Think inflation is done? Think again!

May 30, 2024·Alasdair Macleod

A lethal combination of budget deficits and trade sanctions are going to be reflected in increasing price inflation for the US. And where the US goes, the rest of us follow.

In this article I focus on two reasons why inflation will rise leading to higher, not lower, interest rates and bond yields. The first is the destruction of credit’s value through its non-productive expansion, mainly by governments running budget deficits. The second has had almost no attention but is at least as serious: the consequences of the repatriation of supply chains being accelerated by trade tariffs and sanctions. I shall briefly comment on the first before turning my attention to the second.

Budget deficits always debase the currency

Margret Thatcher said something on the lines that socialism fails when it runs out of other peoples’ money. We appear to have reached that point. Rapacious tax policies are now reducing their yield. We are now sliding down the after-end of the Laffer curve. The economic force which drives any economy is being strangled by the burden of government.

Consequently, with mandated welfare and other expenses increasing, hopes that economic growth will reduce budget deficits are misplaced. Estimates for budget deficits in nearly all high-tax jurisdictions will turn out to be overly optimistic. This has important implications for inflation which are currently being ignored by everyone from governments, central banks, and down to investors. 

Take the situation in the USA. As recently as February, the Congressional Budget Office forecast a budget deficit of $1,507 billion for the current fiscal year. Yet in the first six months, the deficit was already $1,100 billion, according to the US Treasury’s own figures. But this fails to explain the pace of borrowing. According to the US Debt Clock, US national debt is $34.77 trillion today, an increase of $1,600 billion this fiscal year so far. At this rate it will be $2.4 trillion by end-September, nearly a trillion over the CBO deficit estimate. It represents 9% of GDP, raw unproductive credit driving GDP higher and creating an illusion of a strong economy.

I suspect the budget deficit could turn out to be even worse, partly because it is a presidential election year, partly because the debt ceiling is not in place until January 2025, and partly because the productive economy is already in recession. This last assumption is based on simple arithmetic. If, according to the Bureau of Labor Statistics GDP grew by 4.5% in the year to last March, allowing for a budget deficit injection of 9% means the private sector actually contracted by 4.5%.

A rough and ready calculation perhaps, but it is important to understand that not only is the expansion of non-productive government debt concealing the true economic situation, but it is also debasing the currency. And currency debasement becomes reflected in higher prices. In other words, the inflation of CPI prices is not over.

The rest of this article examines how and why government attempts to protect domestic production and employment through trade tariffs and sanctions end up accelerating price inflation even more. The world saw the economically destructive consequences of anti-trade policies in the wake of the Smoot-Hawley Act of 1930, which are still relevant today. 

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