On March 14, 1980, President Jimmy Carter gave a televised speech from the East Room of the White House in which he told the American people that "persistent high inflation threatens the economic security of our country" and that the "dangerous situation calls for urgent measures."
A Time cover story on his speech explained: "his task was not just to proclaim another new anti-inflation program but to calm a national alarm that had begun to border on panic." Inflation, the magazine observed, was "rapidly becoming Carter's most dangerous political liability."
As lawmakers and commentators debated whether President Obama's $787 billion economic stimulus package would effectively combat unemployment and stagnation, less attention was paid to whether it would help trigger something more pernicious.
"I think a major inflation is a really big danger of where we stand now," John H. Cochrane, a professor of finance at the University of Chicago's Booth School of Business, told TAS. "It's going to hurt all of us. A big inflation will come with economic chaos on a scale we haven't begun to see yet."
It would also hurt President Obama's political standing in a way that a deepening recession may not.
"He is probably going to be able to avoid blame for the recession for a long time because it started on Bush's watch," Rep. Paul Ryan (R-WI), who raised alarms about stagflation in a recent New York Times op-ed, said. "But I don't think he'll be able to avoid blame for the inflation that may follow."
A series of government policies designed to boost the economy and stabilize financial markets have made the prospect of inflation much more likely. To start, the federal government is facing deficits projected to be above a trillion dollars for the foreseeable future. When this is combined with the stimulus package, the multiple bailouts, the actions of the Federal Reserve Board, and the trillions in liabilities the government is taking on by purchasing troubled assets that could go bad, it means the federal government will end up with an unprecedented level of debt.
Cochrane explained that while right now, there is an appetite for U.S. Treasury bonds as jittery investors seek safe havens for their money, at some point, the demand will subside and the government will have a difficult time finding buyers for its debt. This problem will be exacerbated because with the global economy suffering, America won't be able to depend on other nations, especially Japan and China, to absorb the Treasury bonds as they have in the past.
When this point comes, either the Obama administration will have to raise taxes by a crippling amount, or the Fed will have to literally print money in order to buy up the debt. The likely result is the type of stagflation America experienced during the Carter years.
Cochrane, who wrote about this prospect as part of a recent critique of the stimulus package, said that America could see double-digit inflation for a period of several years.
In a speech last week at the National Press Club, Fed Chairman Ben Bernanke said, "we see little risk of unacceptably high inflation in the near term; indeed, we expect inflation to be quite low for some time."
While this may be true in the near term, it's unlikely to remain this way over time. Bernanke's mistake, Cochrane said, is to think of the standard type of inflation that results when too many dollars are chasing too few goods -- a problem not likely with the anemic demand we're experiencing in the economy. However, a scenario in which there are too few buyers of U.S. debt is a different beast entirely.
"We usually can say that the Fed can just take care of this problem [by raising interest rates]," Cochrane said, but the central bank would be under tremendous pressure not to, because such action would further cool an already weak economy.
Even putting aside the political pressure, the Fed wouldn't be able to operate effectively in this type of inflationary environment anyway.
"Once you have a flight from U.S. government debt, there's nothing the Fed can do about it," he said, since the Fed's operations are based on trading government bonds. "If people don't want more U.S. Treasury debt, then the Fed is out of ammunition."
Unlike other types of inflation, this scenario would also have major foreign policy implications. If the Fed were to print money to buy up bonds with inflated currency, it would essentially mean that the U.S. government was defaulting on its debt, which would be an international relations headache given the substantial amount of U.S. debt that is owned by other countries.
Ryan said that our problems are made even worse by the looming $56 trillion entitlement crisis.
"What we didn't have after the Great Depression and the Carter years was the entitlement explosion," he said. "So you've got unprecedented borrowing in the credit markets because of the stimulus and deficits and right after that you have an explosion in spending in these unfunded liabilities….Fundamental monetary policy leads you to conclude that we are baking inflation into the cake. It's not going to happen now, it's going to take a while, but it is going to come."
President Obama organized a "fiscal responsibility summit" on Monday to address the nation's long-term debt, and he said the budget he's releasing on Thursday would slash the deficit in half by 2013. But he'll have difficultly following through on such promises given the continued demand for bailouts and his ambitious domestic agenda, not to mention resistance from Congressional Democrats.
Ryan said that now is the ideal time for Republicans "to become the party of sound money again."
As part of that effort, he said that he carries around a 50 billion dollar bill from Zimbabwe in his wallet to educate citizens in his Wisconsin district about what can happen if a country neglects its currency, and he recently gave a talk on the subject at a local high school.
"They don't really know what you're talking about at first," he conceded. "But as soon as you start explaining the consequences of inflation, people understand what you're talking about."
By the fall of 1980, inflation was still high, despite President Carter's calls for fiscal austerity and restraint among average Americans, providing a ripe target for Ronald Reagan.
"We don't have inflation because the people are living too well," Reagan charged in their presidential debate. "We have inflation because the government is living too well."
President Obama may still be enjoying high approval ratings, but by pursuing policies that are sowing the seeds of our next crisis, he could be writing his own political obituary.
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