The near term is really really hard to forecast now. There are lots of things that have gone wrong, and will continue to go wrong. When the near term is hard to know, it’s useful to focus on the long term. Because in times like this the long term is more foreseeable than the short term.

Lots of things have been set in motion that are now bound to happen. And these things are bound to happen no matter how the Iran war ends. Even if everyone agreed to pack up and live peacefully in Iran, the world now knows it can’t rely on that. The die is cast.

This is an energy crisis, but energy runs everything, so it has impacts far and wide. Petroleum and urea are impacted by the closure of the Hormuz Straight, and both of those are critical inputs to fertilizer, which is required in agriculture. If we use less fertilizer, or no fertilizer, crop yields will plummet, affecting food costs. We need petroleum to run manufacturing of every kind. Planes require petroleum. There are no electric 747s in the near future.

Most countries have had a wake up call about their need to have a Strategic Petroleum Reserve. SPRs will have to be refilled later. And countries that didn’t have a SPR will be adding them, and those new SPRs will also need to be filled. All that demand will put upward pressure on prices.

If oil prices look like they will stay high, that starts another predictable series of events. Companies that produce oil will have every incentive to drill more and produce more. If they have operations that weren’t profitable when oil was $60 a barrel, those operations will begin to look very attractive. It takes a long time to re-open closed operations and pursue new ones, so the effect will be delayed, but it is certain to happen. And once those things are put into motion, they won’t easily be stopped. In fact, the reliable history of oil production is a pattern of swinging from producing way too little to producing way too much. As producers swing all the way to “way too much”, that will actually put downward pressure on prices.

The distribution of oil will be revolutionized. Nobody will want to be constrained by a single chokepoint like the Hormuz Strait ever again. Pipelines will be built. New overland routes will be created. Oil that has to pass through choke points may eventually be priced lower than oil that has no constraints, since everyone will be well aware of the risks. If that happens, oil producers will be incentivized to focus on sources that don’t have that penalty, pulling investment away from the risky locations.

Alternative energy is going to look like an increasingly good investment. The higher oil prices are, the more you can profitably spend on the production of oil alternatives. Wind turbines, solar panels, and uranium aren’t shipped in oil tankers that must traverse the Hormuz Strait. Hundreds or thousands of solar panels and wind turbines create a distributed infrastructure far less subject to terrorism than a few huge power plants. Potential new technologies like geothermal power will be worth exploring. Alternative energy investments of all kinds are bound to take on a new life.

We are re-learning old lessons about supply and demand. We had a taste of this in the pandemic. The pandemic was temporary, and we returned to normal life afterwards. In this case, it’s harder to ignore and I’m not sure we’ll go back.

One thing that predictably happens when prices are high is that there is demand destruction. People don’t just pay the price, no matter how high. They start to change their behavior. They do temporary things to use less, like take fewer trips. If high prices persist, they do permanent things to use less, like switching to an electric car. Once they make permanent changes, it won’t be easy to go back.

We’ve talked about how high prices might get. I’ve heard less discussion about what happens if there is not enough supply, at any price. If there’s not enough oil for everyone, who gets it? Does it go to anyone willing to pay any price? That would certainly drive the price up. But that can’t be the result. There are some users that must have priority. Will that priority mean government users get oil? What about hospitals? If there’s not enough for everyone, some will have to do without.

We had rationing in WWII. There are very few people still alive who lived through that, but we may have to learn how to manage shortages. Just as we learned in the pandemic that just-in-time manufacturing might not work when supply chains are threatened, we may have to learn how to prioritize energy and critical materials with rationing.

I discussed in my last post the various types of power that supply the electric grid. If we have a shortage of any of those power sources, we might have to ration electricity use. And any shortage will affect the cost of electricity. It’s impossible to know if electricity will become a scarce resource, but it certainly has become a possibility.

Data centers are huge users of electricity. If we have to ration electricity, data centers running AI may have to take a back seat to keeping hospitals online. Bloomberg News reported earlier this month that “Almost half of the US data centers planned for this year are expected to be delayed or canceled.” That’s just due to shortages of electrical equipment, let alone what would happen if they had constraints on electricity usage. Limits like this on data centers could have important ramifications for the future of AI.

The die is cast. The system we have now will have to be restructured. The short term is impossible to know, but the long term is bound to go in new directions.

Photo by Timothy Dykes on Unsplash

I just listened to a fascinating podcast with Meredith Angwin, Grant Williams, and Michael Kao. Angwin discussed how the grid works, and understanding that has given me lots of food for thought.

So flip a switch and everything just works, right? It’s much more complicated than that. Electricity is generated from a number of power sources, then it is transmitted from where it’s generated to where it will be used. Getting electricity from its source, to the utility, to the consumer requires a network of transmission lines that traverse hundreds of miles of land that belongs to other people (they might not want those lines on their land). Demand for electricity isn’t stable, it fluctuates depending on the weather, the time of day, and many other factors. Somebody has to predict electric demand, then call up the resources that are needed. And swiftly act when demand surges beyond expectations. The whole production is quite a dance.

Electricity Power Sources

It’s interesting just to look at the major sources of electric power and some of the unique characteristics of each of them. Here are the top energy sources, with percentages of usage provided by the U.S. Energy Information Association. All of them have advantages and disadvantages that impact the grid.

Natural Gas (43%)

Natural gas plants are the biggest source of electricity in the U.S. Gas plants can provide what is called “base power”, a steady, reliable source of power that isn’t dependent on external factors like whether the sun is shining or the wind is blowing. They also are “dispatchable”, meaning it is relatively easy to turn them on and off to respond to changes in demand.

Gas plants can also provide “intermediate” capacity, meaning they have the ability to ramp up at pre-scheduled times of the day, like early evening hours when demand is always high. But they excel at providing “peaker” capacity, which means they have the ability to ramp up quickly on demand for unexpected surges in electric demand. Gas is the most expensive of the fuels, so it is not ideal for base or intermediate load, but it is ideal for peaker capacity, and gas is really the only fuel that currently can provide peaker capacity.

In addition to being an expensive fossil fuel, gas has another weakness as a power source. Gas plants are supplied via pipelines. They store little or no gas on site. That makes them vulnerable to anything that interrupts the flow of natural gas. If there is a big demand for natural gas, like during a cold snap, gas lines to homes are prioritized over gas lines to power plants. That means gas plants may be unable to run at capacity at those times. And they will be affected in real time if there are any shortages of natural gas.

Nuclear (19%)

Nuclear plants provide about 19% of all electricity in the United States. Nuclear plants are a natural source of base power. Nuclear plants store their fuel on site, so they aren’t dependent on just-in-time delivery of fuel, making them less vulnerable to supply chain disruptions. They are very self-sufficient. On the other hand, it is not easy to turn nuclear plants on and off. They work most efficiently if they are turned on and left on, or turned off and left off. Of course, the biggest downside of nuclear power is the radioactivity of the fuel, and the problems of safely disposing of nuclear waste. There are lots of rules and safeguards in place to address the safety issues, but they are still a concern to most people.

Many nuclear plants exist in the U.S., but most were built a long time ago, and some of them have been de-commissioned. It would take years to get new ones built today, or even to re-commission decommissioned plants. There are promising new developments in small nuclear reactors that use less radioactive fuel, and in the ability to re-use nuclear fuel to reduce waste, but again, it will probably take years to get those innovations into widespread use.

Coal (16%)

Coal fired plants are being phased out in many places, but still provide about 16% of the electricity in the U.S. Coal used to be very dirty, although modern coal plants are much cleaner than they used to be. Coal is not the future for the electric grid, but it does comprise a significant part of the grid we have today. Coal plants provide base power that can be available regardless of weather. Coal plants also typically store fuel on site, providing some protection against supply chain disruptions. Coal is more “dispatchable” than nuclear, coal plants can be turned on and off to respond to demand. Coal plants are less flexible than gas plants. They are appropriate for providing “intermediate” capacity, but less useful for “peaker” capacity.

Wind and Solar (14%)

Wind and solar currently provide about 14% of the power in the U.S. They are green and renewable sources of energy. But they are not dispatchable. If the sun is not shining or the wind is not blowing, there is no power. They can be turned off on demand but cannot be turned on on demand. There is one other big problem with wind and solar. Compared to other power sources they are very distributed. There are not a few big plants with a few sets of transmission lines, there are hundreds of locations. Even if they are organized into farms, the volume of connections is much larger than traditional power plants. So they require a bigger investment of time and money in transmission lines. And it is more challenging to manage that many sources when matching power to demand.

There is a potential to offset the dispatchability problem by using batteries to store electricity from wind and solar. Electricity stored in a battery would become dispatchable, and batteries could potentially provide base load, intermediate, or peaker capacity. But that requires grid scale battery arrays that don’t currently exist. Battery production on this scale would require huge amounts of critical metals that are in short supply, including copper and rare earths. Those metals have to be mined and then processed. Both mining and processing of those metals is dirty. At the moment, almost all such metal processing is done in China, which is not a reliable partner for America’s grid. Once the metals are processed, they have to be manufactured into batteries, another dirty business that is mostly done in China right now. Even if we ramp up manufacturing batteries in the U.S. there are problems. Angwin notes that she would not want to live by a battery factory, that she knows of one that has caught on fire repeatedly. There are lots of hurdles before batteries will be a significant part of the energy solution in the United States.

Since we don’t yet have batteries at grid scale, wind and solar power has to be offset with predictable, dispatchable, sources of power, like natural gas, to handle surges and periods when there is no sun or wind. Wind and solar cannot yet supplant all other sources of power.

Hydropower (6%)

Hydropower provides about 6% of the electricity in the U.S. Hydropower is a nearly perfect source of power for the grid. It’s green, clean, renewable, and dispatchable. It can provide base load or intermediate load. But there are only a few locations that are suitable for building giant hydroelectric dams, and most of them were built years ago. Building a new dam today would probably be quite an endeavor, A new dam would flood hundreds of acres of land. The approval process would be torturous and take years, not to mention the time it would take to build and bring online.

Geothermal (.4%)

Geothermal power is created by using the heat in the middle of the earth to turn water to steam, then turn that steam into electricity. The earth is a giant natural, but safe, nuclear reactor. This is a solution that could have everything going for it. It’s fossil-free, green, clean, and a geothermally-powered steam turbine would be dispatchable and suitable for base, intermediate, or peaker capacity. Currently geothermal is a tiny fraction of the total because it’s only been possible in a few places where the hot magma at the center of the earth is very close to the surface. But there are some very interesting new developments that might make it possible to produce geothermal power anywhere by digging as deep as necessary in any location. For more information on geothermal power, I highly recommend a MacroVoices podcast with Robert Friedland. This is another solution that won’t help in the immediate future, but will be fascinating to watch.

