Inflation: A Government-Induced Phenomenon That Harms Bond Investors

Authored by Daniel Lacalle

The Rising Inflation Situation

The Federal Reserve's preferred inflation measure, the core personal consumption expenditures price index excluding food and energy, rose by 2.8% in March compared to the previous year. This index is considered a more stable and accurate indicator of disinflation. The current figure is worrisome, especially considering the repeated claims that the battle against inflation is nearing its end. The concern deepens when we examine the upward trend over the past three and six months, indicating that inflation has accelerated on a quarterly and half-yearly basis. E.J. Anthony, a PhD economist, highlights that there was no sign we were heading towards the 2.0% inflation target, let alone the pre-pandemic 1.8% average. We've now reached 3%+ with no indication of a significant decrease anytime soon, especially with the current levels of Treasury borrowing and the Federal Reserve allowing money supply growth.

Understanding the Persistence of Inflation

The persistence of inflation, despite promises and announcements of its decline, needs to be understood. Fiscal policy has been reckless, with excessive deficit spending fueling inflationary pressures through unnecessary government consumption of newly created currency. The government's printing of new currency units and issuing more than what the private sector demands leads to a decline in the purchasing power of money, causing inflation. There is no such thing as cost-push inflation, greedflation, or commodity inflation. None of these factors can cause aggregate prices to rise, consolidate, and continue increasing annually. If cost-push or supply chain disruptions were the cause of inflation, we would be experiencing deflation today, not rising aggregate prices every month.

Government's Role in Inflation and Fiscal Irresponsibility

Governments are responsible for the inflation burst of 2021. They have not only disregarded fiscal responsibility but, in the case of the United States, have maintained an unhealthy and unnecessary budget deficit. Claudio Borio concluded in a scholarly paper in 2023 that an upsurge in money growth preceded the inflation flare-up, and countries with stronger money growth experienced markedly higher inflation.

Inflation: A Policy, Not a Coincidence

Inflation is not a random event; it is a policy. Governments often announce large-scale spending programs to combat inflation. These policies accelerate money velocity in a recovery and increase the quantity of money in the system, causing inflation to rise rapidly. The only way to contain the inflation burst is to cut spending and reduce the quantity and growth of money. However, despite central banks announcing so-called restrictive policies, the reality has shown the opposite.

The Impact on Markets

The impact on markets has been significant. The yen, once considered a stable currency and a haven for investors, has fallen to a 35-year low against the US dollar. The Bloomberg index of globally expanded major currencies and the emerging markets indicator have both declined. The result of the 2020-2024 "free money" wave was a costly destruction of real wages and deposit savings.

Conclusion

Governments are destroying the currency they issue in multiple ways. Persistent inflation impoverishes wage earners and middle-class deposit savers. Rising taxes attempt to reduce a budget deficit bloated by unnecessary spending in a recovery. The safest asset, bonds, have become a bad investment for the most conservative investors and pension funds. The only way to reduce inflation will be if the Federal Reserve abandons its decision to cut rates and starts measures that drain net liquidity. However, without the Treasury's support, this is impossible as it floods the market with new money even if monetary policy is restrictive. What are your thoughts on this article? Do you agree with the points raised? Feel free to share this article with your friends and engage in a discussion. Don't forget to sign up for the Daily Briefing, which is every day at 6pm.