The threat of inflation and the stimulus package

The threat of inflation and the stimulus package
Source: Dado Ruvic, Reuters
Experts are still debating whether inflation caused by the stimulus package presents a credible long-term threat to the US and the global economy.

With the passage of the third COVID-19 relief package in the United States, a debate that started on the Senate floor regarding overspending leading to inflation has begun making the rounds across the media landscape. However, experts are still debating whether inflation caused by the stimulus package presents a credible long-term threat to the US and the global economy.

What is inflation?

To put it simply, inflation is the loss of purchasing power of a particular currency over a span of time. Inflation is often measured by examining the prices of specific goods and measuring the rate of change over a set period of time.

Inflation can be viewed as either positive or negative depending on the individual viewpoint and how fast the change occurs.

Those with tangible assets, like property or physical commodities, benefit from seeing some inflation, as this raises the value of their assets. However, individuals who are holding cash do not see inflation as a positive due to the value of paper money remaining unchanged. In other words, a bill worth US$20 does not change in value regardless of the change of purchasing power over time.

When US officials express concerns related to inflation, they are generally referring to the purchasing power of the US dollar as the global currency.

US dollar as the global currency

In 1944, delegates from 44 allied countries met in New Hampshire to discuss which country’s currency would be established as the global currency in order to set fair international trading without putting any country at a disadvantage. Rather than linking the global reserve to gold, the delegates decided to establish the US dollar as the global currency due to it being backed by gold.

However, in October of 1976, the US dollar was decoupled from the value of gold and became a true fiat currency – a currency not backed by a commodity.

This decision affected countries other than the US as the US dollar had been established as the global reserve’s currency. By becoming a true fiat currency, the currencies that were backed by the US dollar became fiat currencies as well, all of which depended on the value of the US dollar.

Currently, more than 85% of the world’s foreign exchange transactions are completed in US dollars.

US aid and the GDP to debt ratio

When asked about the credible risks inflation presents to the US and global economy, Dr. Tenpao Lee, a professor of economics at Niagara University, referred back to the global financial crisis in 2008 and the quantitative easing (QE) provided by the federal government.

“Since 2010 when QE1 was first introduced by the Fed, economists have begun to warn of the potential risk of inflation,” Dr. Lee told TMS. “Then, we had QE2, QE3, President Trump’s historic $2 trillion stimulus package, and President Biden’s $1.9 trillion coronavirus relief package. As a result, the total debt to gross domestic product (GDP) has jumped from the pre-pandemic level of 107% to 130+%.”

When discussing QE1, Dr. Lee is referring to the first round of quantitative easing when the federal reserve purchased debt – including mortgage-backed securities, consumer loans, etc. – from its member banks. The process began in 2008 in response to the global financial crisis.

Like the initial COVID-19 relief package provided in 2020, QE1 didn’t accomplish enough to incentivize banks to begin offering loans again and the federal reserve proceeded to provide more aid in QE2 and QE3.

Dr. Lee also indicated that the current total debt to GDP ratio had reached 130+%. The high total debt to GDP ratio indicates that a country is not able to produce and sell enough goods and services to pay back current debts without incurring further debt.

The World Bank Group found that a GDP to debt ratio that goes beyond 77% for an extended period of time may negatively impact economic growth. Given that the current GDP to debt ratio is 130+%, the US economy’s growth may be negatively impacted for the foreseeable future.

However, a GDP to debt ratio exceeding 100% does not indicate that the country is “bankrupt.” Japan’s ratio has exceeded 250% in recent years, yet economists indicate that Japan’s risk of “going bankrupt” is extremely low.

The risks of inflation according to Dr. Lee

Dr. Lee provided further comment to TMS regarding the implications of the current stimulus package and the future of the US and global economy.

“It is certain that there is a limit and we cannot print money to stimulate the economy forever,” Dr. Lee says. “The stimulus money will hurt the USD as a global currency in the long run. Nobody knows what the limit is as the total debt to GDP ratio is at a historical high. When the momentum and expectations change, inflation could happen quickly and create an irreversible disaster.”

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