Financial Times chief economist Martin Wolf has warned that US President Joe Biden’s big-spending stimulus program risks generating a burst of inflation that could lead to a financial crisis and deep recession before the 2024 presidential election.

This would bring the re-election of a triumphant and revanchist Donald Trump and spell the end of liberal democracy, according to Wolf ^[1], who says the Republicans are ‘increasingly an anti-democratic cult with a would-be despot as their leader’.

Even the stalwart Democrat-leaning former US Treasury secretary, Larry Summers, has criticised the Biden government’s outlays as ‘substantially excessive’, telling Wolf in an interview ^[2] that ‘it doesn’t seem to me that the preponderant probability is that it will work out well’.

Biden’s US$1.9 trillion stimulus package comes on top of a US$900 billion stimulus package last December and ahead of a proposed US$3 trillion outlay on infrastructure and social welfare reform. At the same time, the US Federal Reserve has cut interest rates to between 0% and 0.25% and is flooding the economy with cash by buying bonds and lending money to financial institutions.

The scale of Australian government’s budget spending in response to Covid-19 is also enormous. The combined Commonwealth injection into the economy over the four years from 2019–20 to 2022–23 is $475 billion with $452 billion in deficits, compared with the $23 billion in surpluses that were being forecast in December 2019, before the pandemic struck.

Budget spending is hitting a peak, outside of wartime, of 32.1% of GDP this year and will still be 26.2% of GDP in 2024–25. During the peak of the response to the global financial crisis in 2009–10, outlays only reached 25.9% of GDP.

There are grounds for concern that the Australian government, like the Biden administration, is paying too little heed to the threat of inflation. The economy is recovering strongly—much more powerfully than was the case after the financial crisis—with unemployment having dropped from 7.5% to 5.6% since last October and forecast to keep falling to 5% by the middle of next year despite the end of the ‘JobKeeper’ program.

In Australia, as in the US, the signs of a boom are everywhere. House prices are soaring, as are used car prices. Consumer goods are flying out the door of retailers in both countries. It’s hard to book space on container ships to the US because demand for consumer goods is so hot. Consumer confidence in Australia is at its highest level in 11 years.

The evidence is in the markets as well. Commodity prices are booming. Iron ore is hitting fresh records while copper, often seen as a bellwether for global manufacturing demand, has been trading at record levels above US$10,000 a tonne. Australian share prices are back to the peak they reached before the financial crisis, while in the US, the S&P 500 was at a record 4,230 points before the latest round of inflation jitters.

Commentary on the budget focussed on inflation risks. The Australian Financial Review’s ‘Chanticleer’ columnist Tony Boyd ^[3] remarked that the budget would help stocks exposed to housing and construction which were ‘in the inflation trade sweet spot’ while the losers would be hospitality, tourism and farm industries all suffering from staff shortages because of border closures.

The Australian’s contributing economics editor Judith Sloan ^[4] argued Treasury’s forecast that wage growth this year would only be 1.5% was too low given the emerging labour shortages. ‘Wage pressures are all on the upside as employers seek to lure workers away from other employers or from out of the workforce.’

In the US, the early signs are that prices are on the move. The April consumer price index ^[5] showed the biggest jump in prices since September 2008, when the economy was running hot on the eve of the global financial crisis. The annual rate of price growth increased from 2.6% to 4.2%.

There is as yet no parallel move in Australia. The latest quarterly report on consumer prices showed that the underlying rate, which removes the influence of the biggest price increases and falls, was only 1.1%, the lowest since it started being calculated in the early 1980s.

The behaviour of inflation across the advanced world has been an economic mystery over the past 10 years. The accepted economic theory holds that once the jobless rate drops below a minimum level where all those that want and are available to work have a job, wages will start to rise and prices will follow.

The central bank can influence the inflation rate because when it cuts rates, it’s easier for people to borrow and invest. This boosts demand and lowers unemployment.

However, across the advanced world, strong employment growth in the years leading up to the pandemic failed to generate the least heat in wages or inflation. Central bank interest rate cuts seemed to produce a boost in asset prices but not in wages or in consumer prices. Since Philip Lowe took on the role of Reserve Bank of Australia governor in September 2016, the inflation rate has averaged only 1.5%, far short of the 2.5% midpoint of the bank’s 2–3% target band.

Is this time different? Policymakers reassure themselves that if prices and wages did start rising, then central banks would know what to do, raising rates to dampen demand and ease price growth.

But there are dangers here. The biggest cause of recessions worldwide since World War II has been central banks acting too late to respond to an overheated economy and then moving too far too quickly. The diminishing population of Australians who can remember the recession that then-treasurer Paul Keating said in 1990 that we ‘had to have’ would also recall the interest rate rises that precipitated it, when mortgage rates reached 20%.

As part of its Covid-19 response, the US Federal Reserve has said it will tolerate inflation rising above its 2% target and will not, in any event, be lifting rates before 2024 at the earliest. The RBA’s Lowe agrees ^[6]: ‘Our judgment is that we are unlikely to see wages growth consistent with the inflation target before 2024’, he said in March.

The risk is that all the government spending and central bank liquidity leads to wages and prices rising, perhaps by as much as 5%, before the central bank starts to take action. With household debts in Australia and corporate debts in the US reaching record levels, any upward move in rates could bring a liquidity squeeze that could be precipitated by a plunge in bond markets before central banks act.

The White House has let the New York Times ^[7] know that officials are keeping tabs on ‘real-time’ price movements several times a day, and are confident that any spike in prices will be temporary, not harmful and will reflect the one-off effect of disruptions to supply chains during the pandemic.

Wolf says he ‘desperately’ hopes that Biden succeeds. ‘He has taken a huge gamble on the success of his programme. It may be the most consequential gamble taken by any democratic leader in my lifetime. The future of democracy is at stake,’ he writes.