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Managing the Covid/Ukraine Inflation

This article was first published in The Hill on 03/24/22 U.S. inflation has surged since COVID-19 loosened its grip in mid-2021 and the war in Ukraine is making it worse. The key economic question is how to get inflation under control and hopefully come out the other end with a more prosperous, stronger, and less vulnerable economy. Poor countries will face more painful problems than the U.S. will --- serious food shortages in Egypt and Africa for example --- but more inflation here is an especially serious problem because Americans are looking for someone to blame. A vitally important political question, therefore, is whether American voters are intelligent enough and care enough about freedom here and overseas to tolerate rising prices for a few years because investments in our economy to deal with inflation will take time.

Understanding what should be done over the next few years starts with a few facts, all of which should make Americans feel confident. The population of the U.S. and our allies in the European Union is 780 million, 5.6 times that of Russia. In the Pacific, Japan, South Korea, Australia, and others, some of the world’s best manufacturers, also will help us. These allies in Europe and Asia have better technology than Russia. Also important, the U.S. alone also has 40 percent more arable farmland than Russia and twice as much as China. We have as much or more oil and gas. The U.S. has made mistakes, but the unfairness and inequality that exists here is less intractable than in the authoritarian countries we are facing.

Inflation though is a serious problem. Prices were rising at 7.9 percent a year before Russia attacked Ukraine because the U.S. economy was bouncing back fast from COVID-19. They will rise further for a few years because Russia is a big oil and natural gas producer, and it will take time for producers of hydrocarbons and alternative energy to ramp up production in the U.S. and in friendly countries. Crude oil was cheap in 2020, roughly $50 a barrel so gasoline and oil products were cheap too. Crude jumped 55 percent in 2021 and at least another 40 percent in recent days to over $110 because of Ukraine. Surging oil and natural gas prices are the root cause of inflation because when they go up the price of gasoline, heating oil, aviation fuel, propane, fertilizer, chemicals and even coal jump. It costs more to run a tractor or a combine: more to generate electricity, heat a home, power a factory, deliver goods and services.

It is helpful to remember that the U.S. and the world suffered from similar oil-driven inflation in the 1970s. Then OPEC, the Organization of Petroleum Exporting Countries, drove world crude oil prices from $1.80 a barrel in 1973 to 20 times that ($35.50) in 1980, making the 1970s a decade of inflation. The good news is that by 1980 the U.S. had adjusted, energy prices fell or were stable for the next 20-25 years, and inflation stopped being a hot-button issue. Based on this experience American voters can be confident that “this too will pass” and would be foolish to blame anything but COVID-19 and Russia for today’s inflation.

Of course, inflation for the next year or two will be driven by other bottlenecks in addition to oil and natural gas. The war will make other products and services scarce like grains and nickel sourced from Russia and Ukraine. COVID-related supply-chain issues have not yet been solved. The supply of semi-conductor chips that go into cars, appliances and electronics will take a few years to expand. Housing is scarce and rents, restrained during COVID, are likely to rise. Energy prices though are the biggest source of inflation. We and our allies in Europe and Asia should be pouring money into job-creating, cleaner and now less expensive alternatives to coal, oil, and even natural gas. Indeed, Europe is doing this already. What the war has done is make this a national security issue for the U.S. as well as an economic one, so our political leaders in both parties need to recognize this new reality. Status quo approaches like “drill baby drill” will not solve the inflation problem.

American voters also need to understand that there are only two ways to stabilize and bring prices down for products like gasoline, and neither approach will be quick. The U.S. can either reduce demand by slowing wage growth and increasing unemployment so people cannot afford gas and other things, or it can pour investment into more secure technologies like wind, solar, and geothermal to reduce our dependence on OPEC+ Russia.

Larry Summers, President Obama’s Treasury secretary, and an influential economist for decades argues in a recent article that the Federal Reserve should raise interest rates faster and higher than it did last week because he sees rising wages as the most important future contributor to inflation. Unemployment below 3.5 or 4 percent Summers believes will set-off an inflationary wage-price spiral. In assessing this view, it helps to remember that in December 1994 when U.S. unemployment fell below 6 percent, Summers called the idea that unemployment could go below 5 percent without igniting inflation “bull s--t.” Unemployment, however, fell below 4 percent a year later and inflation stayed low for almost three decades until COVID and Ukraine.

Reactionaries always favor policies that keep interest rates high, wages down and working people dependent on employers, aka “job givers.” It is shocking however that Summers and his many leftish disciples are still pushing this “slow the economy” monetarist approach. Their belief in high interest rates to slow growth is blind to the specific inflation problems, energy, chip shortages, transportation bottlenecks, and future shortages of grain, all areas where targeted private and public investments is needed.

The way forward on inflation is to invest in “supply-side” alternatives that will make us less dependent on insecure and polluting supplies of fossil fuels, clogged transportation facilities, inadequate day care and schools that keep people from working, and the like. Slowing the economy is the wrong way to go.