact of COVID vaccinations resulting in people emerging from their economic hibernation. Tax receipts increased and social service costs decreased as people went back to work and started spending more. The American Rescue Plan certainly was part of this recovery by putting money in the hands of people most likely to spend it.

Biden can justifiably take credit (especially considering the mess he inherited from Trump) for the Herculean task of rolling out COVID vaccines and boosters to everyone that wanted them. We spent a year watching Trump refuse to take COVID seriously.  Rather than take the kind of steps to contain the disease that worked so successfully for east Asian and Oceania countries, Trump spent his time blaming  Democrats and the media for reporting the number of COVID deaths,

Relatively small steps. like Biden’s invoking the Defense Production Act so that front line health care workers finally got enough Personal Protective Equipment made a major psychological difference. Finally getting a relatively healthy population led to a healthy economy. This is directly responsible for today’s lower government spending and deficits, compared to when Trump left office.

While Biden deserves credit for what he did, he deserves blame for what he didn’t do.. Every president’s first year income and expenditures are a carryover from the previous presidency.  Budgets are passed every two years. Consequently, Biden had to deal with the last year of a budget passed and signed by Trump.

If we look at recent history (and the above table on presidential  sending and the table below on deficits), the Regan/Bush I Administration brought us record deficits and spending increases and ended in a recession. Bill Clinton came in office, passed a tax increase, balanced the budget and we had unprecedented economic growth. Bush II took office and immediately set new records for spending and borrowing. He left the country with the worst recession since the Great Depression. Barack Obama came into of-ice and inherited record deficits from the Bush II recession. He did cut the increase in spending but floundered until his second term when he passed a tax increased that dropped the deficit by half. Unemployment plummeted and his economic boom lasted into the Trump presidency. Donald Trump came into office and set all new borrowing and deficit records. Not surprisingly, he left the country in an even worse recession than Bush II’s.

If you want to blame Joe Biden for today’s inflation, forget the $1.9 trillion American Rescue Plan. A far more logical cause for our present inflation is the $2.9 trillion deficit we had in 2021. Even the first quarter 2022 deficit of over $1 trillion is unacceptable. Biden had the opportunity, with Democratic majorities in Congress, to pass a balanced budget and put the economy on a strong foundation. He missed that opportunity. Wiping out Trump’s  deficit causing tax cuts and raising tax rates on high income people would have maintained our present growth with much less inflation.

In summary, Biden’s spending did not cause today’s inflation. However, if he had immediately passed a tax increase to wipe out the unacceptable deficits he inherited from Trump’s budget that stretched into Biden’s term, he could have lowered inflation.

Table 2. Net Savings by President
Net Savings (billions)
President First Year in Office Last year In Office Average
Ronald Reagan – Rep. 1981-1988 -$104.3 -$201.0 -$210.5
George H.W. Bush – Rep. 1989-1992 -$194.3 -$359.2 -$269.5
Bill Clinton – Dem. 1993-2000 -$328.7 +$152.9 -$108.3
George W. Bush – Rep. 2001-2008 +$1.50 -$774.2 -$382.3
Barack Obama – Dem. 2009-2016 -$1,475.3 -$717.0 -$1,026.8
Donald Trump – Rep. 2017-2020 -$540.0 -$3,251.6 -$1,482.4
Source: Bureau of Economic Analysis, Table 3.2 Federal Government Current Receipts and Expenditures; Line 49.
Where the money came from…

IfJoe Biden’s spending didn’t cause today’s inflation, what did? Private savings is a big part of the answer.

Frugal Ron actually predicted today’s inflation. Only problem was  he was four years early with his prediction. Yes, timing is everything.

When Trump came into office, Frugal Ron predicted his out-of-control spending and deficits would result in high inflation. What wasn’t expected was that almost 93 percent of Trump’s increased deficit (compared to Obama’s last year in office) didn’t get spent.

While Trump was breaking every non-recession deficit spending record in history, corporations used their windfall to puff-up their balance sheets and rich people invested their tax cuts in stocks and bonds and other savings instruments. This didn’t do anything to help the economy but it also didn’t trigger any inflation.

Back to the present, when I wrote earlier in this article about the imbalance of too much money chasing too few goods, the too much money didn’t come from the slight increase in federal government spending. It did come from people and companies lowering their annual  savings.

