Predicting the Next Financial Crisis: Is America speeding towards Inflation?

By Elliott Vavitsas

Is there too much money in America’s economy? The Federal Reserve doesn’t talk much of it, but the amount of liquidity injected into America’s economy recently might just be overstimulating. While this may be counterintuitive to the monetary policy that has done lots to help Americans during the pandemic, the long term impacts of doing whatever it takes to soften the economic fallout of COVID-19 may be frightening. The return of inflation could be imminent.

As states reopen, vaccines are distributed, and case counts fall, it is inevitable that spending levels adjust. Looking at the personal savings rate since March 2020 tells us that households may be able to spend even more than before, having the ability to at most set a new normal in spending, and at least create a temporary increase in consumer spending. In April 2020 Americans saved at a rate of 33.7%. By December 2020 this had lowered to 13.7%. While this shows a gradual return to a more normal saving rate of 7%, it still leaves room for a large influx of cash. Furthermore these statistics do not account for Joe Biden’s imminent stimulus plan, which most likely will push savings back up. As a result, a flood of spending is imminent assuming Americans resume their normal spending patterns once the economy is back open and  majority of people are vaccinated. It is possible that by the end of summer 2021 American consumers are primed to spend and their normal rates leading up to the holiday season. 

The big risk with all of this is a type of inflation known as “demand pull.” Consumers are able to, and do, spend, while the market does not have enough supplies. As supply and demand economics dictates, those selling in the market will raise their prices.  Suppliers will raise their prices as well, due to being down in production capacity. While unemployment is declining, as of March 2021 it is still hovering at 6.2%. In order to satisfy assumed market demand, unemployment must decline another 3.2%. This becomes more of an issue when taking into consideration the domino effect that this has across all industries.  Slowly over the course of a month things could become more expensive, and a cycle of inflation could grip the US economy.

This is not an issue though if the US dollar holds its value steadily. Unfortunately, data from the last year says otherwise. Just like increased personal savings have made it easier for Americans to spend, they have also sharply increased the money supply. From March 2020 to March 2021, the total money supply in the US has increased 26.3%.  For comparison, the UK’s money supply increased about 11%. An increasing money supply drags down the value of a currency. The US Dollar Index is a statistic which tracks the dollar’s value against a basket of America’s top trading partners’ foreign currencies. From a year ago to the time of this article’s publishing, the US dollar has depreciated 6.1% against major foreign currencies.  While a weaker currency is acceptable for America right now, it could be a significant problem if the withheld demand in the US economy is fully unleashed. Prices heading up and currency value heading down would hurt America seriously.  For an average American, this would mean their wages would cost more to their employer and their living expenses would drastically increase. It would be hard for America’s economy to function like this for an extended period of time.  Large inflation, and even hyperinflation would be risks that should be present in the mind of the Fed and the Biden Administration.

What to do then? As troubling as this all sounds the solution may just be accelerating employment. Trying to get as many Americans back to work in time to safeguard them from their own spending. Perhaps new and extraordinary fiscal policy is needed. Figuring out where and what goods and services Americans intend to spend their savings on may allow the government to strategically tax certain purchases for a short time in order to suppress demand for enough time so that 3% unemployment is reached  before a surge in spending. Interest rates could rise as well, and signaling more risk in the economy could keep spending in check just long enough for things to go right. Or perhaps the problem is overblown. Maybe the world’s foremost consuming nation has learned more about saving during the pandemic, and will put that to practice when normality returns, rather than blowing it all.

Even considering the bad and good outcomes of these realities, one thing remains constant. The United States has a money supply problem. Joe Biden’s $1.9 trillion rescue plan is only the latest in a series of programs that have caused this drastic increase in money supply. It is important to remember that the Trump administration put $2 trillion into the American economy and initiated the Main Street Lending Scheme, giving many businesses access to cheap credit. The issue of a rapidly increasing money supply due to the pandemic is in no way a new one. Leadership needs to be taken to encourage the Fed to tackle these problems head on. Perhaps the consideration of an inflation problem in the American economy is more of a wake up call to address the real macroeconomic issues that have been of concern for a while. Whether inflation is the source of the next economic crisis in America or not, its looming possibility should be enough to bring attention to the real issue of beginning to balance America’s books once and for all.

The views expressed in this article are the author’s own and may not reflect the opinions of The St Andrews Economist.

Photo by Jp Valery on Unsplash

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s