We’ve all heard what is now a jingle that inflation is too much money chasing too few goods, a true statement but far from a complete story.
The U.S. economy began its shutdown in March of 2020, resulting in mass worker layoffs and bringing factory production to a standstill. In fact, capital investment (i.e. new inventory investment fell over 29% by the second quarter of 2020). If you’ve studied any economics you know that U.S. GDP is largely made up of two variables, capital investment and consumer spending. Adding to the domestic supply problem is our reliance on foreign manufacturing; so, the global shutdown contributed heavily to the U.S. supply shortage.
Let’s talk about the demand side for a moment. No one spends money more efficiently than a consumer and consumer spending accounts for more than 60% of U.S. GDP but in 2020 the country experience a 2.6% decrease in consumer spending as a national average driving the need for the first stimulus payment of $1,200, in April of 2020. The impact of that stimulus was near immediate and in Q3 of 2020 we begin to see an increase in inventory levels as businesses respond to consumer demand. However, the supply side was still constrained due to their own supply and labor shortages. A number of global suppliers were still locked down as well as large states like California and New York to name just two.
Further complicating supply matters was our failure to do anything to incentivize manufacturers to build up inventory. On the financial side, unsold inventory is reported on a Cost of Good Sold basis and it reduces Gross Revenues. What could have been done at the tax level is to allow businesses to take Cost of Goods of unsold inventory as a tax deduction, businesses could then carry back or forward any tax benefit and offsetting the cost associated with carrying that inventory, remember that interest rates were near zero so inventory could be maintained at a near zero cost of capital.
There were subsequent stimulus checks, a $600 direct payment authorized in December of 2020 and a third and final payment of $1,400 in March of 2021 creating additional demand on manufacturers still constrained by global supply limitations as well as labor shortages.
Failing to supply the stimulus in the form of direct payment is equivalent to reducing power on an aircraft attempting to recover from an aerodynamic stall and in my opinion would have resulted in an economic recovery that could have taken years if left up to divine intervention alone.
This is why we have inflation, but the solution is not increasing interest rates, the solution comes from kicking the supply side into gear by reopening state economies and bringing an end to the COVID overreaction -SP