Prices Fall, Political Stupidity Reigns
As regular readers will know, we have focused heavily on the risk that the US central bank having previously lost credibility, now overreacts and raises rates too quickly or too high and thereby damages the economy.
In fact, there are three general channels by which a government can try and impact inflation:
Monetary policy - interest rates and money supply etc.
Fiscal policy - fiscal tightening that should impact demand.
Structural levers such as price controls and interfering in the market.
The US central bank influences #1 but not #2 or #3.
And so there is also an equally real risk that other levels of government also overreact to the current inflationary environment and, in doing so, actually create a bigger problem down the road.
How so?
Well, here are two of only the most recent examples:
California, always proud to be the first to adopt a bad idea, has agreed as part of their new budget to send as many as 23 million of their residents a check of up to $1050 to help cope with inflation.
And in a similar vein, President Biden has asked Congress formally to temporarily suspend the federal gas tax.
Both of these policies are, on the face of it, pretty different. They are at different levels of government, constructed to do different things and operate in very different ways.
One is a direct transfer. The other is a tax cut. One aims to help a large but specific plurality of Americans who drive, while the other is progressively targeted very carefully to assist those on lower incomes the most.
But both are fiscal stimulus - in other words, #2 above. But also the opposite of what a government should be doing in an inflationary environment. The government are stimulating the economy with cash transferred to specific parties.
Rather than reining in government spending to help curb demand, they are accelerating it.
Both programs are intended to subsidize and help offset the current exceptionally high prices for basic goods and especially food and fuel such as gasoline.
This might sound like a good idea and be motivated in each case by good intentions.
Unfortunately, however, these policies will also certainly create higher, not lower prices for goods.
Why? Well, rather than letting high prices do their powerful work of lowering demand and thereby encouraging people to bike or drive less or buy an electric vehicle, etc you are instead incentivizing the very opposite.
It also means that these policies likely won't work as they are intended to either. They will simply be wasted.
It is just very bad policy.
As we discuss below, gasoline prices most likely won't drop let alone significantly. As with tapping the Strategic Petroleum Reserve in 2021 and early 2022, the measure will leave us more vulnerable to other risks in the future and won't help with the underlying problem.
The California money will be spent quickly without any real change in the inflation predicament for many California residents. Their wages are falling behind, $200 or even $500 might help for a few grocery runs but it will also leave the Golden State with less in reserve for when a real economic crisis occurs (i.e.: a recession).
Remember, US states cannot borrow as easily as the Federal government....
As for the gasoline tax, prices will instead rise to accommodate whatever type of discount is achieved. Why? Because that is how demand works. If I am buying something that the market has set at $6 a gallon and you start offering it at $5 the market will buy more until.....prices hit $6!
It is incredible. By attempting to lower the cost of a good (any good!) or providing people with money to afford more goods these well meaning policies will very likely achieve the exact opposite outcome from their intended effect.
This allows us to remind our dear readers of a core Pebble tenet about politics (or any other endeavor). Intentions don't matter, outcomes do.
In a previous edition we detailed and reviled the tendency of politicians of all types to be confronted with a supply problem and rather than deal with it by finding more supply they turn around and subsidize demand.
This ethos can be best summarized by this meme:
Our earlier frustration, you may recall, was over the baby formula shortage.
That was bad enough but this is much worse because gasoline is so central to the cycle of higher prices and eroded cost of living.
We understand that elections are coming and politicians are feeling the heat and need to appear to be "doing something" but the first rule should still be: do no harm.
And what is perhaps most frustrating is we understand all of these challenges very well. After all, we have tried stuff like this before.
We keep finding ourselves in a very harmful cycle:
Mismanage a situation or willfully create a crisis despite expert warnings.
Come up with a patchwork solution that has more signaling than success and plenty of associated costs.
Declare victory and/or pass the responsibility on and blunder onwards.
And it simply doesn't need to be this way.
The economist Tyler Cowen calls our present age the "Great Forgetting" because we are repeating mistakes from earlier eras that we have learned - often at great cost - do not work or have unintended consequences.
The gasoline tax holiday is a particularly galling example of its kind.
Here is Barack Obama way back in the distant era of 2008 discussing and disparaging the calls for a federal tax holiday:
President Obama was correct in 2008 and we will be correct now. And we must have fallen pretty far to where fanciful ideas that were once dismissed out of hand are now not just taken seriously but presented as viable solutions for our nation's problems.
Take a listen and compare to what you have heard the last 4-5 years, you will be shocked with the contrast.
We simply must do much better.
And battling inflation isn't the only area in need of improvement either.
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