Near term savings peaked in the second quarter of 2020 as corporations stockpiled the money they made from Trump’s corporate tax cuts. In the first quarter of 2021, savings stayed high. As the COVID-19 vaccine became available and our lives normalized, individuals and companies went on a wild spending spree driven by pent-up demand. Again, this spending wasn’t fueled by $277 billion in extra government spending, it was fueled by an almost $3 trillion  drop in annual private savings.

Net Private Savings US ($ trillions)
2020 Quarter 2 2021 Quarter 1 2022 Qtr 1
Net private savings 5.077 4.828 1.973
Source: Bureau of Economic Analysis, Table 5.1 Savings and investmenthttps://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey

It is important to remember, these savings are annual not cumulative. People have cut the amount they were saving. They have not dipped into the large amount they previously saved. These savings numbers could go negative and have the potential to fuel more inflation.

Where the money went…

COVID essentially shut down much of the US economy in 2020. People weren’t buying as they accumulated savings and without demand, it became an easy decision to shut non-essential manufacturing plants while workers were afraid to show up.

While much has been made of shipping boondoggles and overseas supply problems, imports exploded by 2022 compared to pre-pandemic levels in the fourth quarter of 2019.. These 2022 import levels have never been seen before in the US.

US Imports ($ trillions)

2019 Qtr 4

2022 Qtr 1

Percent change

Imports

3.041

3.910

29%

Source: Bureau of Economic Analysis, Table 4.1 Foreign Transactions, https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey

At the same time, Gross Domestic Product (GDP), which measures the value of goods and services produced in the US rose only marginally. Especially, when adjusted for inflation (GDP – Chained).

Gross Domestic Product – US ($ trillions) 2019 Qtr 4 2022 Qtr 1
GDP 21.7 24.4 12%
GDP – Chained 19.2 19.7 2%
Source: Bureau Economic Analysis, Table 1.1.6 Real Gross Domestic Product, Chaind Dollars https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey
Catching our breath…

There is a lot going on here and a lot more to cover. I’ve tried to summarize the impacts of fiscal policy. That is government spending. The lowering of annual private savings has far more impact on our inflation.

Even more important when we talk about controlling inflation is monetary policy. This is the Federal Reserve’s domain. And, then there are areas completely immune from fiscal and monetary policy that have huge impacts on inflation, like energy and food.

Before going there, I want to talk about imports. Typically, we look at high levels of imports as being a bad thing. This is not necessarily the case when we have a full employment economy, This is what we have now in the US. The unemployment rate is 3.5 percent and we still added 390,000 new jobs in May.  In this environment, imports resemble a relief valve on a pressure cooker. 

At the start of this article, I defined inflation as too much money chasing too few goods and services. As consumers and businesses lowered their savings in 2021 and into 2022, the too much money would have caused far higher inflation without our record imports.

Things could have been better. Another Joe Biden failing was not immediately reversing Trump’s tariffs on imported steel, aluminum and other goods. These tariffs increased costs for US consumers and are another cause for price inflation in the US.

Example: If a manufacturer has the price of their raw materials increased by 30 percent because of Trump’s tariffs, that increases the cost of production by that much. If the manufacturer has a 40 percent margin built into their price, the 30 percent tariff is now reflected in a 42 percent cost increase to the next level of the retail chain. If there is another step before the consumer and that step also has a 40 percent margin, the cost increase to the final US consumer is almost 59 percent because of Trump’s 30 percent tariff.

Trump put these tariffs in place to reduce US trade deficits. These tariffs along with all the other trade agreement renegotiations didn’t work. Even with all these in place, we currently have record trade deficits. Republicans can’t blame this on Biden. He hasn’t changed the trade policies he inherited from Trump.

As always, a nation’s trade balance is defined by: Exports –  Imports = Private savings +  Government savings. If  the US wants to lower its trade deficit, it should have a balanced federal budget and make government savings equal zero. Better yet, have a government surplus.

But, getting back to inflation, eliminating Trump’s trade barriers will lower inflation.

How US inflation ranks globally

Inflation is a global problem. While I don’t want to minimize the impact of inflation in the United States, many countries are far worse off than us. In fact, compared to other industrialized countries, the US is about middle of the road in controlling inflation.

