By Martin Tuchman
Inflation is a tricky, tricky business. If it was easy, somebody would push a button and it would go away or get moderated. It’s tricky because inflation is caused by a lot of things. One of them, as a matter of fact, is rising interest rates. So, it’s counterproductive to think that you can raise interest rates and make inflation go away.
When the Fed raises interest rates, somebody who’s borrowing money to fund an apartment house has to raise the rents. So, you are actually causing inflation by raising those rates. To solve the problem, what we really have to do first is pinpoint the causes of inflation, the supply and demand dynamics, and then come up with specific solutions for each of those causes. When the pandemic came, it interrupted the supply chain, which caused a shortage of goods, which in turn created an inflationary environment. The raising of interest rates won’t make the pandemic go away. It won’t cure COVID 19.
The second phase of our current inflation was caused by the Russians invading the Ukraine. I’m fairly confident that Putin won’t put down his arms just because we raise interest rates again. It seems pretty obvious that raising interest rates will not curb the inflation caused by the shortage of oil, gas, commodities, and fertilizer that we are seeing as a result of that war.
The third wave of our current inflationary economy was caused by the closing down of China because of their zero-tolerance policy now for COVID 19. As that continues, the supply chain will be even more interrupted. But raising interest rates in the U.S. will not cure the Chinese decision to close down their economy. We have to look elsewhere in terms of solving these problems if we want to tame inflation.
It’s fair to ask, “What is the thinking behind raising interest rates to curb inflation? Surely there must be a sound logic to that strategy. It’s worked in the past, hasn’t it?” I like to equate it to banging a nail into the wall. You can accomplish your goal of getting the nail into the wall with the use of a sledgehammer, but you will also destroy the wall. That’s the thinking behind raising interest rates, get the nail into the wall at all costs. But wouldn’t it be better to use a hammer instead of a sledgehammer and get the nail into the wall without destroying it? We do have more refined tools in our chest, after all. The idea of raising interest rates to the point where you absolutely destroy the economy is exactly the same, you accomplish your goal, there’s no inflation, but there’s also no economy left. There’s nothing.
In the past, if you look at Paul Volcker (12th Chairman of the Federal Reserve 1979 – 1987), who succeeded in taming inflation, he must have raised interest rates 10, 12, 15 times during his tenure, until it finally reached about 20%, and the economy collapsed. The question is, was it necessary to destroy the economy and all the jobs and the people and the companies for all those years instead of doing it a different way, instead of taking a more targeted and tactical approach?
What would it take to implement this more targeted approach? Does the IRS have capabilities that the Federal Reserve does not? Smaller, more efficient tools at their disposal?
Well, the IRS is a powerful institution, as we all know. If one looks back at how the IRS has stimulated the economy in the past, they’ve offered things such as investment tax credits and accelerated depreciation, levers that help make it worthwhile for an investor to put up the funds for new projects. So perhaps the answer is to take away some of these benefits to slow down inflation. Take the stimulus away by reducing or eliminating investment tax credits, and completely take away depreciation for the next five years, telling investors they can’t use depreciation as a shelter on any new projects. If you’re in a 50% tax bracket, which most investors are today, you save half of that through investment tax credits and depreciation. That’s a real benefit. So if you take that away, the investors will probably say, “maybe I won’t do that project because it doesn’t make sense when I run the numbers, now that I don’t get an immediate tax benefit.”
So that’s one way that the IRS can lend a hand, but only on new projects. Leave the other projects alone. Don’t destroy the rest of the economy just because you want to control inflation. Put the onus on those sectors that are causing inflation, not the ones that had nothing to do with it. They’re just working through their project as they were for the last four or five years.
Before the pandemic, everybody was actually running around trying to figure out how we could get some more inflation into the system. And rates were low. So you had low rates, and low inflation before the pandemic, before the shutdown in China, before the war in Ukraine, before those factors hit, which proves that it isn’t low interest rates that are causing inflation, it’s these outside elements.
You can stop the inflationary runaway by stopping the construction of brand new projects and things of that nature that caused shortages in supply, which fueled the price hikes we are feeling today. The first step is working together, everybody working together, the Fed, the IRS, and the whole banking industry. The banking industry must come to the table because all the funds from these stimulus packages from the pandemic went to the banks. The banks have a tremendous amount of capital as a result of the pandemic. Normally when the Fed raises rates, your bank’s cost of funds also goes up. But in this case, it’s not happening. The banks don’t have to borrow anymore. They just have to sit there and allow their rates to go up as a result of the Fed raising rates. So, the banking industry will continue to get a lot stronger. The rest of the economy will get a lot weaker, until such time as people can no longer meet their payments. And the combination of bankruptcies and businesses closing down, will bring us into a recession.
