America is facing its highest rate of inflation since 1982. Thus, we have the highest rate of inflation in the lifetime of most Americans.
On the positive side, the current inflation rate is far lower than the highs of the early 1980s. The US inflation rate rose to 6.8% in the first 11 months of 2021, the highest rate since 1982. America’s inflation rose to 15% in 1980, Trading Economics estimates.
On the negative side, inflation is rising fast. For example, the Consumer Price Index rose by 0.8% in November 2021 and 0.9% in October 2021. Hence inflation grew by 1.7% in two months. If that growth continues, I calculate inflation could rise by 10.2% in a year or back to around 1980 levels.
Inflation will be disastrous for America
Inflation scares me because I think America is in far worse shape than it was in the early 1980s.
To explain, America overcame the disastrous 1980s because it had several advantages. Unfortunately, I think 2020s America lacks those advantages which could turn inflation into economic catastrophe.
The factors that allowed 1980s America to overcome inflation include:
Far less Income Inequality
Inflation worsens income inequality because rising higher prices hurt those with the least money the most.
In the 1980s, income inequality was lower than today. For example, in 1982, the income of the richest 0.1% of Americans was 58% higher than the bottom 90% of Americans. However, in 2018 the income of the wealthiest 0.1% of Americans was 196% higher than the bottom 90% of Americans.
Inflation can benefit the wealthy because they can afford the higher prices. Moreover, the wealthy often have access to sources of money and capital people lack. For example, the wealthy can afford to put purchases on their credit cards or borrow against assets such as real estate or stocks.
In contrast, middle and working class have less money to save and invest and fewer ways to borrow. For example, people on fixed incomes and those in low-wage jobs pay more of their income for food or utilities.
Moreover, inflation often forces people to sell assets to raise cash. The rich can afford to buy those assets and become richer.
Additionally, the wealthy can buy speculative assets such as precious metals, cryptocurrencies, and growth stocks that grown with inflation. Hence, the rich often make money from inflation and get richer. Meanwhile, ordinary people have less buying power at the grocery store.
In particular, inflation gives speculators many opportunities to make money. For instance, flipping real estate, betting against currencies, and shorting stocks. Most people cannot speculate because they lack the money.
Moreover, inflation makes enormous amounts of cheap money available to speculate with.
Leaders willing to tame Inflation
Historians credit one man with taming the 1980s inflation, Federal Reserve Chairman Paul Volcker.
Volcker ended inflation by raising interest rates as high as possible. To explain, high interest rates limit borrowing and spending. Limiting borrowing and spending drives prices down by stalling economic activity. For instance, home building stops and real estate prices collapse as people stop buying.
For example, the Fed raised interest rates to an astronomical 20% in 1980. Moreover, Volcker cranked interest rates up to around 15% a couple of years later.
Volcker’s high-interest rates hurt ordinary people but they also the rich a haircut. To elaborate, high interest rates deter the rich from borrowing and spending. In particular, high interest rates deter speculation by keeping money expensive. That makes investing on the margin, buying stocks or other investments on credit less profitable.
For example, stock prices fell so low in 1979 that Business Week magazine proclaimed “The Death of Equities.” Ironically, stocks kept falling after that cover, the S&P 500 fell to a low of 305.31 in July 1982. Stocks fell to such lows because of the high interest rates and inflation.
Volcker succeeded because he understood that to limit inflation, you need to dampen all economic activity. Unfortunately, today’s leaders forget that important lesson.
Biden Favors Wall Street over Main Street
Instead, the Fed keeps the interest rate low to keep Wall Street happy. For instance, the Fed set a Federal Funds interest rate of 0.08% on 22 December 2021. That led to an inflation-indexed long term of average of -0.5% on 30 year borrowing.
Consequently, the S&P 500 rose to 4,567 in November 2021. One reason the stock market is so high is that borrowing is cheap.
