The Inflation Opportunity

Inflation has been described as too much money chasing too few goods. This is a remarkably succinct and understandable explanation of a subject that has produced libraries of Ph.D. theses. It is a wonderfully pithy formulation of one of life’s immutable laws, the relationship between supply and demand. An economics professor would explain to you that inflation is nothing more than a graph where the supply and demand lines cross at a point that is uncomfortably high on the Y axis. So the theoretical solution to this discomfort is simple: Either you lower demand or you increase supply and, voila, no more inflation.Uncomfortably, most of the focus has been on the demand side of the ledger, perhaps because that provides the easiest solution to execute. Paul Volcker proved in the 1980s that you can cure inflation by drastically raising the price of money. If you can stand the economic pain — depression-like recession, excruciating unemployment — this will work.This might be called economic chemotherapy: It will cure the disease though it might kill the patient. Crush the demand, denominated in money, and the price of the supply, meaning goods and services, must fall. As someone once said to me as I took a wrong turn at the top of a ski mountain: “You’re going the hard way.”So why not explore a supply side remedy before unleashing the economic equivalent of chemotherapy?The most critical element on the supply side, and the one contributing the most to the current inflation surge, is the cost of energy. Oil has more than doubled to more than $100 a barrel, natural gas the same, to over $4 a thousand cubic feet. Energy is not just directly inflationary, as when you fill up your car, but energy costs infiltrate the price of virtually all products.Energy, though, is an addressable supply constraint. Instead of the futile Biden war on fossil fuel, open up federal lands for exploration; encourage, don’t kill, pipelines; stop the adolescent virtue signaling of shaming energy financing. In short: Drill, baby, drill! More supply of energy would bring down prices.Attacking inflation from the supply side would encourage economic growth in stark contrast to Volcker-style recession therapy that would come from merely hiking interest rates to nosebleed levels. There might be times when the Volcker therapy is necessary, but it should not be employed absent a Reaganesque, supply-side strategy.Like the cost of energy, moreover, the cost of money filters through every aspect of economic activity. Money and energy are, directly or indirectly, the raw materials for everything we make. So to cure inflation, Volcker-style, by raising the cost of money has the unintended, counterproductive, consequence of raising costs, particularly the cost of capital.A supply side solution would require efforts/policies which lower, not raise, the cost of money, a synonym for capital. If cutting interest rates and increasing the supply of money is too radical an idea for lowering the cost of capital in an inflationary period, perhaps we should look at that other major factor in the capital cost equation, the tax code.The cost of capital is computed on an after-tax basis. Anything that lowers that cost will increase investment activity and ultimately the supply of goods and services. So examining the tax code, one can see that some of the obvious inflation fighters would be: Immediate expensing of all capital investments; lowering, or eliminating, the capital gains tax; indexing capital gains for inflation; and simplifying the code so billions aren’t wasted on tax compliance.Lowering capital gains taxes and — or either — indexing for inflation would liberate vast amounts of capital locked in suboptimal investments because of the tax penalty of moving. Improving the mobility of capital not only increases the available supply but it allows it to flow into higher and better uses. In other words, more capital, more efficiently employed: a supply-creating twofer.The last component of supply creation is labor. Right now we are finishing up a labor experiment that could hardly have been better designed to increase inflation by raising the price of labor. We have been paying people not to work. In other words, we have been incentivizing a reduction in the supply of labor.This is not only inflationary because of reduced supply, but the money printed to pay the idled worker increases demand. It’s an inflation double whammy. I’d use an exclamation point but the Sun doesn’t permit them. To attack the labor component of inflation, first do no harm: stop paying people not to work.There’s a saying in certain economic circles that demand creates its own supply. So the previous recommendations designed to increase the supply of energy and capital would increase economic activity and a demand for labor. If the government is determined to print and distribute money, it should reward Americans for working rather than catching up on the soaps at home. How about a $1,000 sign up bonus for going back to the job?The deficit hawk will object that lowering taxes to increase the supply of capital while increasing spending to encourage people to return to work would have a detrimental effect on the deficit. The rebuttal is that the supply side program would certainly increase economic growth, which in the long run is the only way to tame the deficit.Think “The 4% Solution,” published by the George W. Bush Institute. Controlling the deficit through some combination of lower spending and higher taxes has proven to be a political nonstarter in a democracy. Why not try a politically more realistic approach and cure inflation at the same time?

The Inflation Opportunity

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