Also, countries like China, Japan, Australia, New Zealand and Canada that followed the COVID containment advice Donald Trump spurned had much less devastating death and economic losses than the US. It isn’t a coincidence that these countries are less impacted by inflation than the US.

https://www.pewresearch.org/fact-tank/2022/06/15/in-the-u-s-and-around-the-world-inflation-is-high-and-getting-higher/

If current inflation is related to the severity of a country’s COVID losses, Bidden prevented much more serious inflation in the US by aggressively providing COVID vaccinations to all that wanted them.

Monetary policy and the Federal Reserve Board

The Federal Reserve Bank, overseen by the Federal Reserve Board, is the chief government instrument for keeping inflation in check. They try and do this, with varying levels of effectiveness, by attempting to control the nation’s money supply and interest rates. 

Typically, the Fed required banks to keep 10 percent of their deposits in reserve. If a local bank wanted to make a $10 million loan and they had $1 million of extra money in reserve, the bank could make the loan and the Federal Reserve Bank would loan the local bank the extra $9 million. This is how the Fed increased the money supply. 

The Federal Reserve Bank would dictate the interest rate that the local bank would pay the Fed. More businesses would obviously borrow money at two percent interest than if the interest rate was six percent. With low interest rates, the money in our economy grows faster. Going back to my original definition of inflation, too much money chasing too few goods, one can see how the Fed has the ability to create inflation by creating too much money.

At the end of 2018, Trump’s bubble economy was starting to fizzle out. Trump was browbeating the Fed Chairman. Jerome Powell, who Trump appointed, to lower interest rates.  For whatever reason, the Fed started dramatically lowering interest rates close to zero. Businesses and individuals borrowed more money, the Fed created much more money and Trump’s bubble economy kept going.

It became clear in March of 2020 that the dysfunctional Trump was incapable of minimizing COVID-19’s destruction. The US economy was crashing and the Fed had all but exhausted it ’s chief tool for reviving the economy.  Interest rates were already close to zero. 

The Fed did lower interest rates it charged banks to zero. To get more money into the economy, they also lowered banks’ reserve requirements to zero. Desperate to increase the nation’s money supply, the Fed started Quantitative Easing, the buying of private securities. They also instituted a number of other policies to buoy the economy.

https://www.brookings.edu/research/fed-response-to-covid19/#:~:text=Easing%20Monetary%20Policy,of%200%25%20to%200.25%25.

All of this is going on while Trump is running up record government spending deficits.  As COVID is coming under control, consumers and businesses are dramatically cutting their annual savings on a wild spending spree. 

Hindsight is always perfect. It is easy to say the Fed should have pulled in the reins of money supply earlier, but no one has perfect real time information. The Fed reversed their Qualitative Easing and most importantly, has started raising interest rates. Currently, interest rates for borrowers are between 4.5 and 5 percent. That is in the historical interest rate range.

Raising interest rates is certainly not a universal cure for high inflation. Interest rates are a production cost for businesses and increases get reflected in higher costs to consumers. But to emphasize, the FederalReserve Bank is the best tool we have for bringing inflation under control in today’s political environment.

Immune from fiscal and monetary policy

Energy is a major cause of our current inflation that is immune to our best efforts to contain. Republicans love to blame high gasoline prices on President Biden. However, gas prices were rising before Biden took office. 

Obviously, a big reason for high energy prices is Russia’s invasion of Ukraine and subsequent boycotts of Russian oil and gas. While the boycotts are noble, the result is that Russia is selling a smaller amount of product for a lot more money per unit and consequently is making more money off energy than before their invasion. A the same time, countries boycotting Russian energy are dealing with high inflation. International leaders are working to fix this.

One more of the Trump disasters that has contributed to our inflation is his killing the Iranian Nuclear Agreement. President Barack Obama put together this historic agreement that stopped Iran’s development of nuclear weapons. Perhaps more important, the agreement integrated Iran into the world economy. After Trump pulled the US out of the deal, Iran won’t deal with us. They have no incentive to increase oil production because of sanctions we installed on what they can buy. And, they are very close to having a nuclear weapon. Trump’s blunder gave us one less oil trading partner and one more hostile nation close to being a nuclear power.

Climate change and the need to wean from fossil fuels is our world’s most pressing issue. The Russian invasion of Ukraine has shown us that the US has no real energy policy. The high gas prices we have don’t seem to alter people’s driving habits.

A number of solar projects have been cancelled or indefinitely postponed because of Trump’s tariffs on foreign produced solar panels. Biden finally eased them, but still hasn’t removed them. That is a mistake.

