A Case for Managed Inflation

by: Jamin Chen

I would like to start with a brief experience of mine. In 1969 I bought my first house for about $50,000. It was somewhat more expensive than the average house then. My mortgage payment at that time was a large and significant part of my monthly paycheck. Fast forward to the mid 1990s when I sold that house for about $350,000, 7 times what I paid for it about 25 years earlier. Meanwhile, my paycheck had gone up by much more than 7 times since 1969.

Some points can be gathered from this little story: First, there was roughly an 8% annual inflation on the price of the house during that period. Second, I consider myself luckier than most in that my paycheck had increased more than the inflation rate at the same time. Third, even less lucky employees' paychecks were kept in line with the rate of inflation. Fourth, inflation can cure some social-economic problems, if it's handled correctly.

Now, consider the mess we are in today.

The proposed 2011 U. S. budget: $3.83 trillion

U. S. Population: 312 million

Per capita burden of the government budget: $10,000

On average, every one of us, from babies to centenarians, would have to pay an equivalent of $10,000 in taxes each to keep our government going. Here, I am making a gross simplification and assume that all the taxes and use fees paid by corporations and other entities will eventually “trickle” down to all of us in the form of increased prices.

Even with the phantom cut in spending of say $2 trillion over 10 years or $0.2 trillion per year, our burden is still about $9,000 or so each. But not everyone of us is capable of shelling out this amount, and here lies the crux of the problem: Who should pay, and how much? By nature, we all want other people to pay for most, if not all of it. When it comes to money, the debate can get nasty and nonsensical. The recent ugly fight in Washington is no exception.

The other simple fact is that the poor simply have no resources to pay for it. The rich then have to carry more of their share of the burden and provide a subsistence level for the poor, or else risk a social tsunami: riots, revolution, etc., you name it. That was the stuff that led to the great French Revolution of the late 18th century.

Now, I would like to return my story at the beginning of this article. To get out of our current deficit problem, what we may need is a “managed” inflation. By managed I mean we need to engineer a nationwide inflation that would raise not only the prices of everything we pay but also all the salaries as well as social security and other welfare payments. And, don’t forget that we also have to raise the taxes we pay in sync with the inflation. Interest rates need to be raised also so that the banks would be willing to lend more and the retirees on fixed income would get their fair share of the increase.

We've done this once before. After the Great Society program and the Vietnam War in the Johnson years (1961-1963), we had the Carter years (1977-1981) of rampant inflation and high interest rates. That was followed by tax increases (taxing the poor more and the rich less) in the Reagan years (1981-1989). Then there was the famous Bush senior “read my lips: no new taxes” line, which was promptly followed by tax increases nonetheless. Clinton (1993 – 2001) also raised taxes (taxing rich more).

Now, let us look at the performance of the Dow Jones Industrial Average (NYSEARCA:DIA) over these years:

(Click chart to expand)

Click to enlarge

The DJIA was stagnant following the Johnson and Carter administrations (1961 – 1981) even during the great inflation years. But through the Reagan, Bush Senior, and Clinton years (1981 – 2001), the DJIA rose steadily --while taxes were being raised. The DJIA flattened again in the Bush Junior and Obama years, when taxes were being reduced. While this was going on, the Japanese Yen had risen from 360 to 80 Yen/Dollar, wiping out a large chunk of the trade deficit we had been accumulating.

Therefore, in my humble opinion (I am not an economist and I did not have education in economy), a managed inflation (i.e. inflate everything including interest rates, prices, salaries, taxes and entitlement payments, etc.) may be a way out of our current predicament of high national debt, high unemployment and huge trade deficit. Business will make more money, people will be paid more, and the national debt may disappear quicker than you think. It almost did during the Clinton years.

Hopefully, we would do a better job this time: Raising taxes for everyone equitably while inflating everything else, all at the same time. Inflation also means cheaper dollars and if the U. S. dollar is worth only one quarter of what is today, we could bring a lot of jobs back to the U. S. and yet remain very competitive in the world market.

However, there is an 800-pound gorilla in the new world order, and it is the holders of our national debt, predominantly China and Japan. But I will have to leave it to the economists and politicians to handle it for now. After all, they have to earn their keep too, don't they?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.