President Obama and his administration’s brilliant economic team are aware of the possibility of inflationary trends creeping into the economy as spending increases. The paramount reason President Obama was elected was to fix the economy and inject a new life into the financial markets. To say that the task of rejuvenating the economy is difficult is an understatement. Even sophomoric observers can bear testament to that. With the current financial meltdown the economy definitely needs an injection of reasonable fund and investments to correct and stabilize the country’s financial situation.
One can argue that President Obama may not be the luckiest person in the world to be elected to the presidency at this time. However, this can be a golden opportunity to implement the necessary reforms needed to restructure and transform the current turmoil ravaging the entire economic landscape. This will require strategic planning, political will and the infusion of new capital into the economy.
President Obama inherited a bleak economy. His predecessor President Bush did a lot to prop up the economy including stimulus checks that were given to American people and the implementation of tax breaks to big businesses and to those in higher income brackets. Before he left office he launched the mother of all stimulus plans; the $700 billion bank bailout program for the failing corporations and Wall Street. All those spending can contribute to higher inflation and even devalue the dollar due to excessive borrowing to finance the deficit.
As President Obama took over with his cerebral economic and financial team they passed another gigantic stimulus plan – $787 billion including tax relief for a large segment of taxpayers. To most economists the stimulus plan made sense because many states are running out of funds, Dow Jones was dwindling and unemployment was surging. The President reacted prudently to bad economic indicators by asking for necessary spending. A further increase in government spending is necessary at this time because the meltdown must be restricted, and possibly be stopped.
Next on the agenda, may be the health care bill, that will require additional large funding to restructure the health care industry. As spending increases the danger of inflation looms large but President Obama and his team are cognizant of this fact. For now they are meticulously releasing stimulus funds into the economy with prudence to avoid overheating the economy. The ramification of overheated economy is the peril named inflation.
Higher inflation weakens the economy by driving up the price of goods and services while simultaneously slowing the creation of wealth. It will weaken the value of dollar to the extent that too many dollars will be chasing few commodities. Ultimately a bulging national debt and deficit restricts the easy access to capital for wealth creation. This will increase the price of energy especially oil and gas making it difficult for consumers of energy to survive as they will devote a lion share of their disposable income on energy. To industries it will slow down or annihilate industrial activities when the price of energy and raw materials are priced beyond their reach. Capital flight becomes imminent because capital goes where it can appreciate and can create further wealth.
The two major defects of capitalism are inflation and unemployment. America has done a very good job in taming them since the economic breakdown and meltdown of President Jimmy Carter administration. From President Reagan through President Bill Clinton to the present administrations the heads of US Federal Reserve Bank are pragmatic in building an impenetrable bulwark against inflation with a well thought monetary policy.
We give credit to Paul Volcker and Alan Greenspan; these honorable gentlemen are seasoned soldiers in the war against inflation and its disastrous consequences. The chairs of Federal Reserve Bank have been performing wonders even with the explosive deficits and government borrowing through 1980s, 90s and in 2000s; notwithstanding controlling and taming inflationary trends.
I would like to make this perfectly clear; I am not suggesting that higher inflation is the inevitable result of spending increases. Nor I am implying that rising inflation is tangential and proportional to spending. This is not Newton’s Third Law of Motion. The point I am struggling to put across is that as spending increases the possibility for higher inflation becomes probable, thus making increase in spending susceptible to inflationary trends.
Another angle worth exploring is the commingling of government borrowing, large deficits and inflation. As government spending increases, they may commence to lack resources therefore they restore either to borrowing or printing money. The latter is quick to trigger inflationary developments. When government prints and borrows, she spends more money to service her debts and may likely to increase interest rates to satiate those buying her debts. All these may trigger inflation.
What to do
For now Chairman of Federal Reserve bank, Ben Bernanke is doing a fine job and he deserves to be reappointed by the president. The great thing about Ben Bernanke is his willingness to try something new with prudence and efficiency. With monetary policy at his disposal he has done all right things. Having reduced interest rates to their lowest levels without turning off fiduciary investors, he has increased capital market liquidity. Bernanke is wisely talking up the economy and displaying a confidence building postures that reassured the public and the financial community. The Federal Reserve Bank can do more through the application of cash conservation which is slowing down the volume of money in circulation. This does not mean that they should restrict the flow of money but to be methodical and gradual in release of budgeted money for circulation. This can slow the force of rising inflation and diminish the possibility of overheated economy.
A crucial point must be noted that America’s trade imbalance with so many countries notably and especially China is of great concern. The trade negotiators must argue incessantly that China must find away to rectify the large trade gap and deficit with America. In as much that China finances our huge deficit by mostly buying US short-term treasury bonds, there is also a considerable concern. "Treasuries of all maturities have lost 2.8 percent so far this year, after returning 14 percent in 2008, indexes from Merrill Lynch & Co. show. The Dollar Index, which tracks the greenback against the currencies of six major U.S. trading partners, fell today to the lowest level since September, 2008. Chinese investors have doubled their holdings of U.S. government bonds in the past three years to $776 billion as of June, according to Treasury data." When and if they unleash those bonds, it can do so much harm to the value of dollar and can trigger, if not heighten inflation in America. Although the continue China investment on US treasuries buttress their unflinching trust in America’s economy but China must buy more of long term treasuries and also invest in other areas of the economy while slowing their intense export. China must understand that they cannot export their way through this global recession. They must devise a method to stimulate and increase the internal consumption of their products.
The executive branch of the government can stimulate wealth creation and fight back rising inflation through prudent application of fiscal policy. Inasmuch as we desire the public to spend more during this recession, self restraint can be good as the increase in savings can deter inflation and simultaneously consolidate and foster the discipline of savings that has become so elusive.
Emeka Chiakwelu is the Principal Policy Strategist at Afripol Organization. Africa Political and Economic Strategic Center (Afripol) is foremost a public policy center whose fundamental objective is to broaden the parameters of public policy debates in Africa. To advocate, promote and encourage free enterprise, democracy, sustainable green environment, human rights, conflict resolutions, transparency and probity in Africa. www.afripol.org