The Economy Is Set to Take Off. Inflation Will Be a Major Problem.

Although there has recently been an increase in the number of COVID-19 cases, the administered vaccines should reach 70% of the population before summer begins. If that happens, the virus will be mostly contained so that economy of every state should fully reopen. That will lead to an economic boom, albeit an inflationary economic boom.

Sometime next week, the Commerce Department will report on GDP growth in the first quarter of 2021. That number will be at least 6% and could be as high as 8%. Since growth in the second, third, and fourth quarters will be greater, as the economy fully reopens, growth for all of 2021 will be at least 8%.

That will be the highest economic growth number in almost four decades. It means that GDP will be higher than it was before the pandemic, so the economy will have recovered very quickly from the steep, but short-lived recession seen last March and April.

By year-end, the unemployment rate, which is currently at 6%, will fall to under 5%, as millions of unemployed workers are called back.

Americans are flush with cash that they are ready to spend. Because of the massive stimulus bills already passed, a family of four with less than $150,000 in income, will have received more than $11,000 of free money from the federal government.

The households received that money whether they were financially hurt by the pandemic or not. Much of that money has been saved, giving consumers cash to spend after the economy fully reopens. That spending coupled with the federal governments huge spending increase from the Biden stimulus package, will fuel an economic boom.

The problem is inflation or, worse yet, possibly stagflation.

The U.S. has not experienced an inflation problem since 1981. Because inflation hit 13%, the Federal Reserve (Fed) took action. Realizing that the inflation was primarily caused by a too rapid increase in the money supply, the Fed reduced the money supply and increased interest rates. Inflation fell to 3% and except for a year or two, remained under 3% for the next 40 years.

Today inflation appears to be increasing. In January prices increased .3% which is about a 3.5% annual rate. In February prices rose by .4% which is about a 4.5% annual rate. In March, prices increased a whopping .6% which is nearly an 8% annual inflation rate.

As the economy continues to reopen and supply chain disruptions still exist, prices will increase even further, meaning we could see inflation running at a double-digit rate. There are basically four reasons for this.

One is that since the Biden administration has declared war on fossil fuels, energy prices are rising sharply. As the world economies continue to recover there will be a higher demand for energy which will drive prices higher. High energy prices ripple through the economy and push all prices up.

Second, there has been a rapid growth in the money supply. Virtually all economists agree that a high money supply growth rate will be inflationary. Biden’s economic advisers do not agree. They say traditional monetary theory is wrong so that vastly increasing the money supply at a time when the economy is operating at less than full capacity, will not lead to more inflation.

Unfortunately, those “Modern Monetary Policy” theorists are incorrect. As we are beginning to see now, inflation is starting to spike. It will get worse as the economic boom accelerates.

Third, the federal government is annually spending $3 trillion more than they take in from tax revenue. Under any economic theory, this stimulative action is inflationary when the economy is operating at full capacity, which is where we will be before the end of this year.

Four, because the public debt is approaching $30 trillion, there may be a capital shortage. About $24 trillion of the total comes from selling bonds to the public. The remaining $6 trillion comes from selling bonds to the Fed, which simply prints the money to make the purchase. That, too, is inflationary.

By selling $24 trillion of government bonds to the public there is less capital available to business. If business can’t raise enough capital to increase output to meet the high demand, the only thing left to do is to raise prices.

Increasing energy prices, rapid growth in the money supply, huge government budget deficits and a potential capital shortage all lead to higher inflation and possibly stagflation.

The overall good news is that the economy is growing rapidly. The bad news is that inflation is becoming a problem and if business can’t expand, the economy will stagnate.

Clearly, no more stimulus is needed, and we have probably over-stimulated already.