The low interest rate is wonderful for those with the ability to borrow. For instance, Bankrate touted a 2.75% APR on a 30 year fixed mortgage refinance and a 2% APR on a 15-year fixed mortgage refinance. Borrowing is cheap for those with money, for example, professionals with high salaries.
However, the cost of living is rising for those who cannot borrow. For instance, people stuck in low-wage jobs and those trying to pay off student loan debt.
One problem is that cheap mortgage credit allows the affluent to pay more for homes which drive real estate prices up. That makes housing more expensive as other prices rises, which further squeezes the working class.
Disgustingly, President Joe Biden (D-Delaware) has nominated Fed Chair Jerome Powell, who is famous for his refusal to raise interest rates, for a second term. Sadly, I predict the US Senate will easily approve Powell’s second term.
Thus, America’s wealthy, and speculators can enjoy cheap money and borrowing. By renominating Powell, Biden shows he favors Wall Street over Main Street. When historians get around to writing the history of the Biden presidency, I predict many of them will list Powell’s renomination as Biden’s greatest mistake.
In contrast, President Jim Carter (D-Georgia) appointed Volcker Fed chairman, and President Ronald Reagan (R-California) reappointed Volcker for a second term. Hence, in the 1980s, America had leaders who favored Main Street over Wall Street.
One reason America did not experience civil or political unrest in the early 1980s was that Volcker’s policies limited the excesses of the rich and Wall Street. High interest rates forced the wealthy to behave themselves, which made the economic pain bearable for ordinary people.
In contrast, I predict Powell’s low-interest rates will drive speculation and excesses of wealth that will fuel protests, riots, and worse violence. Unrest and violence will break out because ordinary people are angry at the luxury and prosperity the rich enjoy as they suffer. Notably, so-called Flash Mobs are already pillaging luxury stores such as Nordstrom’s in California.
Why America cannot Deal with Inflation
Leaders who understood the dangers of wealth and income inequality was only one advantage America had in the early 1980s.
Other advantages 1980s America had were large numbers of high-paying manufacturing jobs, high-rates of union membership, a strong manufacturing sector, and a comfortable position in the world. For example, America had 20.12 million manufacturing jobs in 1985, that number fell to 13,885 million in 2020, Statista estimates.
In the 1980s, enormous numbers of manufacturing jobs and high rates of union membership created sturdy middle and working classes. Hence, many American workers weathered the 1980s inflation with high salaries. Today, many of those jobs and salaries are long gone. Hence, the working and middle classes are far weaker.
Moreover, American communities and America’s welfare state safety net were far stronger in the 1980s. America’s social and political capital was far higher in the 1980s. For example, 33% of Americans said they trusted the government in 1982, Pew estimates. By 11 April 2021, that number had fallen to 24%.
Finally, in the 1980s, America had a secure place in the world. For example, in the 1980s, European and Japanese leaders had a powerful incentive to prop up the United States: the Cold War. Fear of the Soviet Union drove European and Japanese leaders to prop up US industry and back America.
The World Will let America Crash
For example, the G-5 tried to rectify America’s trade imbalances with the 1985 Plaza Accord. Today, European and Japanese leaders have no incentives to bail out the United States.
Yes, China is powerful, but it is not a direct military threat to Europe as the Soviet Union was. In fact, weakening America and strengthening China could be better for Europe. China is a greater threat to Japan, but it is a threat that a treaty could contain.
Consequently, I do not expect other powers to come to the rescue of the American economy as they did in the 1980s. Instead, I expect the other powers will let America crash.
In conclusion, I think America cannot deal with inflation as did in the 1980s. Instead, inflation will be nastier, more disruptive, and more destructive in the 2020s than it was in the 1980s. Moreover, inflation will last longer because our leaders will refuse to deal with it.
America faces destructive inflation that our leaders and institutions are incapable of dealing with. Hence, those investors and speculators who understand inflation could prosper while everybody else suffers.
Originally published at https://marketmadhouse.com on December 30, 2021.