Where Next?

As you can see, every one of these power sources presents big challenges that will take years to resolve. I have to confess that the one that excites me the most is geothermal. I certainly hope that plays out!

Regardless, I have a new respect for the electric grid. And, maybe, I won’t just take it for granted that I can turn the lights on any time I want to.

Everyone will be touched by these tariffs in some way, and all of us have to plan how to adapt to them. One of the biggest questions is what will tariffs do to the economy? They might cause inflation or recession or stagflation or set the economy on fire. Those are wildly different results, and depending which is coming I have to plan for the future in wildly different ways.

The first question is, who is paying the tariffs? One thing I know for sure is that other countries are NOT paying the tariffs. The checks for tariffs being deposited into the US Treasury are signed by whoever imports goods into the United States, generally either US companies or US individuals. Companies in other countries may be losing business due to the tariffs, and perhaps in some cases they are reducing prices they charge their US customers, but they are definitely not writing checks to the US government. And it’s even more certain that tariff checks are not written by the Chinese government or other countries.

Given that, it seems logical that the price of the goods that are imported will have to be increased to offset the tariffs. And that increase logically might lead to inflation. But, so far at least, we haven’t seen rampant inflation. But it’s way too early to conclude that tariffs won’t result in consumer price increases.

We have some evidence that consumer prices haven’t gone up much, based on the latest (July 2025) Consumer Price Index (CPI) results. That report measures prices for a basket of consumer goods. The CPI is divided into several categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. Each of those categories might be differently impacted by tariffs. Housing is a big component of the CPI, but it is calculated by looking at rents. Tariffs might increase the cost of building materials and supplies, but that won’t translate into higher rents immediately. Higher building costs will slowly impact the cost of new rentals, and only eventually bleed into the average cost of rent. Other things would be more immediately impacted, like the cost of imported food. Another thing thing that impacts the calculation of the CPI is an assumption about “substitutions”. If the cost of bananas goes up, the CPI assumes people will eat fewer bananas and switch to other foods. So the increased cost of bananas will never really be reflected in the index.

There is a different report called the Producer Price Index (PPI). That measures what is happening with the prices that manufacturers receive. You might think that would be the same as the CPI. Surely manufacturers receive what consumers pay. But the price that manufacturers receive is usually a wholesale price, not the final retail price. Goods may pass through several hands before they get to consumers. The July 2025 CPI report shows inflation at 2.7% while the July 2025 PPI report shows inflation at 3.3%. That may sound like a small difference, but it’s an indication that manufacturers are increasing prices but those increases aren’t being passed on to consumers. Yet.

Many experts agree that the difference in those reports is a strong indicator that companies have been eating the price increases. That is backed up by a stream of company financial reports showing that their earnings are under pressure. Most experts assume that many companies will be unable to continue to eat the increases, and that they will be forced to pass them on in the near future.

The CPI and PPI reports are only just beginning to reflect the higher costs of tariffs. Keep in mind that we just saw additional huge tariff increases in August 2025. And a another new tariff cost just hit yesterday, August 29, 2025, with the elimination of the “de minimis” tariff exception. Up until now, shipments under $800 were exempt from tariffs, but they no longer will be. This one will hit consumers and small businesses especially hard. There are estimates that there are 1.3 billion de minimis shipments every year, and that the new de minimis tariffs might amount to over $70 billion.

Putting that all together there is really no way to argue that prices won’t go up. So how is it possible that inflation might not go up? I have been reading up on various arguments about why that might actually be true.

The first argument that tariffs won’t affect inflation is that tariffs are “just” a one time price change. Inflation is measured as the percentage change of this year’s price to last year’s price. The year they go into effect there will be a big increase, the next year there will be no percentage increase. (altho the price will stay higher) This argument was mostly made at the time of Trump’s initial April 9, 2025 tariff announcement when it looked like tariffs would be a one-time event. It’s clear now that there won’t be one big price adjustment, and instead will be a constant stream of changes. If tariffs get locked in at some point and quit changing, the inflation rate will afterward be unchanged. This is an example of the confusion between prices and inflation. Prices will go up, but the inflation rate may not. I have to agree that if tariffs are set and left unchanged they will not technically affect the inflation rate. That doesn’t mean they won’t be felt or have an impact.

Another argument I have heard is that prices will go up, but people will quit buying imported goods and switch to other things. That assumes that there are other things to switch to that are less expensive that the imported goods. If everything that is tariffed has an alternative, the US-made alternatives will be bought. But they are probably already more expensive than the the imported goods we used to buy. And tariffs will allow US producers to increase their prices to just below the price of the import plus its tariff. So even if everyone switches to alternatives they will be spending more than they were before, and that will show up as inflation. As with the previous argument, you might say that there will be a one-time price increase when people make the switch, and thereafter there will be no inflation. But prices will be higher, and that will have an impact.

A third argument about why tariffs won’t cause inflation is that prices will go up and people will just have to pay higher prices. Then they’ll quit buying other things because they won’t be able to. That will take other prices down, offsetting the higher prices of tariffed items. This argument is a doozy. It certainly could happen, but calling this an economic success is a real stretch.

A fourth argument about why there won’t be inflation is the most depressing, but probably fairly likely. That argument is that prices will go up and people will just have to pay them, then they’ll quit buying other things and the economy will go into a recession from all the pressure. So there won’t be inflation because we will be in recession.

I spent some time studying “A User’s Guide to Restructuring the Global Trading System”, the paper by Steven Miran where he sets out his proposal for using tariffs to bring production back to the US. That paper forms a basis for much of Trump’s tariff policies. Miran says that tariffs have minimal inflation impacts and will ultimately be borne by the tariffed country because their purchasing power and wealth will decline. Miran recommended adding tariffs gradually, not all at once, which is not at all what happened. His argument for why tariffs won’t impact inflation is that the dollar will become stronger, and that will offset inflation. But what actually has happened so far is that the dollar has become much weaker. So the path to avoiding inflation Miran laid out is not at all the path we have gone down. Based on that paper, we might be headed for inflation after all.

Finally there are Trump’s statements. Forget inflation, he clearly believes tariffs will lead to a booming economy. That scenario assumes that production of everything will return to the US. We will build everything here and buy almost everything from American companies, and Americans will all have great jobs producing all the things that they buy. Even he knows that couldn’t happen instantly, so he has admitted there might be a “little pain” between here and there.

Building a manufacturing plant is a big project, and it takes years to make plans, purchase property, build and/or rehab it, and then finally start production. The plants that get built will be highly automated, so they won’t employ as many people as the old car plants in Detroit in the Fifties and Sixties employed. And whatever employment there is will not be until several years in the future. What happens in the meantime? People will have to pay higher prices until US alternatives are available, and that sounds like inflation. And the eventual US alternatives will be built in expensive new plants and probably not be cheap either.

So there are arguments to be made that tariffs won’t cause inflation, but nearly every argument acknowledges that tariffs will increase prices.

We just had an interesting development in the tariff story. Yesterday, August 29, 2025, a federal appeals court ruled that Trump can’t use emergency powers to unilaterally enact tariffs. He will certainly appeal that to the Supreme Court, so nothing will change until then. If the Supreme Court agrees, that will be a game changer. Unwinding the tariffs could be just as disruptive to the economy as the tariffs have been. But unwinding tariffs will definitely not be inflationary. Hopefully the case will get to the Supreme Court quickly. The current uncertainty is not good for the economy.

Photo by Pat Whelen on Unsplash

Child Care has always been a problem, and we don’t talk about it enough. Without good, affordable, child care, many families can’t earn enough money to support themselves. That’s an especially big issue for single parent families, but just as impactful in many two-parent families where neither parent earns enough for one parent to stay at home caring for the children. The whole world is facing a demographic cliff as fewer and fewer young people will have to support more and more older people. We need more young people to restore demographic balance, and we need those young people to be able to raise their own children. Making child care work is in everyone’s best interest.

Another crisis is Elder Care. A huge percentage of the country is getting old enough that they need some level of assistance, if not total, round-the-clock, care. We really have no system for that care. We rely on a duct-taped combination of long term care insurance and Medicaid, but mostly hope that family members will be around to do the bulk of the work for free. Those family members might be working age adults or parents, and their ability to provide elder care comes with an impact on their ability to continue to work and provide for their own families and needs.

I started to allude to the Health Care Crisis in my previous post. Health care in the United States is expensive, and our health insurance system has gigantic holes in it. Just one procedure like a knee replacement can cost up to $100,000, and someone with cancer or another serious disease could accumulate $1 million or even more in expenses. Nobody can pay those costs without insurance, and our health insurance system isn’t really up to the task. Making it even worse, our current system expects health insurance to be provided by employers, but sick people may not be able to work. Our system kind of works for people who are mostly well but is bound to fail just when it’s most needed.

None of these have easy, obvious, solutions. Every “obvious” solution brings it’s own set of alternative problems. I’m not in a position to fix any of these, but maybe I can help enlighten a few people, and maybe some good can come of that. Real solutions start with understanding where we are and why we got here.

Getting really sick could result in bills that are too expensive for one person to afford, but most people are well most of the time. The easiest way to protect patients from unexpected medical bills is to collect a small fee from everyone (all those mostly healthy people), and from time to time pay the expenses of a few people who get sick. As long as most people stay well, and the cost of the care that the few people need is not too onerous, it works.

Note that “health insurance” just means any third party that collects premiums from the many and pays out the expenses of the few. That can be the government or it can be a non-profit entity or it can be a for-profit entity. In some countries the government provides health insurance to everyone. In the US the government provides insurance to seniors (thru Medicare) and the poor (thru Medicaid). Everyone else has to get their insurance elsewhere. About 60% of health insurance in the US is provided by employer plans.

The earliest non-government insurers in the US were Blue Cross and Blue Shield, initially two separate agencies that later merged into one. In some ways, they proved that a health insurance system could work. Later lots of other insurance companies emerged, including both non-profit and for-profit entities.

One important premise of insurance is that for it to work, most people must have expenses that are less than the amount that they pay in. That excess is what will be used to pay the expenses of the people who get really sick. That means most people who get insurance should not “need” it. This is the reason why insurance systems have mandates that require people who don’t need it to participate. It’s pretty easy to understand if you think about it. If people don’t need to buy insurance until they need it, they won’t. Then instead of a big pool of mostly well people, the insurer will have a big pool of mostly sick people. Mathematically, that won’t work out. The government might decide to accept the losses that go with a system like that, but no one else could do it. Even non-profit entities will go out of business if only sick people sign up for their programs. This problem is called “adverse selection”.

