Cause and Effect

The Three Great Inflations

Welcome once again, my dear readers, to the asylum. This week, we will be grateful that while times are hard, they are hard only by the American standard of what constitutes hard times, and not by the standards of other countries. In my 49 years of life and 31 years as an adult, nominally out on my own, I think I have had 9 or 10 good years economically, and the rest have been hard. Sometimes, it's due to self-inflicted wounds, and sometimes it's due to situations beyond my control. In truth, at the time, almost all of it seemed situational to me, but the older I get, the more I can see the self-sabotage. Before setting out on my own at 18, as far back as I can remember, I had 1 good year, and that was the year mom and dad split up (temporarily at the time). The rest is primarily fear, pain, and anger, trying to survive in an environment of madness. But that is neither here nor there and has nothing to do with economics. Today, we are discussing the current challenging times and how I am grateful that they are American hard times. While I will use myself and my family as a real-world example, talking to people reveals that we are not alone, and the issues covered apply to many people in the middle of the middle class.

To illustrate my point, from all sources, my household brings in just under $9,000 a month before deductions, and after deductions, it is around $6,000. In America, this is right at or slightly below the poverty line. Globally, the median annual household income after being adjusted to Purchasing Power Parity (PPP) dollars (so they are equivalent to US Dollars) is right around $10,000 (here), with an average of around $18,000 PPP (here). The American poverty line is equivalent to the world median annual salary in a month (or nearly so) and the global average in two months, as those numbers appear to be gross as well.

Unfortunately, we are seeing the third Great Inflation in this country. The first instance occurred in 1934, when Franklin Roosevelt devalued the US dollar by 75% by declaring that an ounce of gold was no longer worth $20 but was now worth $35, to fund the government's spending. This was immediately after he had confiscated all privately held gold in 1933 at $20 an ounce (here, here, and here). This was odd, as the President doesn’t have the authority to set the value of money, determine weights and measures, or coin money, as per the Constitution, which is the job of Congress (here). However, Roosevelt did it, and it was his only real option because to inflate or debase hard currency, you have to either mix it with base metals, reducing the actual precious content (this wouldn’t have flown), or, as Roosevelt did, declare it worth less in relation to the currency you are forcing people to use. Before 1933, one ounce of silver was $1 (that is why a dime was 1/10 ounce and a quarter ¼ ounce of silver until 1964), and one ounce of gold was $20. Paper currency was convenient, so it existed at the time, but it wasn’t the money; it was a certificate redeemable for gold or silver coins (the money).

While Roosevelt ended public possession of gold and limited people to using paper currency, the dollar was still nominally backed by gold, as the government had to pay its debts to other countries in gold, which served as a check on the government's ability to print money and spend. The second Great Inflation occurred as the cost of funding Johnson’s Great Society social welfare programs and executing the war in Vietnam mounted, America went from a creditor nation to a debtor nation, squandering the advantages it ended WWII with in 36 years. To the point that paying America’s debts to other countries was depleting our supply of gold. How do you fix a problem with overspending? If you are the American Government, you redefine the terms of your loans. That is essentially what Richard Nixon did on August 15^th, 1971. In defiance of the Bretton Woods Agreement of 1944, Nixon “temporarily” closed the gold window by declaring that America wasn’t living up to its word and would no longer pay its debts in gold as promised. Instead, the government would print new bills out of thin air to cover our debts (here and here). This led to the massive inflation seen in the latter part of the 1970s, as more and more dollars were printed to cover increasing debt, including unwinding bonds that had been backed by gold, which had been printed to cover the Vietnam War and the rapidly growing welfare system. This existing debt, coupled with unprecedented growth in government with the advent of more agencies than any other decade, including the Environmental Protection Agency (EPA) in 1970, the Occupational Safety and Health Administration (OSHA) in 1970, the Nuclear Regulatory Commission (NRC) in 1974, and the Consumer Product Safety Commission (CPSC) in 1973. Carter, while not a great president, was in office at the height of the inflationary cycle and took most of the blame, but in truth, unless drastic action had been taken to remove fiat dollars from existence and stop the massive spending increases, it wouldn’t have mattered who was elected; the outcome was inevitable.

The second significant inflation slowed after Reagan took office. This was mainly due to Federal Reserve (FED) Chairman Paul Volcker raising the Federal Reserve's interest rate to 20%. This caused a contraction of credit and slowed the multiplicative effect of fractional reserve banking. At the same time, Reagan cut taxes and implemented significant deregulation policies, lifting controls on oil prices, reducing environmental regulations, and easing restrictions on industries such as broadcasting and savings and loans. By 1986, nearly half of the federal regulations that existed in 1981 had been eliminated, making deregulation a core component of his economic program (here and here). This allowed for businesses to boom, and as companies competed for labor, wages increased faster than inflation. Reagan also pledged to make significant cuts in the Federal Government. That rhetoric went away shortly after the assassination attempt in 1981. That is a topic for another time, probably on a Tuesday. While Reagan did cut regulations and taxes, he didn’t cut spending, and the deficit, as well as the national debt, soared to new highs on his watch. The 1980s were so good, predominantly because of deregulation and tax cuts, which allowed businesses to start and expand. High interest rates also kept inflation lower than the rate of wage growth. Unfortunately, the 1980s were also the era when many of the more problematic investment instruments emerged, setting the stage for the market manipulation and disconnect between the real Main Street economy and the paper Wall Street economy we see today. Things like junk bonds and many derivatives (all of which are simply ways to sell the same shares multiple times), as well as others, would have been seen as fraudulent before this period in American history (here). Ultimately, without the cuts to federal spending to match the deregulation and tax cuts, Reagan’s economic policy set the stage for the massive spending and debt of the next thirty years.

