Time says Tea Party will cause hyperinflation

If hyperinflation arrives, Time Magazine wants its readers to know who the real culprits are.  It won’t be the federal government that hiked annual spending by 38% in three years and began running trillion-dollar deficits.  It won’t be the Congress that kept raising debt limits to allow for that spending spree.  And it won’t be the Federal Reserve that, in desperation over the government’s spending and debt spree, began printing money to artificially keep interest rates low.  No, the real culprit will be the political movement that opposes all of the above, according to The Curious Capitalist:

In a recent paper, called Temporarily Unstable Government Debt and Inflation, which can be downloaded from this website, Leeper has a chart that he unofficially calls the Tea Party shock graph, on page 25. Before the Tea Party, inflation is rising slowly. But in the first year the Tea Party or a group with similar views wins the Presidency or takes over Congress, whamm-o. Inflation doubles, and keeps going up. He wrote the paper in October, so he puts the potential date of Tea Party takeover as 2019, but after this election Leeper concedes Tea Party induced hyper-inflation could come much sooner than that. So is Palin riding the Hyper-Inflation Express? Maybe. Here’s why

But here’s the trick. Leeper doesn’t just model actual tax policy. He is looking at tax expectations. You don’t actually have to lower taxes for inflation to rise. Nor do you have to raise taxes to get inflation to fall, for that matter. Leeper says as we get closer to the point that is looks like the government is unwilling to raise taxes people will get increasingly nervous about our debt. And that’s the problem with the Tea Party.

Now before you go claiming that Leeper’s research is a Liberal hit piece consider this: Leeper agrees that when governments have high levels of debt higher taxes do slow growth and cause massive inflation. But we’re not there yet. Currently, our US Federal Debt is equal to about 62% of annual GDP. That’s a lot, but not enough to make higher taxes a threat. According to Leeper’s calculations, at our current level of US Federal Debt higher taxes, even modestly higher taxes, tends to reduce inflation by three quarters of a percentage point. And the inflation fighting affect of higher taxes tends to grow as the level of debt rises closer to one. Inflation drops by about 1.3 percentage points when the US Federal deficit equals GDP. After that the equation shifts. When debt hits 120% of our annual debt, that’s when the trouble hits. At that point, higher taxes tends to make inflation rise, not fall. But even if Bush’s tax cuts are kept in place we are ten years or more from hitting that point.

Perhaps at some point, Mr. Curious (or Mr. Capitalist) can explain why we had runaway inflation in the 1970s even with a low debt-to-GDP ratio and a predilection for higher taxes.  Curiously, when we started cutting taxes in the 1980s, that inflation disappeared, and remained under control during a long period of low tax rates, especially in the 1980s and in the last decade as well.  Those years of low taxes, low inflation, and consistently high real growth in GDP would tend to argue that tax cuts don’t create inflation but actual growth — as well as confidence in both the economy and the currency.

Not only does Mr. Curious fail to take that into account, he also fails to use accurate accounting of our debt.  With a projected GDP growth rate this year of 2.5%, we can estimate the final GDP for 2010 at around $14.48 trillion, rounding up a little generously.  According to the Treasury’s own debt calculations, our national debt stands at $13.73 trillion as of November 9th, which would put our debt-to-GDP ratio at 94.8% of our GDP even if we didn’t add a single dollar from now until the end of the year. By this measure, the ratio was 55.9% in 2001, and 65.6% by the end of 2007.  In 1995, it was 67.3%.  The rate now is significantly worse than any time in the last 60 years.

Time Magazine gets to 62% by ignoring intragovernmental holdings, which are IOUs held by such trivial creditors as, say, the Social Security Administration (and that’s actually 63%, not 62%).  So our debt ratio is only 63% if one is inclined to believe that the government will simply eliminate Social Security and default on its debt to other governmental trust funds, rendering them defunct.  The CBO leaves out intragovernmental holdings because, technically, Congress isn’t committed to honoring those IOUs until it approves the expenditures in each annual budget.  That debt is just as real as the “public” debt, though, with perhaps even bigger political and economic consequences for defaults.

By the way, when we last experienced hyperinflation at the end of the 1970s, our debt-to-GDP ratio was … 33.4%, one of the lowest levels of debt we have experienced in that same period.

Uncontrolled inflation doesn’t get created from tax cuts; it arises from bad monetary policy, ill-advised government interventions, and a serious lack of confidence in the currency.  Tax cuts uncoupled from spending cuts can certainly make for bad policy and set the stage for inflation, but all one has to do is look at the last nine years of stable tax rates and the runaway rate of spending increases in Washington to determine where the actual problem lies.  It’s not the tax rates that kept changing, nor is it a decline in revenue that created the massive deficits.  For most of the last ten years, revenues have increased, with the exception of the last two years of deep recession; the deficit problem resulted from spending increases that have far outstripped the revenue increases.

Finally, the Tea Party may be philosophically inclined to low taxes (seeing how well they worked in the 1980s and in the early 2000s in stimulating growth), but that’s not the issue on the table.  Democrats in Congress want to raise taxes on the employer class, not cut taxes for everyone else.  The Tea Party and Sarah Palin want to cut spending instead and shrink government, a strategy that has worked to restore economic growth in this country when it was tried in the 1960s, the 1980s, and in 2001-3, and in none of those cases created runaway inflation.  Perhaps Time needs a little more intellectual curiosity.