How do insurers make sure they have a pool of healthy people? In the United States, one way they do it is by providing insurance mostly through employers. Tying health insurance to employment is one of the goofiest aspects of the US healthcare system. But it also solves the adverse selection problem. Anyone who is working could be assumed to be generally healthy. So a pool of employees is actually a perfect target for an insurance company plan. It’s a big group of mostly healthy people.

Conversely, an individual who tries to buy an individual health insurance plan is riskier, therefore hard to price. Insurance companies generally require “medical underwriting” for individual insurance plans, which means they want to know the medical history of the applicant. If the applicant looks like they might be expensive, the insurer will either deny the application or try to price the insurance very aggressively to protect themselves.

A government insurer can solve the adverse selection issue by requiring participation from everyone in the country, sick or well. Medicare and Medicaid aren’t mandated, but they have rules about when and how you can participate and you can be denied later if you don’t follow the rules. That discourages people from waiting until they are sick to enroll in the government plans.

One big controversy around Obamacare was that it originally included a mandate that everyone had to participate. They didn’t want only sick people signing up, they wanted a big pool of well people to sign up too. Political pushback finally killed the mandate and many of Obamacare’s other problems were inevitable without the mandate. Insurers had to charge more because they didn’t know if there would be enough well people in the pool.

The history of why employers provide healthcare insurance in the US is interesting. The practice emerged after World War II. Inflation was a problem and the government was trying to control inflation wage caps. Employers couldn’t raise wages but needed to do something to entice the workers they needed. They responded by adding health insurance as a new benefit. At the time, health insurance was very inexpensive. It was a cheap benefit that didn’t violate the wage caps. If health insurance cost then what it costs now, I’m not sure employers would have ever jumped into the fray! But of course, they didn’t know where it was headed. Later employer coverage was required by union contracts, and then the federal government threw in tax advantages to encourage employers to offer plans. For lots of reasons, it would be really complicated to eliminate that now.

Insurers need to have a balanced pool of well and unwell participants. They also need to be able to predict the costs. Predicable costs are essential to deciding how to price the insurance. The costs of healthcare have been surging, for lots of reasons. There are expensive new drugs and expensive new treatments, along with big increases in traditional medical costs. As new expensive treatment options emerge, they generate discussions about who is “entitled” to those treatments.

One interesting podcast describes the challenges employers face when they have multiple “Million Dollar Patients” in their health care plans. As they note, it used to be rare to see a million dollar healthcare bill, now it is common to have multiple million dollar claims. As healthcare costs increase, that changes the mathematics for whoever (government or private party) is providing insurance.

Federal or state governments dictate what must be covered by private plans. If the government mandates specific coverages, insurers have to adjust their calculations, and that ultimately will affect the premiums that they charge as well.

Ironically, one reason that healthcare provider costs have increased may be because of healthcare insurance itself. Insurance plans originally paid whatever the “cost” was, which encouraged providers to mark costs up. Then insurers tried to find other ways to control costs. This has resulted in a very gamified system where providers try to find creative ways to get insurers to pay more, while insurers try to find creative ways not to pay.

Finally, the insurance system adds a new cost to the doctor/patient equation, the administrative cost of the insurance program itself. And, in at least the case of for-profit insurance companies, some profit has to be carved out too. Even a government-run insurance program has administrative overhead that has to be covered. All of this increases the cost of the insurance.

So where do we go from here? We can’t eliminate insurance and go back to everyone choosing to pay their own costs or do without care. We can’t ask everyone to quit being sick for a year (or two, or ten) while we build a new system from scratch. I don’t know what the solution is, but I do know that the starting point is to understand what we have, and how it works now.

I have a good friend who helps run a clothing pantry. There are different models for clothing pantries, some sell things and use the funds for good causes, others give clothes away to people who need them. Her pantry is the second one. Their clients are a combination of homeless people and people who have places to live but are living on the edge, just getting by.

They have several tasks, generally. They have a system to accept donations. They have volunteers who process the donations and get them ready to give away, and they run a weekly “shopping day” where clients can come and shop through whatever is available that week.

They are staffed by volunteers. I don’t know if they have any paid staff at all. So everything that has to be done involves getting enough volunteers set up to do it. They can’t spend unlimited hours getting things done, they are constrained by the number of people who are available to help. So they have to set up rules that make the whole thing manageable. They have certain hours when they accept donations. They have a list of the specific donations they are equipped to handle. And they have rules about when and how clients can select and take their clothes.

Listening to the things that she has to do each week, I have come up with a list of things that would get more mileage out of the work their charity does.

Donate When and Where They Ask

Theirs, and every other charity that I am familiar with, has a web site that describes how you can make donations. In their case, they are set up to accept donations one day a week. That’s the day when they have volunteers to set out bins, pull them in when they are full, and answer questions from people dropping things off. The rest of the week there is nobody there. One big headache they deal with is people that drop bags of stuff there other times of the week. The bags get wet and ruined and block traffic, since nobody is watching for them. Processing those donations actually takes more work later than donations made on the specified dates.

Donate What They Ask

As noted above, they have a clear list of the types of things they are equipped to handle. They are not set up to handle anything else. Many times when people want to get rid of a bunch of stuff, they throw in a lot of unrelated items. This charity can’t or won’t put those items out for shopping, so they have to get rid of them. My friend generally ends up loading up her personal car with items they can’t use and then drives around town dropping them off at more appropriate places. In some cases, she ends up discarding them because there aren’t any appropriate places for those items. Some items are liability issues (many places can’t accept used car seats or mattresses for instance), sometimes they just aren’t things their clients can use. Leaving things a charity can’t use is just giving the charity another job to get done with what is probably already an inadequate staff. If you can’t tell what they take from a web site, call them and ask ahead of time!

Donate Only Clean and Usable Items

Apparently it’s quite common to get a bags of dirty, stained, smelly, torn items. As noted above, many of their clients are homeless, and have no way of washing things, or live in apartments without in-unit washing machines. The charity itself does not have washing machines. Who is going to clean this stuff? Those items can’t be put out, nor can torn or broken items. The charity has to pick through the donations, separating good items from bad ones. The dirty ones will probably just end up in the trash because they can’t do anything with them. If things are in good shape but dirty, take the extra step of washing it before donating them. If they are torn or broken, don’t donate them. I confess I’ve donated some questionable items in the past, thinking maybe they can find a way to use them. I didn’t do anyone any favors.

Donate in Season

This is a funny one that I wouldn’t have realized before. If it is summer, donate things that can be worn in the summer. Don’t give a charity a bunch of winter coats then! They have limited storage space. They can’t give out winter items and they don’t have room to store them. They will have to get rid of them. If you like to clean things out at the end of a season, switch that around and do your cleaning at the beginning of the season!

Charity Begins With You

Giving away stuff you don’t need is a great idea. But with a little extra thought and work you can make that donation mean a lot more! It is a little more work to do these things, just think of that as part of the donation!

One big item in the proposed Big Beautiful Bill (BBB) is to close a loophole that props up Medicaid payments to hospitals and nursing homes using “Provider Taxes”. The subject sounds really dull and unexciting, who could care about this? But it would have a huge impact and it really matters.

I have been involved in the long term care industry for years. I spent almost 10 years as the CFO of a nursing home chain, was a member of the national eldercare task force of the AICPA, and published an eldercare web site from 1995 until 2017. Because of my background, I hope I can simplify the subject of provider taxes and the potential impact of changing them.

First, some background. Medicaid is a national program that is jointly funded by the federal and state governments. Some of it is paid for by the federal government and some by the state government. Medicaid was created to focus on medical costs for people who can’t otherwise pay for them (“medical” is the origin of “Medi” in the word “Medicaid”, it is aid for medical expenses).

People who go to a hospital might have insurance (through their employer or otherwise), and if so, their costs are paid by insurance. If patients don’t have insurance they either have to pay hospital expenses out of their pockets or they have them covered by some government program. The primary government programs would be Medicare (for the 65+ and disabled population) and Medicaid.

People who go to a nursing home are mostly covered by Medicaid. You might guess nursing home bills would be paid for by Medicare, the program of health insurance for people who are age 65 and older, but Medicare only covers some limited, short term, post-hospital nursing home stays. Hospital insurance is commonly provided through an employer, but long term care insurance is sold to individuals and is much less common. And very few people have enough money to pay expensive nursing home bills out of their own funds. So the vast majority of nursing home bills are only covered by Medicaid. If grandma is in a nursing home, her stay is probably being paid for by Medicaid, no matter where or how she lived when she was young and healthy.

As medical costs have skyrocketed, Medicaid has paid for a larger and larger proportion of hospital costs, and the vast majority of nursing home costs.

Medicaid is funded partly by the federal government and partly by the state. It is set up as a matching program. The state determines what rate they will pay and the federal government matches it. It’s more complicated than that, the federal government does not match dollar for dollar, they pay more in some states and less in others. But what’s important is to understand that the rate is set by the state and matched by the federal government. If the state increases their rate, the federal government will increase the match.

Medicaid is a big and expensive program. Almost every state has grappled with figuring out ways to keep their costs under control. Many years ago states found a way to stretch their budgets by getting the federal government to pay more of the Medicaid bill. What they did is start charging a tax to hospitals and nursing homes, something they called a “Provider Tax”. Then they turned around and used the proceeds from the tax to increase the Medicaid rate they paid to the providers. On its face, the tax is a wash. The provider pays a new tax, but then they get a higher Medicaid rate of the same amount, leaving them whole. But because of the federal match, states can do better than that. If the state increases the provider’s rate by $100 a day, the federal government will also pay more. Depending on the percent of the match, the system might provide $100 a day of additional funding. Some of that extra $100 might go to the provider but some of it could be used by the state to pay for other things.

Doing this is not illegal, it is a loophole. But it was certainly an unintended outcome for the federal government. And its use has spread. Almost every state uses provider taxes to prop up their Medicaid payments.

There have been discussions for years about closing this loophole. The problem is that closing it will reduce the Medicaid rate paid to providers, and many of them could not stay in business if that happened, they just don’t have any way to offset the lost revenue. If hospitals and nursing homes suddenly lost funding, they might have to close, and that is a huge problem.

Remember that most nursing home patients are on Medicaid and a very significant percentage of rural hospital patients are as well. So one big problem in particular is the potential impact on rural hospitals and nursing homes. There is a realistic chance that rural areas could suddenly lose their healthcare services. There are similar risks for hospitals and nursing homes that serve poor inner city populations.

Both versions of the current bill propose putting limitations on the provider tax. One version proposes a freeze on the current provider taxes and one proposes immediately cutting the current taxes.

If the tax is cut, each state will have to make a decision how to react. They might decide to just continue to pay the current Medicaid rates and fund the difference with other budget cuts or tax increases. But every state’s Medicaid budget is huge and it wouldn’t be easy to find that many additional funds in any state. The BBB assumes that states will respond by cutting their Medicaid rates, which will then cut the federal match. (And if states don’t do that the assumed savings in the BBB won’t come to pass.) So we can assume Medicaid rates will be reduced. When will they be cut? It depends on the state, but probably rates will be cut as soon as administratively and legally possible.