We are currently experiencing the third Great Inflation, which has been ongoing. Arguments can be made that it started with the 1999-2000 dotcom bust, the 2007 housing bubble bust, or the 2020 COVID-19 bailout, all of which involved significant money printing. I would argue it is a cumulative product of the fact that the core issues that caused the problems in 1999 and 2007 were never addressed, setting the stage like fine kindling for a fire, and that the boundless money printing of 2020 was the spark that lit the conflagration. Followed by baby steps, half measures, and cooked economic data (here) that have only prolonged and exacerbated the problems.

Rather than allowing the malinvestments in companies that never turned a profit to unwind, and investors to take their lumps in 1999-2000, the government artificially lowered interest rates. It repealed parts of the Glass-Steagall Act in an effort to stimulate growth through banking deregulation, artificially. This differed significantly from previous government stimulus policies, which typically cut taxes and reduced production regulations, allowing for more organic growth, especially in light of interest rates remaining the same or increasing (here). Then, the government doubled down on backing home loans, equal opportunity quotas, and other policies. This resulted in record-low interest rates by 2001, when we purchased our first home at 6.3%. All of our family and friends were amazed at how low the interest rates were. Historically, before that, the average home interest rate had been nearly 11% and the record low was just over 8%. The reduced interest, combined with government backing and relaxed lending standards, led to a significant increase in demand for homeownership. These policies turned lots of should-be renters into buyers. It was further exacerbated when the lenders found they could mitigate the risk of adhering to all the new government policies by exploiting the changes to Glass-Steagall and combining commercial products in the form of mortgages with investment products by securitizing the mortgages. They did this by bundling some high-risk loans with some low-risk loans and then selling the package to recoup the money lent.

I am not particularly sympathetic to banks, large or small, but mortgage-backed securities were a solution to a problem. Equal opportunity laws are frequently enforced by ratios. Once a case goes to court, if a protected demographic makes up x% of the population, and a bank is sued for violation of equal opportunity laws, the fact that they have issued less than x% of loans to the protected demographic can be used as proof that the bank is not abiding by the law. There is a risk that it won’t matter even if they can show evidence of fewer applicants or that applicants from that demographic don’t meet the minimum criteria. Then if you lose one, the floodgates are open (here). This resulted in constant downward pressure on mortgage qualifications. It got to the point before the bust that if anyone could fog a mirror, they could buy a house in late 2007 (here). This also created a new class of non-lender brokers that would “issue a loan” then sell it before it even closed to fund the loan and make their money. Then that loan would be bundled with others and sold, leaving investors on the hook. They often use adjustable-rate mortgages (ARM) to make a home affordable for traditionally unqualified buyers. Oftentimes, these traditionally unqualified buyers didn’t understand the terms of the loan and just saw the initial payments. All of this acted to drive home prices higher faster than at any other time in history. The rapidly rising home values gave rise to the commercial flipper that would buy up properties, renovate them, and then sell them 30 or 60 days later for a profit again, driving up prices even higher.

This continued with the mortgage qualifications declining and home prices rising steadily from 1999 until the bust almost a decade later. Due to the number of traditionally unqualified buyers who could only afford a home with an ARM, the moment interest rates were raised by a very modest quarter of a percentage point in 2006, the ARM reset the following year, and began a spiral of carnage that would persist until at least 2010. Sadly, rather than let the malinvestment unravel, investors take their lumps, and banks that got too fast and loose fail, the government and the Federal Reserve began a program of market intervention not seen since Roosevelt's New (bad) Deal. They did everything from giving banks tons of cash, allowing the Federal Reserve to buy busted mortgage-backed securities at pre-bust market value (even after they busted to no value), brokered deals for banks to buy each other, and much more, so that by 2011, they had dumped 29 trillion into the total bailout both here and of course abroad (here). To avoid immediate severe inflation, the Fed, for the first time in history, paid banks interest on their excess reserves held at the FED (here and here). This “clever” accounting trick enables banks to appear solvent on paper without increasing the amount of money in circulation. Much of the excess reserve money was paid to banks to purchase their bad mortgage securities, thereby removing them from the banks' balance sheets and making the banks appear healthier than they actually were.

Unfortunately, sixteen years later, many of the temporary measures implemented during the housing crash remain in place. It has, however, fueled inflation much higher than reported, as those funds slowly worked their way out of excess reserves and into the economy over the last decade or so. In addition to bailing out banks, the Fed also continued to suppress interest rates artificially. While lending standards tightened temporarily, by 2012 they had already begun to relax again, and housing prices started to climb once more. Then, we had the scamdemic of 2020, and the gates opened. With interest rates near zero and thousands of free government dollars being handed out like candy on Halloween, the housing market exploded, and demand went up as much as 20% a year. Previously, commercial real estate was typically only interested in multifamily units, such as apartment buildings, because they offered a better return on investment with less risk than single-family homes. With property values skyrocketing and free money to buy, big commercial investors looking for rental income entered the single-family home market, bidding home prices up higher and often offering more than the asking price to shut out regular homebuyers (here and here). We are at a place in 2025 where the average household income cannot buy the average house, even at still historically low interest rates under 7% (here). This has created a situation where the rental market is exceptionally competitive, driving up the cost of renting, and the housing market hasn’t cooled due to cheap money and institutional investors seeking rental income.

All of the free COVID-19 money and very cheap credit that have been circulating since 2020 have contributed to an explosion of inflation. Shadow stats using the inflation calculation method used before 1980 (in my opinion, a more honest