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“Squishing” The Economy

By Terry Savage on July 25, 2018

The economy has always reminded me of one of those squishy toys that children so enjoy. If you squeeze the middle, the ends get distorted. If you squeeze one end, the other end bulges and changes shape. Same thing with the economy: If you change trade policy or interest rates or tax rates, the results are felt far from the part you squeezed.

That’s exactly what’s happening now. And as a result you’re going to hear more about subjects that haven’t been in the economic headlines for at least a decade, like inflation, rising prices and the value of the dollar. It’s time to get prepared.

Inflation on its way

The simplest definition of inflation is rising prices — although economists will tell you it’s all about money creation. We are definitely starting to see rising prices as the result of tariffs. When we put taxes on imports — whether they come from China or any other part of the world — those taxes are passed on to consumers in the form of higher prices.

Manufacturers that import everything from computer parts to tires to washing machines will try to hold prices steady so consumers aren’t turned off. But in the end they will raise prices just to stay in business. Whether it’s raw materials (think fresh vegetables from Mexico) or telephone handsets, prices will move higher.

And as the higher prices deter consumer buying, the slowdown will be felt by retailers and manufacturers alike. Instead of saving jobs, the tariffs will cost jobs. But it will take a while for the effects to be felt.

In the end, inflation is a monetary issue. Because if you fear that prices will be higher in the future, it means that your dollar will buy less. So workers will demand higher wages to pay for the increased cost of living. And higher wages mean more money chasing after things to buy, pushing prices even higher.

In the end, no one is better off with inflation. Just ask Venezuela, which is suffering with a 46,000 percent — yes forty-six thousand! — inflation rate this month. There are no basic supplies of food and water available at any price for worthless Venezuelan currency. And Venezuela has the largest oil reserves in the world, so the country should be wealthy. But it can’t pay workers to keep its refineries operating.

Higher interest rates follow

Future inflation expectations inevitably drive interest rates higher. It’s not just the Fed announcing small rate hikes that drives rates. It’s the marketplace where lenders of dollars, fearing that inflation will result in less buying power for the dollar, will demand higher interest rates to compensate.

Politicians can blame the Fed for their small increases. But once the global marketplace decides that the United States dollar is losing value because of inflation, there will be no way to stop rates from rising. After all, we have so much debt — more than $20 trillion — that we must keep borrowing, and paying the price in higher interest rates.

On a personal basis, debt will become a huge burden as monthly payments rise. Think of your credit card bills and your adjustable rate mortgage or home equity loan.

Downside of a strong dollar

But there is another negative aspect of higher interest rates. If U.S. rates move higher than those in other countries, our currency will become more attractive and rise in value against other countries. This “strong” dollar makes our exports more expensive because foreign buyers will have to scrape together more Euros, for example, to buy one dollar’s worth of our manufactured goods. As a result, sales of U.S. products are likely to drop, resulting in layoffs at our factories. Obviously, that was not the intended result when tariffs were imposed.

All these impacts, and we haven’t even mentioned retaliatory tariffs. They pose the potential to cost jobs everywhere from the farm belt to manufacturing to technology to retailing. The tariffs could be the biggest “squish” of all!

That’s the thing with economics. Our economy and the global economy are indeed inter-connected, like a giant squishy toy — with bulges and odd results taking place far from the original squeeze. And that’s The Savage Truth.

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