As soon as the bill is passed, every provider in every state will have to start figuring out what that will mean to them. They will have to guess how much their rates will be cut. They will have to project how much of a shortfall they will have. And they will have to start scrambling to figure out how they will survive. I would guess the uncertainty alone will put some places out of business, and I would expect to start to hear announcements of closings pretty quickly. There might be some bargain basement M&A sweeping up of hospitals and nursing homes at risk of closing. That will be disruptive as well, not least because there are plenty of examples of poor care in places that undergo changes of ownership. The whole industry will be turned upside down.

To be clear, I never liked the provider tax shell game and would love to see it closed down. But the only way to do that is slowly and carefully over time. It took decades to get into this mess, we won’t get out cleanly in the current fiscal year. That will not provide the immediate savings to the federal government that the BBB wants to count on, but it’s the only responsible way to do it.

Resources

If you want to do any reading on the subject, here are a couple of good articles:

• G.O.P. Targets a Medicaid Loophole Used by 49 States to Grab Federal Money, New York Times

• What’s the Impact of Eliminating Medicaid Provider Taxes?, Hilltop Institute, UMBC

There are lots of ways to think about saving money for the future, and one way to differentiate methods is to separate the idea of “investing” from “trading”. Trading is when you make bets on things you think will happen very soon. You get in and then you get out. You can make lots of money quickly and you can lose it overnight. Investing is buying and mostly holding, but sometimes selling. You are worried about where things are going over a long term and hoping to make good decisions over time. Traders have to watch the market continuously, they have to anticipate every move. Investors can, and probably should, ignore every day noise and focus on finding and holding good companies that will survive and thrive over time. Traders can make money on bad companies if they time it right. Investors will not make money on bad companies, they need to find good ones.

I am an investor, not a trader. I have fallen prey to the lure of some hot stocks in the past, and sometimes I even made money on them. But I made money by getting out of the trade, not by holding it. It’s a lot of work to figure out when to get in and when to get out, and I got it wrong as often as I got it right. I’m done with that. Now I invest.

But buying and holding has some interesting complications as well. What stocks are good enough to buy and hold? A relatively common way to make a choice is to just buy an index. One huge advantage of this is that you don’t have to become a stock market expert. The indexes are pre-selected collections of companies. The Dow Jones Industrial Index are the “top” 30 industrial companies. The S&P 500 are the “top” 500 stocks across all industries. If you buy a fund or an ETF, your returns are reduced by expense fees charged by the companies that run them. Those fees can be high or low. Fees for index funds should be very low because there are no decisions to make. All they do is hold the stocks that are in the index. So the low fees of an index fund are another benefit.

I was thinking about how well buying the index might work in the future, and did some research into what has happened to the companies in the Dow Jones Industrial Index over time. I picked a starting point of September of 1929, right before the big stock market crash that preceeded the Great Depression. If there was ever a bad time to own stock, that would have been it. So what happened to the stocks in the Dow Jones?

Here’s the list of the original stocks:

• Allied Chemical & Dye Corporation

• American Can Company

• American Smelting & Refining Company

• American Sugar Refining Company

• American Telephone & Telegraph Company (AT&T)

• Bethlehem Steel Corporation

• Chrysler Corporation

• General Electric Company

• General Motors Corporation

• General Railway Signal Company

• Goodrich Company (B.F. Goodrich)

• International Harvester Company

• International Nickel Company

• Mack Trucks, Inc.

• Nash Motors Company

• North American Company

• Paramount Publix Corporation

• Postum Company

• Radio Corporation of America (RCA)

• Sears, Roebuck & Company

• Standard Oil Company of New Jersey

• Texas Company (later Texaco)

• Texas Gulf Sulphur Company

• Union Carbide Corporation

• United States Steel Corporation

• Victor Talking Machine Company

• Westinghouse Electric Corporation

• Woolworth Company (F.W. Woolworth)

• Wright Aeronautical Corporation

• Johns-Manville Corporation

There are a lot of companies there that I never heard of. I wondered if they all went out of business during the Great Depression. Surprisingly, they did not! Only General Railway Signal Company actually went out of business in the Great Depression. The other 29 survived! Considering how much of a bloodbath the Great Depression was, that is an impressive survival rate!

What did happen to these companies? It’s been nearly a hundred years so it’s not surprising that there have been massive changes since then. Quite a few of them did eventually go out of business, but mostly not until long after the Great Depression. Here‘s what Claude AI had to say about companies in the 1929 Dow Jones that eventually went bankrupt. Note that most of them didn’t go bankrupt until the year 2000 or later:

Multiple Bankruptcies:

• American Smelting & Refining Company (ASARCO) - Filed bankruptcy multiple times, including major reorganizations in 2005 and other instances

• Sears, Roebuck & Company - Filed for Chapter 11 bankruptcy in 2018

Single Major Bankruptcy:

• Bethlehem Steel Corporation - Filed for bankruptcy in 2001, liquidated assets

• General Motors Corporation - Filed for Chapter 11 bankruptcy in 2009 during the financial crisis, emerged as "new GM"

• Johns-Manville Corporation - Filed for bankruptcy in 1982 due to massive asbestos-related lawsuits, one of the largest product liability bankruptcies in U.S. history

Bankruptcy Through Corporate Evolution:

• Chrysler Corporation - The original entity went through bankruptcy as part of Chrysler LLC in 2009, though this was technically a successor company

• Nash Motors Company - While Nash itself didn't go bankrupt, it merged to form American Motors Corporation (AMC), which later filed for bankruptcy before being acquired by Chrysler

Uncertain/Complex Cases:

• International Harvester Company - Faced severe financial distress in the 1980s and restructured, though the specific bankruptcy status of the original entity versus its successors (Navistar) is complex

• Wright Aeronautical Corporation - Went through various mergers and restructurings, some involving financial distress

So what’s the take away? First, if you want to buy and hold, buying an index might be a good idea. Second, you can’t act like Rip Van Winkle and go to sleep for 30 years once you do that. You still have to pay attention!

Inflation is a measurement of the percentage increase in prices over a period of time. if prices went up 2% last year and another 2% this year, inflation last year was 2% and inflation this year is 2%. To professionals, Wall Street, that’s good news, inflation did not increase, it stayed the same. But on Main Street, prices are still going up every year. Wall Street is happy, but Main Street may not be. There is a disconnect in terminology.

The Wall Street argument about tariffs is that there might be a one-time “price shock” from tariffs, but they will have no long term affect on inflation. They are not saying that prices will go up and then return to normal, They are saying that prices will go up and then stay at that higher price as long as tariffs are in place. If tariffs go up more, there will be another, one time, price shock, and then prices will stay even higher afterward. If tariffs are reduced, or removed (we can only hope!), there would be a one-time price shock in the other direction.

The lived experience of Main Street will be less sanguine. Prices might go up pretty significantly with the imposition of tariffs, and prices will stay higher unless or until tariffs go down. Unless consumers have an equivalent upward “shock” in their wages, they are going to feel the effect of tariffs, and not just one time.

Another terminology disconnect is how Wall Street and Main Street think about the word “economy”. Is the economy doing well or badly? I listened to professionals talking about the economy before the election. It was fine, they didn’t know why voters seemed unhappy. They used inflation and employment statistics to explain how great the economy was, and assumed consumers were just getting bad information. If consumers had the right data, they would have known how great the economy was.

But on Main Street, the “economy” was less wonderful. Prices went way up after Covid and mostly stayed there. Some prices were even worse than others (egg prices up 60%). Even if the price of gasoline went down, you still had to pay for eggs and lots of other things that cost way more than they used to.

Employment statistics told professionals the economy was healthy, but on Main Street that might have meant working two jobs, or being stuck in the wrong job, or maybe working Uber or Door Dash was better than collecting unemployment.

To Wall Street, the economy is healthy if the data is good and if the big companies in the stock market are doing well. To Main Street, the economy is healthy if I have a good job and can pay my bills.

Back to tariffs. There is a debate about who will take the brunt of the cost of tariffs. It could be borne by the manufacturers in other countries, or by distributors, or by retailers. But it’s pretty likely that some, if not all, of that increased cost will end up as higher consumer prices. That may not cause lasting inflation, but it will hit Main Street hard. And if it does, it will also hit Main Street’s economy.

Most coffee used in the United States is imported. Hawaii produces less than one-tenth of one percent of the world’s coffee, and the rest of the United States is mostly unsuitable for growing coffee. One of the reasons for the new tariffs is to encourage production in the United States of the protected item, but with coffee, that isn’t possible.

The United States imports about $1B of coffee every year from many countries. And there are new tariffs on anything imported from them:

• Brazil: 10%

• Vietnam: 46%

• Colombia: 10%

• Indonesia: 32%

• Ethiopia: 10%

• Uganda: 10%

• India: 26%

• Honduras: 10%

• Peru: 10%

• Mexico: 25%

Coffee used to be duty-free, an exception to tariffs. So the tariffs are a brand new cost, and they are complicated because they vary depending on which country the coffee comes from.

Tariffs are paid by the “importer”. In the case of coffee, the importer is any business that imports the beans. That might be the owner of the local coffee shop. If the owner has been buying coffee from different countries, which many shops do, they will have to pay different tariffs based on the coffee’s source.

The importer is the one that writes the check for the tariffs, but the real question is who is going to bear the penalty of the new cost?

The cost might be borne by the exporter. The exporter could cut the price they sell beans for to offset some or all of the tariff. If they do that, prices would stay the same to the local coffee shop. But the exporter most likely would offset that lower price by reducing the price they pay to the farmers that grow the coffee. Coffee is often grown in very poor areas. In many cases coffee farmers already operate on very thin margins. In this example, the farmer would bear the cost.

The cost could be borne by the importer. The coffee shop owner could pay the new tariff and just eat that cost. They will make less money or try to make the shortage up somewhere else.

Or the coffee shop owner could decide they can’t afford to absorb the tariff cost and pass it on to their patrons as a higher price for a cup of coffee.

That’s a really simple example. Things are much more complicated than that. Coffee is a commodity. There is a world market for coffee, and a world price that can fluctuate wildly for lots of reasons other than tariffs. Arabica coffee prices surged by 13% in December, a 60% year-over-year increase, according to the World Bank. Coffee futures have been high since 2011 due to bad weather in Brazil and Colombia.

Tariffs could have unexpected impacts on world coffee prices. If American consumers have to pay more for coffee , and start buying less after tariffs trickle through the system, there would be less demand in the world market, which might push world prices down. Coffee producers could go out of business if prices go down, pushing prices back up.

