Inflation: Where do we go from here?

In just the past two decades, Congress and several administrations, with full support from the Federal Reserve, have grown our budget deficit to over 130 percent of GDP with no end in sight. This increase has put the U.S. among the top 10 worst deficits in the world, alongside Greece and Italy. According to the U.S. Treasury Department’s recent Financial Report of the U.S. Government, “The current fiscal policy of the U.S. is not sustainable.”

This cannot continue, and the Federal Reserve must immediately cease aiding and abetting it. The scourge of inflation is upon us again. For a playbook on how we might deal with it, we can look to the period from the late 1970s through the 1980s, when we dealt with it successfully, albeit with extreme pain and disruption.

The cause of inflation during the 1970s is straightforward. President Kennedy was assassinated in 1964, and Vice President Lyndon Johnson became president. Johnson decided to expand greatly an already costly and hugely unpopular war in Vietnam without raising taxes to pay for it. Then, he declared a very expensive war against poverty by implementing extremely costly social welfare programs, again without raising taxes to pay for them.  

The Federal Reserve expanded the supply of money to accommodate the massive deficit spending and kept interest rates at moderate levels. President Nixon inherited both the war in Vietnam and the growing deficits, but he became so weakened by the Watergate scandal he had little political capital to spend on fighting inflation and ultimately was forced to resign from office.

When President Carter was elected in 1976, rapidly increasing prices, particularly for petroleum used to heat homes and fuel cars, were becoming a major political issue. The impact was felt in the financial world causing pressure on interest rates and threatening banks and thrifts, particularly those making long-term, fixed-rate loans.  

Carter turned to Paul Volcker, who was then serving as president of the Federal Reserve Bank of New York, naming him chairman of the Federal Reserve Board in 1979 with the mandate to do whatever it might take to eradicate inflation. Volcker responded with alacrity, boldness and determination, raising the prime rate ultimately to an unheard of 21.5 percent.

This in turn led to two recessions, a depression in the agricultural sector, a collapse in energy prices, massive business and personal bankruptcies, as well as over 3,000 bank and thrift failures, including some of the largest banks in the nation. Things were so serious that the Fed and Federal Deposit Insurance Corporation (FDIC) planned for the possible nationalization of the nation’s largest banks if their loans to third-world countries defaulted.

All who were involved in implementing these policies believed we had no realistic choice. The longer it took to eradicate inflation, the more pain and hardship it would inflict, particularly on our middle- and lower-income Americans.

In addition to monetary policy, fiscal policy is today far looser than in the 1970s. The federal debt stood at $5.5 trillion, or roughly 55 percent of GDP, at the end of the Clinton administration in 2000. A little over 20 years after Clinton left office, the federal deficit had increased nearly six-fold, much of which has been monetized by the Fed.

President Biden shows no sign of being willing to urge Fed Chairman Jerome Powell to follow in Volcker’s footsteps. Powell, like his two immediate predecessors, shows no signs of being willing to do so, either. Nor does there appear to be much appetite among congressional leaders for going down that path. The COVID-19 pandemic took center stage about two years ago. Congress, backed by two administrations, has been throwing trillions of dollars at it with a seemingly insatiable desire to run up even more spending — inflationary consequences be damned.

It may be that the Volcker playbook used to defeat inflation in the 1980s cannot work this time around. Monetary policy has been wildly out of control for much too long and the Fed has created such a massive role for itself in funding the government’s enormous deficit spending (in addition to carrying the housing markets) that we might be addicted and cannot come off the high — at least not without more pain than our current leaders are able to tolerate.

We have previously criticized the Fed’s obsession with increasing the inflation rate to 2 percent and called for the Fed to immediately begin normalizing/increasing market interest rates. We observed that the Fed’s extremely low interest rates “were benefitting mainly the wealthy, with meager income growth for middle- and lower-income Americans, including retirees trying to live on pensions.”  

We went on to urge the Fed to “begin reducing … its outsized balance sheet and let the markets begin to function properly.” We noted that prior to recent years, the Fed’s “balance sheet had never reached a trillion dollars” but in 2017 “it stands at more than four trillion dollars, or nearly 25 percent of the entire debt of the Federal government.”

We also noted that the “Fed’s eight-year intervention in the markets [had] contributed to asset prices rising to ‘bubble like’ levels, including the stock market, long-term bonds, at least some commercial real estate, and other assets, [which are now] beginning to show signs of stress … [while the] incomes of a substantial and growing number of Americans are flat or declining, and still too many individuals who want to work cannot find a decent job.” 

Ironically, today we are in the opposite situation where there are twice as many jobs available as there are unemployed people receiving government handouts that don’t require them to seek jobs.

Our calls — and those of former Volcker during that same period — for sound monetary and fiscal policies went unheeded. It is past time to bring an end to reckless spending and the monetary policies that enable it. 

William M. Isaac is former chairman of the FDIC and Fifth Third Bancorp. He is currently chairman of Secura/Isaac Group and Blue SaaS Solutions.

Richard M. Kovacevich is retired chairman and CEO of Wells Fargo & Company.