The Labor Department’s consumer price index surged 5% year-over-year in May, the largest increase since August 2008 when oil was $140 a barrel. But don’t worry, Americans. The Federal Reserve says inflation is “transitory” and that it has the tools to control prices if they start to spiral out of control. Let us pray.
Nobody should be surprised that prices are increasing everywhere from the grocery store to the car dealership. Demand is soaring as the pandemic recedes while supply constraints linger, especially in labor and transportation. As always, this is a price shock largely made by government. Congress has shovelled out trillions of dollars in transfer payments over the past year, and the Fed has rates at zero while the economy may be growing at a 10% annual rate.
The personal savings rate in April was 14.9%, double what it was before the pandemic. Record low mortgage interest rates have enabled homeowners to lower their monthly payments to burn more cash on other things. Congress’s $300 unemployment bonus and other welfare payments for not working have contributed to an enormous worker shortage, which is magnifying supply shortages.
All of this is showing up in higher prices. Over the last 12 months, core inflation excluding food and energy is up 3.8% and much more for used cars (29.7%), airline fares (24.1%), jewelry (14.7%), bikes (10.1%) and footwear (7.1%). Commodity prices from oil to copper to lumber have surged. Higher lumber prices are adding $36,000 to the price of a new home.
What Congress has given in relief payments, inflation is taking away. The Fed says annual inflation only looks high compared to depressed pandemic price levels. But core inflation on an annual basis was 9.2% in May and 5.2% over the first five months of 2021. Most ominously for the political class, rising inflation for the last two months has outstripped wage gains, meaning that real average earnings have fallen.
The Fed believes all of this is temporary, that supply shortages will work themselves out, and the demand surge will subside. Chairman
may even want more inflation since his new policy doctrine, issued last year at Jackson Hole, is to wait until inflation averages higher than 2% for a sustained period. Markets may agree with him, as bonds and equities reacted to Thursday’s price news with relative calm.
But the months ahead will test both the Fed and markets. The money supply has increased 31% since the end of 2019, and federal spending is 50% higher. Now Democrats want to pass another $4 trillion spending bill including a massive social-welfare expansion.
The Fed has monetized more than half of the Treasury issuance during the pandemic with its bond purchases, which is distorting price signals and capital allocation. Junk bond yields are at a historic low, and companies with almost no revenue have been raising billions through SPACs. With prices rising, workers may begin to demand bigger raises, which could set off a wage-price spiral.
A big risk is that the Fed will feel politically compelled to continue monetizing the federal debt and won’t put on the brakes until it’s too late. Fed governors deny this left and right, but what matters is what they do.
What’s undeniable is that Washington is conducting one of the most radical fiscal and monetary experiments in peacetime history. Even if the current inflation is transitory, Americans are paying more for it now.
Copyright ©2020 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8
Appeared in the June 11, 2021, print edition.