Inflation up almost 5 percent past 12 months amid torrent of spending and weakening dollar. Is the economy overheating?

Image: ALG/Branco with permission.

By Robert Romano

Inflation is up 4.92 percent the past 12 months as of May, the most since July 2008’s 5.5 percentaccording to data compiled by the Bureau of Labor Statistics, amid a torrent of trillions of dollars of government spending, Federal Reserve money printing and a weakening dollar combined with the continued economic rebound led by reopening businesses from the 2020 Covid lockdowns.

The past three months alone, inflation has grown at an accelerated rate of 2 percent combined. If that trend were to hold up for the rest of the year, inflation would come closer to 8 percent.

In the month of May, price jumps in fuel oil at 2.1 percent and piped gas service at 1.7 percent offset a 0.7 percent drop in gasoline prices. In addition, new car prices grew 1.6 percent. Used cars and trucks grew at 7.3 percent again after a 10 percent jump in April. Apparel jumped 1.2 percent. And transportation services grew 1.5 percent after a 2.9 percent jump in April.

Now, in part the price spikes being seen now have been offsetting the price deflation from a year ago during the Covid lockdowns. From May 2019 to May 2020, inflation was a mere 0.22 percent. When you average out the two years, inflation comes in at almost 2.6 percent a year.

However, a month ago that same reading — averaging April 2019 to April 2021 — was just over 2.2 percent a year, meaning the inflation is accelerating. The question is for how long.

A hint can be gleaned from the value of the dollar compared to foreign currencies, specifically, the growth rate of the U.S. trade-weighted dollar index, broad, goods and services, which demonstrates an inverse relation with the consumer price index.

Looking at 12 episodes dating back to 1999 of the growth rate of the dollar’s value reaching a low during a cycle, like clockwork, it took on average 3.5 months before the next peak in inflation.

In Sept. 1999, the dollar hit a low and then in March 2000, inflation hit 3.76 percent, six months later.

In July 2000, the dollar hit a low and then by Jan. 2001, inflation hit 3.72 percent, six months later.

In Jan. 2004, the dollar hit a low and then by June 2004, inflation reached 3.16 percent, five months later.

In May 2005, the dollar bottomed and by Sept 2005, inflation climbed to 4.74 percent, four months later.

In March 2008, the dollar reached a bottom, and by July 2008, inflation hit 5.5 percent, the highest since the 1990. That was right before the financial crisis and the Federal Reserve moving its policy rate to near-zero percent.

In Nov. 2009, the dollar hit a low and by Dec. 2009, inflation hit 2.81 percent, just a month later.

In June 2011, the dollar bottomed and by Sept. 2011, inflation reached 3.81 percent, three months later.

In Dec. 2012, the dollar dropped and by Feb. 2013, inflation ran up to 2.01 percent, two months later.

In May 2013, the dollar hit a low and by July 2013, inflation climbed to 1.88 percent, two months later.

Then in 2016, the Federal Reserve began moving its policy rate up, slowly at first and then accelerating through former President Donald Trump’s term of office.

In Jan. 2017, the dollar hit a low, and by Feb. 2017, inflation hit 2.75 percent, a month later.

In Jan. 2018, the dollar value’s growth rate bottomed again, and by July 2018, inflation hit 2.8 percent, six months later.

And in Nov. 2019, the dollar hit a low, and by Jan. 2020, inflation reached 2.5 percent, two months later.

So, looking at each of these episodes, it appears the transmission of the dollar’s weakness into consumer inflation took a bit longer before the financial crisis and Great Recession than afterward. Before 2009, it took five months on average to reach peak inflation after a temporary bottoming of the dollar value’s growth rate. And after the financial crisis in 2007 and 2008, it took 2.3 months.

Now, the most recent bottom of the growth rate of the dollar’s value was felt just last month in April 2021. Assuming that was the dollar’s bottom for this cycle, if the peak inflation will be felt quickly, then it might peak in June, or given the slightly longer timetable, perhaps in September or October. With oil now climbing over $70 per barrel this month, the worst could be yet to come.

Of course, Washington, D.C. could change that metric if Congress and the Biden administration pursue policies that would further weaken the dollar and prompt even more inflation, for example with more massive spending bills.

Since Jan. 2020, the national debt has increased by $5 trillion, of which, the Fed has bought $2.8 trillion since then and U.S. financial institutions bought the rest. Foreign central banks and institutions largely held their share steady as it grew slightly from $6.9 trillion to $7 trillion.

After the $2.2 trillion CARES Act, the $900 billion phase four under former President Trump and President Joe Biden’s $1.9 trillion Covid spending bill, Congress and the Biden administration are lining up yet another $2.3 trillion infrastructure spending bill.

More big spending will in turn flood treasuries markets and temporarily cause interest rates to rise until the Fed sops up the treasuries with its quantitative easing, thereby adding more cash to the economy. Prices will follow suit.

So, Biden should be careful. The last two times 12-month consumer inflation got over 5 percent, in 1990 and 2008, big recessions followed as the economy overheated. As it is right now, the dollar appears to be moving in the direction of strengthening, and interest rates are starting to come down. Unemployment is still dropping. If Washington, D.C. pauses new spending for a while, the current bout of inflation could calm down on its own, and the economy might not overheat.

But if the big spending continues, and inflation gets well north of 5 percent, the economy could easily overheat and fall into a double-dip recession, with prices then dropping and unemployment climbing again — thereby endangering Democrats in the 2022 midterms and Biden’s own reelection prospects in 2024. But with control of the House, Senate and White House, will Democrats be able to overcome their own worst profligate impulses? Stay tuned.

Robert Romano is the Vice President of Public Policy at Americans for Limited Government.