It’s also more complicated for the coffee shop owner. The price may go up for the coffee, but other tariffs mean other prices may be going up too, the coffee bags, the roasting equipment, pretty much everything. Maybe the owner could absorb the coffee price increase but not all the other increases. The coffee shop owner might even go out of business.

We generally think of inflation as the cost that consumers pay. So will the tariffs cause inflation? It’s possible somebody else will absorb the cost, but it certainly looks likely that the end result of tariffs will be a higher price for a cup of coffee.

At the time of the McKinley Tariff, tariffs were the primary source of revenue for the federal government, and part of their justification was to raise money to pay the bills of the government. But in 1913 the states ratified the 16th Amendment which created a federal income tax, and the income tax became the primary source of revenue for the country. You can see from the following graph that from the time we created a federal income tax in 1913, until this year, 2025 (which is off the right side of this graph), tariffs have never been a significant source of U.S. federal revenue.

Source: Biden White House

How high did tariffs get? That sounds like a straight forward question but it is not. Not everything has a tariff on it, and the goods that have tariffs might have different tariff rates, so there’s no easy way to calculate the average tariff rate over the years. Wikipedia has a graph that shows two ways to calculate the impact of tariffs. One is to divide tariff revenue by the total value of goods that have tariffs on them (dutiable imports). The other is to divide tariff revenue by the total value of all imports (total imports). These two items look very different. The rate on dutiable imports is always higher, since it isn’t pulled down by rates on items that don’t have tariffs. But, no matter which way you calculate it, tariffs have been fairly insignificant since 1950.

Source: Wikipedia

The most recent, and the highest tariff rates we’ve seen, was the Smoot-Hawley Tariff of 1930. The Smoot-Hawley Tariff is often blamed for causing the Great Depression of the 1930’s, but it actually was not enacted until the Great Depression had already begun. It certainly could, and probably did, make matters worse though.

There are lots of places to go to learn about the Smoot-Hawley Tariff, but one of the best and most extensive I found was a book, Peddling Protectionism: Smoot-Hawley and the Great Depression, by Douglas Irwin, and I leaned on information from that book pretty heavily for this post.

The Smoot-Hawley Tariff was initially proposed in 1929 as a way to prop up agriculture. At that time, agriculture kept 25% of the country employed. This was a boom time for the economy in general, but the agriculture industry was in recession. The bottom had fallen out of prices of agricultural products and Congress wanted to do something. The initial idea was to add tariffs to imported agricultural products to encourage consumers to “Buy American”.

The argument was that a tariff would stimulate US producers to start shifting production, reducing exports and eliminating the need for imports. For things the US did not produce, like bananas, the idea was that high tariffs would make them so expensive that people would buy things we do produce, like apples, instead. President Hoover’s election platform was that lower tariffs would lead to more imports and lower wages, and he said he planned to make agriculture a focus of his administration by reversing that. He was elected in a landslide, indicating that the country was behind this plan.

However, nothing in Congress happens without everyone getting a piece of it. They called it “log rolling”. The tariff was supposed to be about agriculture, but more and more things kept getting added to the list of products subject to tariffs. Both houses of Congress held extensive hearings, and the hearings mostly consisted of a stream of business representatives who had new things to add to the tariff list.

The hearings in the House ran to over 10,000 pages of testimony, and hearings in the Senate ran to over 8,000 pages. Nobody argued against tariffs, everyone just wanted their own interests supported as well. By the time the bill got through the House and the Senate, over 3,000 items were on the tariff list, and tariffs to be exacted on those items were 50% and even higher.

There was little or no discussion about how these tariffs would impact exports, but other countries quickly responded with tariffs on US exports. Leaders in other countries who were friendly to the US lost their elections. Prices of imports went up. Agriculture and other industries who depended on exports for revenue saw that revenue drop.

It is debatable to what extent the Smoot-Hawley Tariff made the Great Depression worse, but between 1929 and 1932 total imports fell by 40%, and GDP dropped by 25%. And the tariffs certainly didn’t make anything better for agriculture, which was the original intent. In fact, it’s pretty clear that the agriculture industry was more hurt by higher prices on things they had to buy than any benefit they gained from any protection against agricultural imports.

Hoover, Smoot, and Hawley all lost their next election. It seems clear that public at least partially blamed them for the subsequent damage to the economy.

Ironically, one of the final outcomes of the Smoot-Hawley disaster was that everyone agreed that Congress could no longer be involved in the process of setting tariffs, and that in the future tariffs should be initiated by the President, who presumably would be less vulnerable to special interests.

President William McKinley called himself a “Tariff Man”. He actually was responsible for two major tariffs. Before he was president, he was a congressman, and as a congressman he sponsored Tariff Act of 1890, which later became called the McKinley Tariffs, under President Harrison. Then later, as President McKinley, he implemented the Dingley Tariffs.

Both were huge tariffs that averaged almost 50%. They were designed to protect US producers, punishing anyone who imported goods instead of producing them in the US.

1890 was a very different time, and a very different set of circumstances then today. At that time, there was no federal income tax, so tariffs were a primary source of revenue for the government. During the Civil War and after it, tariffs were the only source of federal revenue, and served as a way to pay for the war. By the time of the McKinley Tariffs, tariffs brought in about half the revenue of the government, with the remainder coming from excise taxes like liquor and tobacco taxes.

On the other hand, the government then had a faction of today’s expenses. There was no Medicare or Medicaid or Social Security. The US military wasn’t the policeman of the world back then. So tariffs represented a huge part of a vastly smaller budget.

Ironically, at the time of the McKinley Tariffs, the government was not looking for more revenue. Civil War debts were mostly paid off by 1890. In 1890 there was actually a huge budget surplus, the government had more money than they needed!

There was a big debate, called the Tariff Debate of 1888, about what to do about the budget surplus. The Democratic argument was that tariffs were too high and should be cut. The Republican argument was that if tariffs were too high, that showed they weren’t working. If they were working nobody would be paying tariffs, they would be buying products made in the US. The Republican solution was to raise tariffs until they got so high they fixed the problem, when they would disappear because nobody was buying imports.

Republicans won the debate, and the elections. They implemented the tariffs and they caused prices to go up on the protected items. There were winners and losers. In general, the winners were the owners, and to some extent, the workers, in protected industries. The losers were the people paying higher prices for things that had tariffs on them. At that time, a huge percentage of the country lived on farms, and farming was in a recession. Tariffs failed to fix the downward spiral of farm prices, but now the cost of many items farmers had to buy went up.

The next election showed that the popular consensus was that tariffs were a mistake. President Harrison, Congressman McKinley, and the rest of the Republican party lost resoundingly.

So why wasn’t that the end of tariffs? In 1893 was a huge depression, the Panic of 1893. Democrats were in charge at the time, and somebody had to be punished for the depression, so this time Democrats got thrown out. In 1896 McKinley ran for President and won on a platform of restoring prosperity to the country.

After his election, McKinley implemented a new set of tariffs, the Dingley Tariffs. If anything, the Dingley tariffs were higher than the McKinley tariffs. McKinley used the tariffs not only to raise revenue but also to extract concessions from other countries. Do you want to avoid tariffs? Make sure US exports are protected in your country!

The economic period following McKinley’s election was a pretty good period. This may not have anything to do with tariffs at all. The country was recovering from a huge depression, and it is probably a time where any policy would have done well. It’s impossible to say how much different it would have looked without tariffs.

One of the most interesting end notes to the McKinley story is that right at the end of his presidency it looks like he changed his mind about tariffs. He gave a speech at the Pan American Exposition where he said “We should sell everywhere we can, and buy wherever the buying will enlarge our sales and productions, and thereby make a greater demand for home labor.” We’ll never know where that might have led, because he was assassinated the next day.

There are several ways to measure inflation, but the one most people know best is the Consumer Price Index (CPI). The CPI is published by the Bureau of Labor Statistics (BLS), and is measured by a basket of common goods and services that is used for reference. Prices are measured each month, and the change in those prices is the thing that is reported in the news as “inflation”.

Some things are easy to measure, like the price of milk and eggs. Others are harder. One of the oddest items tracked in the CPI is the cost of health insurance.

Medical costs in general are complicated to track. They are paid for by a combination of consumers, employers, Medicare, Medicaid, insurance companies, and even by health care providers (who may have to eat the cost of care for uninsured patients.) For measuring inflation in health care costs, the BLS generally focuses on “out of pocket” costs to consumers. So far so good.

If you didn’t know anything about it, you might assume that the CPI would measure the change in health insurance premiums. As most people know, those premiums can be high and have gotten higher. But that is not how health insurance inflation is measured.

Health insurance has its own special section in the CPI documentation. Hold on to your hats. Inflation in health insurance is measured not by the changes in premiums but by changes in the earnings of the insurance companies! The health insurance CPI calculation was changed in October 2023. Before that the category actually measured health insurance premiums.

The justification is that eggs and milk are commodities. A gallon of milk is basically the same as any other gallon of milk, so one price of milk is the same as any other price of milk. But health insurance can cover all kinds of different things, and can cover them for people who have completely different risk profiles. Therefore, you can’t measure one premium against another, or the premium in month against a premium in another month. The BLS also wanted to take any increase in the cost of medical care out of the increase in premiums, since the cost of medical care is calculated separately. And in the United States there is another problem. A significant portion of health insurance premiums are paid by employers, and are not an out of pocket cost to the employees. and some companies pay an lot of that cost and others pay little, so looking at employee costs is not quite right either.

As soon as they changed the calculation they ran into a problem. Health insurance company profits were skewed by the aftermath of the pandemic. During the pandemic profits were high because elective procedures weren’t being done, and some of the cost of COVID care was being borne by the government. After things returned to normal, so did health insurance profits. Early reports showed health insurance costs going down because insurance company profits were down, when any consumer knew premiums were going up. So the BLS had to alter the calculation they use to “smooth” the results, making the calculation even more arcane.

Does this better measure health insurance inflation? It depends on who you are. If you are a consumer who thinks that increasing health insurance premiums are a source of inflation, maybe not.

Inflation has non-intuitive implications on debt. Debt involves payments that go into the future where inflation can have a compounded effect. 0n a payment schedule, it looks like future debt payments are indistinguishable from current payments. But in a world with inflation that is not true. One way to make the impact of inflation on debt more clear is to think about future debt payments in terms of what they can buy, like cups of coffee at the local coffee shop.

Let’s say a cup of coffee currently costs $4. If there is no inflation at all, a cup of coffee ten years from now would probably still cost $4. But say there is inflation, and the cost of a cup of coffee goes up the same amount as inflation does.

