A Short-Term Solution With Long-Term Costs

Inflation is often described as a hidden tax on the middle class, and that’s a good description. Politicians know they will get pushback if they try to pass an outright tax increase (although that doesn’t always stop them from trying).

Inflation works along the same lines as a tax increase. It reduces the burden of government debt. The nominal amount of the debt is unchanged by inflation, but the real burden of debt shrinks because the value of the dollar is lower.

At the same time, Americans have to pay more for everything because prices are going up. When Americans pay more, and the government reduces debt (in real terms), that’s the same as a tax increase to reduce the deficit – and that’s what inflation does.

The government likes inflation more than tax increases because they don’t have to vote for it; all it takes is negligence by the Fed, bad policy by the administration, and profligacy by Congress. And many Americans don’t quite understand how it works as a tax increase even though they feel the pain of inflation every time they pull up at a gas pump to go to the grocery store.

Still, everything has a cost, whether it’s a tax increase or inflation. High inflation causes Americans to spend more on essentials like gasoline and food, so they have less to spend on everything else, including restaurants, clothes, travel, entertainment, and household items.

Eventually, the demand destruction in those non-essential sectors leads to layoffs, business failures, and ultimately a full-scale recession. That may be exactly what’s happening in the U.S. economy right now.

Technically, the U.S. is in a recession right now, but the decline in GDP has been somewhat mild. That could get a lot worse once the demand destruction from inflation and Fed monetary tightening kicks in.

One development that is keeping the economy going for the time being is described in this article. Americans trying to deal with inflation are using up their credit card lines of credit. That’s a stopgap, but it’s non-sustainable.

Interest on credit card balances can be 20% or higher. Inflation is running around 9% for now. This means the credit card balances will grow faster even than inflation, which will eventually cause Americans to run out of new credit.

That’s when the demand destruction will emerge with a vengeance. Americans will be facing high inflation and high credit card bills. That’s a recipe for complete economic collapse. It’s coming.

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