People don’t like major power line projects and they don’t want huge solar or wind farms in their backyards. The best long term solution is to de-regulate power companies and turn innovation loose. Small scale projects, perhaps co-ops, that produce electricity and sell their excess at retail prices without interference from established power companies are the future. 

Since both Russia and Ukraine were major grain exporters, the war and trade embargoes raised international and domestic food prices. Ukraine was also a major fertilizer exporter. Increases in US fertilizer and fuel prices raise the cost of production for US farmers. Cost of production increases are passed onto consumers. Like energy prices, food prices are immune to both fiscal and monetary management.

Consequences of inflation

This year, the federal government will spend $413 billion on interest payments on the national debt of $28 trillion, according to the Congressional Budget Office. https://www.thebalance.com/interest-on-the-national-debt-4119024

The average interest rate paid on this debt is 1.4 percent. With some simple multiplication, one can see the impact a four fold increase in interest rates would have on the federal budget. 

Another problem with inflation is the impact on bondholders. For easy figuring, let’s assume a major Chinese bank has a one year $ 1 billion treasury bond paying 2 percent interest at the end of the term. Let’s also assume the US has an 8 percent annual inflation rate. At the end of the term, the Treasury Department pays the Chinese bank $1.02 billion. However, because of inflation and the 8 percent drop in the value of the dollar, the real value (or buying power) of the $1.02 billion is actually only $938.4 million. The Chinese won’t make that mistake again.

The consequences of inflation on our national debt are significant and also significant for the ability to sell treasury bonds when inflation is high. This is where the doomsday scenario of a government default gets repeated. This is probably overblown. Trump made us immune to $multi-trillion deficits.

The major consequences of inflation falls on us. Inflation does not hit everyone equally. If you are a renter in an already tight market, you are really screwed. Annual rent renewals in some cities are up 40 to 50 percent. Low income people are the ones who usually suffer most.

Wrapping-up

The main causes of today’s  inflation in the US are the large deficits in the 2021 federal budget Biden inherited from Trump, the unprecedented reduction in private savings in 2021, an overzealous  Federal Reserve that should have put the brakes on monetary growth sooner and the war in Ukraine.

For those that are looking to blame Joe Biden, there are plenty of opportunities. Biden’s sending is not a significant cause of today’s inflation. When blaming Biden, focus on what he didn’t do; balance the federal budget and eliminate Trump’s trade restrictions.

The most important part of this article is, what can be done to rein in price increases?

  • The Federal Reserve will do most of the work containing price increases by raising interest rates. Inflation is as much psychological as fact driven. When consumers start thinking  they don’t need a new car (or any other purchase) now, but are going to buy it because they expect it will be much more expensive next year, we have a problem. It is the Fed’s job to make this kind of speculation expensive with higher borrowing costs. The trick is to do this without setting off a recession.
  • The opportunity to control inflation with fiscal (government spending and taxes) management passed. If Republicans win the House and/or the Senate this November, we will need to wait until the Democrats control the presidency and both Houses of Congress again for any fiscal reform, like balancing the budget. Today’s Republicans aren’t a serious political party. The only solution they offer to stop inflation is to reinstall Donald Trump as president. Considering Trump’s history of breaking every deficit and percent spending increase record in existence, he would be the worst possible inflation cure imaginable. In our dysfunctional political system, Republicans will do everything possible to prolong inflation through the 2024 presidential election. “Party over country” is their motto.
  • Biden could help lower inflation by reversing all of Trump’s tariffs and trade restrictions. He can do this without Congress. If he renegotiates major trade agreements like the revised NAFTA (now the USMCA), he needs Congressional approval.
  • Deregulating the electricity industry is probably another fantasy unless Democrats hold the presidency and both houses of Congress. If deregulating electricity brought about even a fraction of the innovation deregulating the phone industry brought, we would be well on our way to controlling energy costs with clean electricity production.

What I am not suggesting to lower inflation is capitulating to Russia and forcing Ukraine into subservience or ending the country’s existence. Russia needs to be punished even after hostilities end. Eliminating trade restrictions on Russia should only be considered after Vladimir Putin dies or is removed from power.

Many things are worse than inflation. Appeasement of a bullying dictator with illusions of empire is one of those things. If we want to combat inflation, far more effective is voters maintaining Democratic majorities in Congress and voting for a strong Democratic president in 2024.