If inflation is 2% a year, next year that $4 cup of coffee will cost $4.08. In ten years it will cost $4.78. One month of coffee at the coffee shop will cost $120 this year and $145 in ten years at 2% inflation.

If inflation is 5% a year, coffee will cost $4.20 next year and in ten years it will cost $6.21. One month of coffee will cost $120 this year and $189 in ten years at 5% inflation.

If inflation is 10% a year, coffee will cost $4.40 next year and in ten years it will cost $9.43. A 10% inflation rate is very high. One month of coffee will cost $120 this year but $287, more than twice as much, in ten years at 10% inflation.

For the debt example, let’s say we have a loan with fixed payments over 10 years of $120/month. At today’s prices, the debt payment is exactly the same amount we’d pay for a cup of coffee every day. But inflation changes things.

If inflation is 2% a year, by tenth year of the loan the loan payment would no longer cost 30 cups of coffee a month. It would only cost 25 cups of coffee a month.

If inflation is 5% a year, by the tenth year of the loan the loan payment would only cost 19 cups of coffee a month.

If inflation is 10% a year, by the tenth year of the loan the loan payment would only cost 13 cups of coffee a month.

Inflation is beneficial to borrowers because future debt payments will cost them less in real terms. Our borrower doesn’t have to give up as much in the future to make the payments.

On the flip side, say that loan was borrowed from Aunt JoJo. As the lender, she will see the opposite impact from inflation. She will get receipts sufficient to buy coffee every day for 10 years in a world with no inflation. But at 2% inflation after 10 years she will only be able to buy 25 cups of coffee a month with her receipts. And at 5% inflation after 10 years she will only be able to buy 19 cups of coffee a month. And at 10% inflation after 10 years she will only be able to buy 13 cups of coffee a month with her receipts.

So inflation hurts lenders by making their future receipts less valuable.

There are lots of examples of borrowers who can benefit from the impact of inflation on debt: consumers who borrow money to buy a house or a car, companies who borrow money to operate their businesses, and federal and state governments who issue bonds to fund governmental obligations. In fact, inflation potentially helps fix governmental payment problems by deferring outlays to the future when they will cost less in real terms. You will sometimes hear people saying the government hopes to “inflate their debt away”.

Examples of lenders who can be hurt by inflation include banks and other traditional lenders, but also individuals who buy bonds in their retirement accounts, since buying a bond is making a loan. Those future bond receipts may not have the hoped for value to the bond holders if inflation is high.

The examples above consider only at the impact of inflation on debt, ignoring everything else. There are many other factors to consider, but it’s interesting and instructive to think about how inflation affects debt.

By the end of WWII, the United States was one of the few major developed countries that was undamaged by war. Other WWII participants had to repair years of significant war damage while getting their peacetime economies going again. The United States was in a position to lend other countries money to help them recover, and that made the US currency, the dollar, critical to most or all of the rest of the world.

In a 1944 meeting at Bretton Woods, New Hampshire, 44 countries agreed to guarantee that their currencies would be convertible to the US dollar, letting the dollar be the peg, or centerpiece, for a worldwide monetary system. The Bretton Woods participants still had fresh memories of the problems that happened after the end of WWI, when war reparations resulted in hyperinflation in Germany, which in turn ultimately led to the start of WWII. The Bretton Woods agreement was intended to create a stable, world-wide, post-war monetary system with a systematic plan for recovery and repair from the war.

The Bretton Woods agreement, and the massive amount of lending of US dollars to other countries to pay for their recoveries, led to the dispersion of the US dollar around the world. Other countries needed to acquire US dollars so they could repay their dollar-based loans, and that meant that they had to sell things for dollars and accumulate dollars in their central banks.

Over time, US dollars became a universal form of money, and many transactions outside the US were settled in US dollars without ever involving a US bank or anyone in the US. Economists use the term Eurodollar to describe this. Although it sounds like it applies to US dollars used in Europe, the term actually is used to describe any US dollars held outside the USA.

Another reason the dollar is so prevalent is explained by another economic term, the petrodollar. Since at least the 1970s, oil has been priced and settled in US dollars. Countries that produced a lot of oil, like the OPEC countries, accumulated huge stockpiles of US dollars they received in payment for their oil, and they then spent those dollars elsewhere. Countries that needed to buy oil had to accumulate US dollars so they could buy oil. SInce every country is either a buyer or a seller of oil, US dollars have been widely distributed around the world.

For anyone outside the US, everything priced in US dollars has two prices, the price in dollars, and the price in their local currency. To buy oil, countries in Europe have to convert their local currency to US dollars first, then purchase the oil in dollars. The number of dollars they get for their currency is constantly changing, depending on the exchange rate. Their cost of that purchase will be the cost in US dollars plus or minus their gain or loss on the conversion of their currency. For instance, it is possible that the dollar cost could be dropping but the exchange rate loss could be increasing, making the oil more expensive than it was previously in Europe while the price is less expensive than before in the US. US companies do business in lots of other countries, and the money they earn in those countries has to be converted to dollars, and that conversion could increase or reduce the value of those foreign sales. Exchange rates add a confusing wrinkle to the raw price in dollars.

When the dollar is expensive relative to other currencies, it is called a strong dollar. When the dollar strengthens, it means that each dollar can buy more units of foreign currencies. This makes imported goods cheaper for US consumers, since they can buy the same amount of imported products for fewer dollars. A stronger dollar makes US exported products more expensive for foreign buyers because the same product now costs more in their currency.

When the dollar is cheap compared to other currencies, it is called a weak dollar. A weaker dollar makes imports more expensive for US consumers since each dollar buys fewer units of foreign currencies, so the same amount of goods costs more in dollars. A weaker dollar makes US exports cheaper for foreign buyers because the same product now costs less in their currency,

The dollar typically becomes stronger when inflation is low and the US economy is in good shape. Higher US interest rates tend to strengthen the dollar since others want to invest here. The dollar tends to be weaker when inflation is high, the economy is sagging, or if there is any question about the country's ability to pay its debt, like when the national debt is high. All of the considerations of what makes the dollar strong or weak are relative to what's going on in other countries. If other countries are in worse shape, the dollar will be stronger. If other countries are doing better, the dollar will be weaker. Another thing that could potentially weaken the dollar would be if it was no longer as widely used around the world.

An interesting development in Argentina is a newly-elected President, Javier Milei, who intends to dollarize the country by make the dollar the official currency of Argentina. The Argentinian peso is extremely weak right now because Argentina has been experiencing hyper-inflation, which was 143% a year leading up to the election. The goal of dollarization would be to stabilize prices by tying them to the much more stable US dollar.

On the other hand, there are other world events that may weaken the dollar. Monetary sanctions were applied to Russia when Russia invaded Ukraine, the goal was to make it difficult or impossible for Russia to use US dollars. Some experts are now concerned that punishing Russia with monetary sanctions encourages more countries to reduce their dependence on the dollar. One unsurprising result of the sanctions is that Russia is working hard to de-dollarize. They are selling oil to China and other countries for Chinese yuan instead of dollars, and are working with several countries to develop an alternate global currency system called BRICS (based on the names of the countries that started the effort, Brazil, Russia, India, China, and South Africa).

It’s unlikely that anything will replace the dollar as the world reserve currency in the short term, it would take years for any other currency to supplant the importance of the dollar. But new currencies like BRICS and efforts to price oil in other currrencies could lead to big changes in the role of the US dollar in the long term.

The Federal Reserve was created after a national emergency, the Panic of 1907, a crisis that endangered the entire banking system. Multiple runs on banks caused banks to go out of business. Nobody wanted to loan money to anyone, and the interest rate on overnight loans between banks jumped to 100%, making it impossible for banks to raise cash and pay off depositors. The entire banking system was locked up and commercial activity was impossible. Prior to this time there was skepticism about centralized federal control over banks, but the Panic of 1907 made it clear that something had to be done to calm the markets and keep the banking system working.

Congress created the Federal Reserve system in 1913. The country was divided into 12 Federal Reserve districts, each with its own Federal Reserve bank. Those 12 banks, collectively, make up the Federal Reserve. The Federal Reserve banks are “bankers’ banks”. The Fed acts as the central bank for the federal government, and as the banks’ bank for commercial banks. Commercial banks can deposit funds with the Federal Reserve to earn money on them, or borrow funds if they need more. The Fed processes checks, distributes currency, acts as a lender of last resort, and performs other services for the federal government and commercial banks.

In addition to its banking functions, the Fed, together with the Federal Deposit Insurance Corporation (FDIC), has regulatory oversight over banks. The purpose of the oversight is to increase public trust in the banking system, ensuring everyone that banks are safe and reliable.

The Fed is overseen by a seven-member Board of Governors. The chairman of the board is appointed by the President and approved by Congress. The remaining governors are chosen from the presidents of the twelve Federal Reserve banks. The terms of the chairman and governors are staggered to try to eliminate the chance for one party to control the Federal Reserve by changing all the governors at once.

In addition to its banking activities, the Federal Reserve has a Federal Open Market Committee (FOMC). The chairman of the FOMC is the chairman of the board of governors, and the FOMC members are the seven members of the board of governors and a rotating group of five of the twelve regional Federal Reserve Bank presidents. Each regional bank president is expected to contribute knowledge of things going on in their part of the country as a part of creating national monetary policy.

The FOMC is the arm that does most of the things that we hear about in the news related to the Fed’s efforts to fight inflation and set interest rates. At the highest level, the job of the Federal Reserve is to keep the monetary system working smoothly. The FOMC specifically has what is called a “dual mandate”, although the mandate actually has three parts:

• maximum employment

• stable prices (by influencing the inflation rate)

• moderate long term interest rates

The “maximum employment” part of that mandate was added in 1977 when a long hard fight against inflation resulted in high unemployment. The FOMC is now supposed to manage inflation without letting unemployment get any higher than necessary.

The FOMC can’t directly do any of the things in their mandate, but they have “tools” that they use to try to influence what happens. For instance, they have no ability to directly set long term interest rates, nor do they have any direct control over employment, nor inflation. All they can do is use tools that they hope will impact those things.

The tools that the Fed uses have expanded and changed over time. Here are some of them:

The Fed sets the Fed Funds rates, which is the interest rate paid on excess reserves that banks park overnight at the Fed, and the rate paid for repurchase agreements (repos), which is another overnight transaction where money market funds and other financial institutions can loan money overnight to the Fed to earn a little safe interest on those funds. This puts a floor under interest rates so they don’t go too low. This was really important when interest rates were extremely low prior to 2020, it kept interest rates from going negative.

The Fed Funds rate is an ultra short term interest rate, an overnight rate, the shortest possible interest rate. Generally short term interest rates are lower than long term interest rates. A lender will want a higher interest rate if they are tying up the money for a longer term. And generally interest rates for very safe lenders will be lower than interest rates for lenders who might go out of business or not pay their bills. So the Fed Funds rate is literally the floor. It should be the lowest possible interest rate, because it is the shortest possible term and the safest possible lender.

