Inflation is crushing the middle class and below, and many Americans don’t understand where it comes from. And it doesn’t help that most politicians are ignorant or dishonest when defining inflation. Let’s first talk about the myths regarding inflation.

Inflation isn’t caused by rising oil prices, rising wages, Russia’s invasion of Ukraine, or greedy corporations. Inflation is not even rising prices in general. Rising prices are the result of inflation. You wouldn’t define a hurricane as a flooded house. Inflation is an increase in the supply of money. Rising prices are not immediate, no more than your home doesn’t immediately flood when a hurricane hits. It takes time for that money to find its way to goods and services, and that includes rent, oil prices, wages, insurance, etc.

Getting off the gold standard in 1971 was our biggest mistake. Government spending was no longer restrained by the amount of gold we held. This led to massive overspending, and the COVID response tested the limits of sanity when it came to deficits. But it never stopped, thanks to baseline budgeting. Despite the pandemic’s end, the trillions in overspending continues today. Deficits are expected to run in excess of $1T per year, indefinitely, likely multi-trillions, every year! 

How do we finance these massive deficits? We borrow. The US Treasury sells notes, t-bills, and bonds, with varying maturity dates, to governments worldwide, corporations, pension funds, individuals, et al. Thanks to the US government’s full faith and trust, buyers swoop them up every month with the expectation of getting paid in the future. And when they don’t, the Federal Reserve buys them up, called Quantitative Easing (QE), created after the 2008 meltdown. At the time, the Fed held $600B in UST. By 2021, their balance sheet had swelled to over $9T. And they didn’t just buy UST. They purchased mortgage-backed securities (MBS) too. Today, the balance sheet is just below $8T (they’ve been Quantitative Tightening, QT, selling their holdings). 

This is called debt monetization, or in layman’s terms, money printing. It’s all wonky fed-speak, but understanding it is critical if you’re looking for a way to solve the inflation crisis. Fiscal policy creates massive deficits. Monetary policy enables it. The government alone is responsible for inflation. By spending beyond tax revenues, they inject excess dollars into the economy. Eventually, these dollars will find their way to goods and services and drive up prices. It’s also important to note that if the Fed wants to tackle inflation (part of its dual mandate), it must raise interest rates, not lower them. In 1980, with 13% inflation, rates went as high as 21%. Higher rates discourage borrowing and increase savings where that money can fuel sound investment. Lower rates (like the 0% we had 11 out of the past 15 years) lead to a borrowing frenzy that injects more money into the market and creates more inflation. 

In short, inflation is a factor of increased money supply. The solution is simple: massive spending cuts, end QE, and let the markets set rates. While painful, this is the only solution, or we will see another spike in inflation that will dwarf prior readings. If you’re going to smoke a carton a day, don’t expect the cancer treatments to be fun. We got here after years of fiscal insanity. Getting out won’t happen overnight.