So, if we continue on the way we are going now, we’re definitely going to have a recession, and a serious one. It’s not going to last six months or a year. It will last many years. That’s why I say we’ve got to try our best to come up with solutions now rather than continuing to just arbitrarily raise interest rates. It’s a matter of dealing with the problem, not trying to figure out who to blame for the problem, because that’s not going to get us anywhere. It’s finding solutions to the problems collectively to moderate it. And this takes time. We have to slowly address the specific problems and not look to quick turnarounds and quick price increases. Food prices have gone up a tremendous amount. And slowly but surely, this will eat into the economy. You can’t turn it around with higher rates. You need a plan.
If we were to have the ear of the Biden administration, I would suggest they first remove any benefits for building and constructing. Eliminate any accelerated depreciation, but not for everybody. I’m saying for new building, new construction, we need to eliminate that. Additionally, instead of having an investment tax credit; reverse engineer it. Let’s call it an investment tax debit. So, you tell an investor who is looking to start a new project that instead of giving them 15% of their project as a credit, we’re going to charge them 15% if they start that project. That will act as a real damper for any logical investor. They won’t start new building projects, and as a result, won’t create inflation. They won’t buy more lumber, won’t buy more nails, sheet rock, and concrete. Because that’s what we’re trying to do, we’re trying to dampen that end of the market without destroying the existing system.
You may ask, “Is this limited to the construction realm?” I would answer no. It ripples throughout a lot of the elements that add to the inflationary equation. If you build rail cars, then you need steel to build those rail cars. You need coal to make the steel to build those rail cars. But if you take away those incentives, you decrease demand, which in turn will bring down the prices of those materials.
You might say, “I understand how the price of a nail goes down, I see how the price of sheetrock goes down with this plan, but would it bring prices down across the board? How will disincentivizing new construction bring down the high price of food today?”
The answer is you have to address every problem as if it’s a problem on its own. If you’re talking about food prices, that has to do with the war in the Ukraine, because you have fertilizer and other commodities that can’t be shipped out of the ports because the ports are blocked. The point remains: raising the interest rate will not solve the problem of ports being blocked due to a war. We need another solution for that problem. Perhaps it’s growing more food in countries that have the ability to grow more food if given the right stimulus. Perhaps there’s another way. But you shouldn’t use raising interest rates as ammunition towards eliminating the fact that you can’t sail a vessel out of Odessa with grain to feed the people. That’s most certainly not going to do it.
Out of the three major problems that we’re facing right now that are causing inflation, I don’t look at them in terms of which one is the worst. I look at them in terms of which one is the easiest that can be corrected, and that is probably the so-called supply chain tangle. I think the shipping companies, particularly the container shippers moving cargo from China to America and other countries will eventually sort that one out because they are building more containers, more ships are coming online. That will take care of that problem. The infrastructure problem in the United States with all the railroads and the rail cars, that’s being sorted out. It takes some time, but that stress from the supply chain issue will go away from the inflationary market in time.
The second problem that I think will probably sort itself out will be China. They will eventually allow their citizens to go back to work and produce an export product which will take pressure off of the current price of that product. And the last problem, the war in the Ukraine, that’s going to be a longer process. Not only in terms of how long the war will last, but because of the aftermath of that war. How will people engage and work together after such a situation has taken place? I have no comment on how to solve that problem at this point. But I will say it again, what we can be assured of, is that raising interest rates will not end that war.
An innovator and entrepreneur, Martin Tuchman started his career at Railway Express Agency where, together with a group of shipping engineers at the American National Standards Institute, he created the standards for intermodal shipping containers and chassis still in use today. Subsequently, he co-founded Interpool, one of the nation’s leading container leasing companies and later formed Trac Lease, the largest chassis leasing company in the US. He was named Entrepreneur of the Year by Ernst & Young and together with Interpool earned a Grand Prize in Cisco’s Growing with Technology Award. Today, Martin is the Chairman and Chief Executive Officer of PIP Group and serves on the Board of Directors of The Bank of Princeton, a community bank with over $1 B in assets, as well as on the staff of the Martin Tuchman School of Management at New Jersey Institute of Technology.