The Fed’s mandate is not to control short term interest rates, though, it is to control long term interest rates. Long term interest rates are set by the market, and it’s often a matter of supply and demand. If lots of people are willing to loan you money, they will compete to give you a lower interest rate. But if nobody wants to loan money to you, interest rates from anyone who does will be much higher, because the lack of competition allows them to charge more. So increased demand reduces interest rates and reduced demand increases interest rates.

Therefore the Fed can affect long term interest rates by buying or selling securities. Treasury bills, notes, and bonds are printed by the Treasury Department then sold to the public. If the Fed steps in and starts buying those securities instead of waiting for other buyers to do it, they expand the pool of buyers and that should help lower long term interest rates (this is called Quantitative Easing or QE). If they want interest rates to go up, they can do the reverse and start selling securities. In that case they are no longer a buyer and they are making the buyer shortage even worse by adding more securities for sale than what was already on the market (this is called Quantitative Tightening or QT).

Another way they can influence long term rates is by adding money supply to the economy using their position as the nexus of the banking system. They can add reserves to the banks, which should then encourage banks to go loan their excess reserves out. That is “easy money”, which should push long term interest rates down. Or they can reduce bank reserves, creating “tight money” which would discourage banks from lending money, and that should push long term interest rates up.

During the pandemic the Fed took things even further. Not only did they purchase treasuries when they did QE, they also purchased lots of mortgage-backed securities, impacting mortgage interest rates. Early in the pandemic the concern was that the monetary system might lock up as the economy shut down, so the Fed was trying to make money extremely easy.

The ability of the Fed to impact inflation is controversial. The general idea is that if they can push interest rates up, that is going to reduce economic activity, and the reduced economic activity will reduce inflation as well. If they pull interest rates down, that should encourage economic activity, which will allow prices to go up. They can also impact inflation because they have control over the money supply. If more money is in circulation, inflation should go up, and the reverse should happen if money is taken out of circulation.

The Fed’s impact on employment is just as controversial. If the economy is humming, there should be lots of jobs and low unemployment. If the economy is contracting, employment will probably contract as well. But what direct impact can the Fed have on the unemployment rate?

There are reams of material written about how much, if at all, the Fed can actually control any of the things in their mandate, and about exactly which Fed tools might actually work. Another fascinating discussion is about the potential lag effect of changes the Fed has already made. Let’s say they figured out the right thing to do to reduce inflation, how long will it take for their steps to take effect? And at what point will they have gone too far because they don’t realize they already achieved their aim and are now sending things into a downward spiral? All of this is complicated by questions about how we measure unemployment and inflation and whether we are getting an accurate picture from those measurements. And all of this is even further complicated by the fact that lots of other things affect inflation and unemployment. For instance, if the federal government is sending everyone stimulus checks, that might completely undo anything the Fed tries to do. The whole thing is a crazy complicated subject.

Early bankers realized that most of those deposits were just sitting there most of the time. Since not all customers needed their money at once, bankers figured they could earn some income on that money while it was sitting there. They could do that by making interest-bearing loans or investments with their excess deposits, then share part of the earned interest with the customer to encourage them to keep their money in the bank, and keep the rest of the earnings as an additional stream of revenue.

To make this work, bankers had to make estimates of exactly how much money they needed to keep on hand to pay their depositors, taking into account their history and experience with depositors in the past. That calculated balance is called a reserve. Once banks established a reasonable reserve to keep on hand, they could go ahead and make investments and loans with the rest of their deposits.

This system of only keeping only a part of their deposits on hand and investing the rest is called the fractional reserve banking system. There are several benefits of a fractional reserve banking system, but there are also some risks. The big benefit to the bank is that they can earn money to support their operations, and it gives them a way to hang on to their customers by paying interest to depositors. If it wasn’t for this system, banks would not be able to pay interest on deposits.

But there is another benefit to the fractional reserve banking system. The fractional reserve banking system is a money multiplier for the economy. For instance, someone might deposit $100,000 in a bank. Now the depositor has $100,000 that they can spend, but the bank might also make an $90,000 loan from those deposits. The person who got the $90,000 loan now has $90,000 to spend and the original depositor still has $100,000 to spend, so there is a total of $190,000 of money available in the economy. Money multiplies even more from there. The person who got the $90,000 loan could deposit those funds in yet another bank, and that other bank might make another $80,000 loan from those proceeds, which would then add up to $270,000 of money created from the original $100,000 deposit. So the fractional reserve banking system has the capacity to inject lots of money into the economy. That is one reason why the government works hard to keep banks in business.

On the other hand, there are downsides of a fractional reserve banking system. One is that the bank might make bad loans or bad investments, and lose some of that money, because they’ve introduced risk that they didn’t have when they simply held on to the deposits. Additionally, they have to be prepared for runs on the bank. If many depositors show up wanting to pull their deposits out all at once, and their deposits total up to more than the cash the bank has in on hand, the bank will have to liquidate their investments and call in their loans in to generate cash to pay depositors. Liquidation sales usually only return a fraction of the original investment, and they also take time. Neither of those helps if there is a run on the bank. Bad investments and bank runs can easily, and very quickly, put a bank out of business.

Banks in a fractional reserve system never have enough currency on hand to pay all depositors immediately, so, if everyone panics and runs to pull their money out at all at once, the depositors who cash out early will get their money back, but those who wait may get nothing but a promise. That’s why runs can quickly accelerate and are highly contagious. The old movie “It’s a Wonderful Life” illustrates it perfectly. When people see a bank run, they pile in fast and ask questions afterward. When everyone wants their money out all at once, the run itself can put an otherwise solvent bank out of business. Deposit insurance is designed to quell depositor worries about losing their deposits and hopefully prevent runs from even happening.

The country has seen significant bank failures several times in modern history, notably the Great Depression in the 1930’s, the savings and loan crisis in the 1980’s, the Great Financial Crisis of 2008, and the Silicon Valley Bank crisis of 2023. In the earlier crises the most notable statistic was the number of mostly smaller banks that failed. In the crises after the year 2000 we experienced fewer numbers of failures, but those failures were exponentially bigger in size.

In the United States, banks have evolved in three distinct groups. Banks, savings and loans, and credit unions. Banks are owned by private investors. They can be small community or regional organizations or huge publicly listed corporations. They are for-profit corporations and are run to make a return for their investors. Their deposits are insured by the Federal Deposit Insurance Corporation (FDIC), currently up to $250,000 per account. They make commercial and business loans as well as consumer loans, and offer many other services, like trust services.

Savings and loans, also called thrifts, look a lot like traditional banks, but they may be member-owned or shareholder owned. They were initially created to focus on home mortgages for middle income Americans at a time when banks weren’t very interested in that market. By the 1980’s half of all home mortgages in the US were held by savings and loans. The savings and loans industry had its own insurance agency, the FSLIC, until the FSLIC went insolvent in the Savings and Loan crisis of the 1980’s. The FDIC now insures both banks and savings and loans up to $250,000 per account.

Credit unions are non-profit and member owned. Their members have something in common, like a common employer. Since they have no stockholders that expect to make a return, they often can provide slightly better interest rates and terms for their deposits and loans, and they return to members any profits that they make. They focus on consumer loans like car loans. They are insured by the National Credit Union Administration (NCUA), which currently provides deposit insurance up to $250,000 per account.

The Great Depression of the 1930’s

The stock market crash of 1929 and the Great Depression of the 1930’s put tremendous pressure on the banking system. At the time, there was no deposit insurance. As the economy tanked, questions rose about the safety of the banks and their ability to stay in business. About 9,000 banks went out of business between 1930 and 1933. The prospect of failure generated bank runs all over the country. There were so many runs on so many banks that every state had to shut banks down with periodic bank holidays to try to restore order. Finally President Roosevelt used his emergency powers to declare a national bank holiday in March of 1933, shutting down all the banks in the country for four days.

Franklin then worked with Congress to establish the Emergency Banking Act of 1933, which, among other things, created Federal deposit insurance, initially providing depositors with $2,500 of protection for their deposits. The Act also created the Federal Deposit Insurance Corporation (FDIC), which is the agency that is responsible for managing the deposit insurance program. The goal of deposit insurance was to reassure depositors that they didn’t need to run to the bank to get their money back, and prevent bank runs from even starting.

Deposit insurance and other new regulations worked. The number of bank failures dropped to about 50 per year from 1934-1941, and annual failures dropped even further to single digits from the 1940’s through the 1970’s.

The savings and loan crisis of the 1980’s

The savings and loans industry got into big trouble in the 1980s when the Fed funds rate soared from 5% to almost 14% in about 2 years. At that time, the interest rates that savings and loans could pay on savings were capped by regulation, and in some states the rates they could charge on mortgages was also capped.

The fixed rate mortgage loans they held on their books were worth less and less as interest rates rose. The only way to pay off a lot of depositors all at once was to sell or foreclose on their mortgages, but as the value of the mortgages dropped, thrifts couldn’t even do that.

Many thrifts became insolvent (their liabilities were greater than their assets). At first insolvent thrifts were allowed to remain open and regulations were loosened to allow them to make riskier investments, in an effort to try to give thrifts a chance to recover. That led to more failures and even fraud in the industry, which was followed by high profile bailouts of failing savings and loans. Throughout the 1980’s about 500 savings and loans a year were technically insolvent, and around 1,000 eventually went out of business.

The Great Recession and Great Financial Crisis of 2008

By 2008, the banking industry was making increasingly risky loans. They lowered standards for home mortgages, allowing people to borrow with little or even no down payment. The easy credit caused home prices to increase, and the higher prices triggered the need for easier mortgage terms so people could pay those higher prices. The whole bubble was predicated on the idea that national average home prices would never go down, so there would always be collateral behind these loans. Everyone understood that regional home prices might ebb and flow, so mortgages were sliced and diced into packages that combined mortgages across regional areas to lower the risk. But then the impossible happened, home prices went down everywhere at once. Banks were left holding mortgages that the owners couldn’t afford and that nobody else would take off their hands. Homeowners were under water, as home prices dropped below the amount they owned on the mortgage. Some homeowners just walked away, leaving their banks high and dry. The bank failures during this time mostly resulted from banks with high numbers of risky mortgage loans that left them insolvent.

The Silicon Valley Bank crisis of 2023

The Silicon Valley Bank crisis in March of 2023 has some things in common with previous crises. Like the 1930’s, it was triggered by a run on a bank and it looked like it was going to lead to many more bank runs. Like the 1980’s, the insolvency originated from having long term assets on the books at low, fixed, interest rates, when they had lost a lot of their market value due to high interest rates. In the 1980's, the assets that had lost value were mostly home mortgages. In 2023, the assets were low interest rate long term treasury bonds accumulated during years of low interest rates. As with previous bank failures, the government stepped in to protect depositors and stave off further bank runs. At this point, in the fall of 2023, things seem to be settled down. However, the problems on the banks' balance sheets will remain until and unless long term interest rates drop again.

There were two ways to fix the barter problem, both of which form the underpinnings of today’s monetary system. One was to find a third item, something both of them could use. Lots of different things have been used as “money” over the years, but the most obvious winners have been gold and silver. So the person with the wheat was not limited to trading only for milk, they could trade for silver or gold, then they could use the silver or gold to get anything else that could be traded for silver or gold. Metals like gold meet a lot of the important criteria for being a good medium of exchange, it’s something everyone agrees is valuable, it’s rare (you can’t create more of it), it’s durable (it won’t decay over time), and it can be divided into small amounts for smaller trades.

The second important development was a credit system where you could keep track of who has how much money. If you get paid by someone, you could just save the money until you need it. Or perhaps you might need something before you have the ability to pay for it. In a ledger system we keep track in a central ledger of who has what. In small societies the credit system could be informal and based on people’s honor or their word, but bigger societies required a more formal system. That more formal ledger system eventually became the banking system, where a trusted third party, the bank, kept track of transactions and balances for everyone. Banks made it possible to do business with people you did not know and might not trust, and to do business over great distances, not just with people who were nearby.

Other changes were made over time. Instead of everyone carrying gold and silver around, the government could keep gold and silver in their vaults, and then issue metal coins (for small amounts) and notes and paper currency (for large amounts) instead. These were easier to transport and handle, and were valuable because they were still backed by gold.

Paper currency (bank notes) were “bearer” notes, meaning they could be used by anyone who was carrying them. Banks also introduced checks so depositors had a way to pay bills without actually withdrawing cash every time. Currency and checks were “negotiable”, meaning they could be given to others, they didn’t have to be used only by the person who first received them. This freed everyone from the need to go to the bank for every transaction and made it much easier to buy and sell things.

In time, all these ways of paying bills and lending money coalesced into formal networks recognized not just within a local area or a country, but across the world. At their heart, all these monetary networks function as an alternative to actually carrying gold around. Currency is used for every day transactions, with the understanding that somewhere in the background gold, or reliable promises to pay, back the currency.

Initially US dollars were backed by actual physical gold held in Ft. Knox, but in the 1970’s, as a part of the war on inflation, the gold standard for the US dollar was eliminated. Instead of being backed by a specific amount of gold, the US dollar is now backed by “the full faith and trust of the US government”.

Money that is not tied to gold or some other precious metal is called “fiat” money, it’s money that can be created out of thin air by the government. There is no longer any guarantee that dollars are redeemable for gold, so there is technically no limit to the number of dollars that can be put in circulation.

Over time, almost every country has eliminated the gold standard for their money. Most world currencies are now fiat currencies. The value of each currency varies, in part, based on how much faith and trust the world has in the government that issued it. As long as US citizens, and the world as a whole, trusts the US government to keep its promises and pay its bills, the US dollar will continue to be safe and valuable.

Shadow housing inventory could affect home prices

For instance, I talked about shadow housing inventory in an earlier post, The Future of Home Prices, Partly Cloudy? That post discusses the fact that there are a huge number of homes that are not occupied by their owners. If nobody lives there, the dynamics about when and why to sell them are different than the dynamics for owner-occupied housing. Non-resident owners facing higher interest rates or flagging rental income have fewer reasons not to throw those houses on the market to get out from under their problems. Housing is “priced at the margin”. That’s a fancy way of saying that the value of all houses is based on the latest prices, the “comps”. If you have some distress sales, they are factored into the “comps” that are used to value all other houses in the area. A few distress sales can reduce the value of all the houses that aren’t for sale, and that in turn can change the calculus for anyone else pricing a sale, or a purchase, or a refinancing. This is what happened in the great financial crisis of 2008, where the value of real estate dropped into a downward spiral. Housing prices are too high now, unaffordable by most standards. If the shadow inventory floods into the market and pushes prices down it would be a blessing to people priced out of the market now but a big problem for an economy that isn’t expecting it.

Employees and jobs have to get back in balance

Another place where something is going on in the shadows are the job numbers. Ever since the beginning of the pandemic the numbers have been odd compared to what they were before the pandemic. Initially lots of people were out of work as businesses were shut down. Then business re-opened but not everyone came back to work.

There are several ways to look at the job statistics. The absolute number of people who are unemployed has stayed the same even while job openings have surged. It seems like unemployed people could have filled at least some of the increased number of jobs, but they didn’t. The unemployment rate has returned to what it was before the pandemic but the labor force participation rate never got back to previous levels. Why isn’t everyone coming back to work?

Either way you look at it, some employees have just disappeared. One theory is that a lot of older workers just retired early. Another is that it’s too hard to get daycare for children now so some parents are out of the work force until their children get older. Either way, post-pandemic, there seems to be a missing, shadow, labor force.

There are a couple ways this could resolve. One is that some job openings could evaporate so workers are again in balance with the jobs available. This could happen in a recession, for instance, or if the horror stories about AI prove true and AI eliminates hundreds or thousands of jobs. Another way this could resolve is if the shadow workforce returns. Maybe retirees decide they can’t afford or don’t like retirement and come back to work. Or maybe someone solves the shortage of childcare. Or people quit having children because who can afford them any more?

The current imbalance between jobs and workers keeps wages higher. Any resolution of the imbalance that reduces jobs or increases workers might push wages lower. Higher wages keep the economy humming and lower wages cause people to cut back on spending or maybe unable to make their mortgage and car payments. This is another shadow that makes the future uncertain.

Bank credit will be hard to come by

During the banking crisis in March we saw that many banks held long term, low interest, loans and treasuries. This didn’t look like a shadow, these were “safe” assets. After all, what is safer than a treasury note? But they were only safe if they could be held to maturity. If they had to be sold, for instance to pay out a run on the bank, they were not safe at all. Because the interest rates were so much lower than current interest rates, they were worth far less than their face value. The bank crisis pulled this issue out of the shadows. For now it is resolved. The Fed created a new program that allows banks to use the value of those treasuries without selling them at a loss. I posted about this in Banks, Shadow Banks, and Loans. The Fed fixed the valuation problem but buried in the result is another shadow, the fact that banks are now in no position to make new loans. And credit is what makes the economy go around. Small business loans, car loans, home mortgages, all will be tougher to find, and that will throw a wrench into the economy.

Businesses may have credit problems

This is a big one and I don’t know if it can be measured. Interest rates have gone up a lot but many businesses and consumers have been protected from the rate increase by being locked into long term low interest loans. But the terms of loans for businesses, including commercial real estate, are not the 20-30 year terms of home mortgages, they are more like 3 years. At the end of the term the loan will have to be refinanced. If interest rates had briefly gone up and then gone back down again, the businesses would have been able to wait until rates were low again to refinance. But that isn’t what happened. Rates went up and stayed up. That means those businesses will get a proposed new loan at much higher interest rates. If their credit is bad, they’ll have even higher interest rates or even less chance of getting refinanced. If they don’t have sufficient cash flow to make the new higher payments, they won’t be approved.

The other side of the equation is that business bank loans are backed by some kind of collateral. It may be the value of real estate that the business owns. It might be the personal net worth of the owner. It might be the accounts receivable for the services the business performed. If the business loan is backed by commercial real estate that has lost value, or if sales have dried up and customers aren’t paying what they owe, those loans may not be refinanced.

Both of these outcomes are going to hurt. Some significant amount of loans won’t be refinanced at all, and another significant amount will be refinanced but at much higher interest rates. If the business can’t get financing they will have to make drastic cuts in their business model, or even go out of business. If they go out of business they will put their employees out of work and may also endanger their vendors. There is no telling how big this shadow is, but it could be huge.

On-shoring makes things more expensive

The housing market isn’t the only place where there are shadow inventories, or lack of inventories, that might create issues. As almost everyone has heard by now, a lack of inventory was a big reason for the spike in inflation during the pandemic. Supply chains dried up, almost every kind of product was hard to get at some point or another. Then the problems lurched the other direction. Some businesses over-ordered to compensate for potential delivery issues and ultimately ended up with too much inventory. The big story of 2021-22 was inventory shortages. The big story of 2023 has been companies trying to get rid of excess inventory. Prices went up, then they went down. If that’s the end of it and we’re back in balance, that shadow is gone.

One place the shadow remains is around items sourced from unfriendly countries. The new trend will be finding reliable and safe inventory sources. This may mean on-shoring, or building more things in the US. We have a great country and I love to see us produce more things at home, but the reality is that we have never been and never will be the cheapest place to build things. In addition, we seem determined to charge higher and higher tariffs on goods coming in from other countries. Both of these actions will come with a price, things US consumers will pay more for many things. We haven’t seen the full impact of this yet, that’s why I still classify this as a shadow, but tariffs and on-shoring mean future prices will probably be generally higher. And higher prices means inflation will be higher. And higher inflation will fuel other impacts on the economy, and in every part of our lives. Ironically, in this situation a recession might be a good thing, since that might reduce the cost of producing things at home, at least as long as the recession lasts.

Fuel and food prices are still wild cards

The core CPI that the Fed pays attention to ignores fuel prices and food prices because they are volatile, and because the Fed’s interest rate policies don’t have much effect on them. But those prices are still important to the American economy. If they spike up and stay up it will take a big toll on most household budgets. Food prices are important because everyone has to eat, and going without food is not an option. Fuel prices are doubly critical. There are the prices that directly impact consumers, like the cost of heating fuel and the prices of gas at the pump. But fuel costs affect every stage of the production cycle from the cost of manufacturing and mining and processing to the cost of shipping. High fuel prices bleed into the cost of pretty much everything. Fuel prices dropped quite a bit mid-summer, which is a time of the year when fuel prices often drop. But there are lots of factors conspiring to push those prices up. High interest rates make it expensive to drill for oil or dig for metals. Unfriendly countries can cut production or refuse to ship fuel to the US. Green energy initiatives require huge up-front investments, and depend heavily on materials that are mostly sourced outside the US. The only thing that is likely to bring food and fuel prices down is a big recession where demand for everything dries up. If we have a soft landing, with no recession, prices will probably stay high.

Watch the shadows

The message is to pay attention to the shadows and don’t get blind sided by them. We can’t be sure what will happen or when, but we can be aware of things that might create problems and try not to be in the wrong place at the wrong time if they start to have an impact. People who don’t pay attention to things going on in the shadows are the ones that end up saying “nobody saw that coming” when things go off the rails.