CAPITAL IDEAS: What Canceling Student Debt Means for Inflation

Last week, I was on vacation, so I didn’t have the opportunity to write a column. While I was away, it was clear to me that the topic of this week’s column should be the Biden administration’s student debt relief plan. The plan includes debt forgiveness of up to $20,000. I knew that such a generous gift would have many borrowers and families wondering, “How can I claim my student debt relief?

But then my colleague, cousin, and financial planner extraordinaire, Lauren Russo, got ahead of me and wrote her own white paper. Lauren was faster than me, which makes sense since she knows this material better than anyone I know, myself included. Lauren founded the academic planning department of Berkshire Money Management. And she wrote the “Smart About College” chapter of the book “Don’t Run Out of Money in Retirement: How to raise income, escape tax, and keep more of what is yours.”

I submit that you are in good hands with Lauren’s assessment. And I’m grateful to him for working for hours while I rested comfortably on a beach.

However, there are two parts to this story. Lauren helped us with part one – how to claim $20,000 in student debt relief. The other part is the macroeconomic consideration.

Estimates vary widely, but canceling student debt will cost about $300 billion to $500 billion over ten years. There are some macroeconomic benefits to this, and I will touch on them. But let’s state the obvious first: timing is not helping to correct inflation.

Last week the Federal Reserve met in Jackson Hole, Wyoming to discuss its efforts to fight inflation. Then the government added $300 billion to $500 billion in student debt relief spending. The cancellation of student loans will increase the monthly cash flow of households. This goes against the Fed’s efforts to slow inflation.

Tweet by Jason Furman from August 25, 2022.

Allow me the latitude to take inflation out of the equation for a moment. In this case, the debt relief plan should stimulate the economy. Debt cancellation is one of the least effective forms of federal budget support. But it should be useful. Academic studies have shown high correlations between student loan burden and lower rates of home buying, household formation and entrepreneurship. A positive impact on these things would add to economic growth.

It should be noted that Jason Furman, the former head of President Obama’s Council of Economic Advisers, disagrees with me. He argued that the economic multiplier effect of debt cancellation is close to zero. While I suggest that debt relief would stimulate the economy, Mr. Furman does not expect any return on investment. He is probably more right than me since I certainly chose the easy way out and omitted the impact of inflation on economic growth. He and I seem to agree on the inflationary implications.

Mr Furman predicts that the debt relief plan will add about 0.2 to 0.3 percentage points to inflation.

Do you know what’s grinding my gears?

Let me editorialize a bit. Other than when this plan is useless to control inflation, I’m not mad at that. However, lawmakers forgot to give up to $20,000 in loan forgiveness to traders who skipped college and honed their trades or started a business.

Before I go too far, I know the absurdity of “whatabout-ism”. Whatabout-ism is a debate tactic, sometimes called a “red herring.” Whatabout-ism misleads and distracts. For example, one might ask, “Why give money to those who have gone to college when you can give it to the homeless?” Or, “Why give money to Ukraine when there are people in the United States who need help?”

I don’t see my consideration as falling into the category of whatabout-ism because I’m not trying to distract from the general conversation of helping people out. It seems to me that if you’re going to support those who went to college, you should also help those who went straight into the trades: the plumber with a loan on his truck; the entrepreneur with a mortgage on his building; the housekeeper who bought her vacuum cleaners and products and paid for gas and car repairs to get from job to job.

I’ve heard people rant about Biden’s student debt relief plan because of the “moral hazard” of potentially inducing prospective students to borrow more and schools to raise tuition even further. Others say it’s unfair because their tax money shouldn’t be used to change contractual relationships between lenders and debtors. Maybe I’m alone here, but I think the plan is downright insulting to those who have pursued a passion or created jobs but whose path hasn’t led them to college.

I don’t do politics here. For context, I’ve met President Biden a few times, and he seemed like a fun guy. However, the timing and focus of the debt relief plan could have been much better.

Easing supply chain issues help Fed tame inflation

“I’m starting to hear that some of the supply-side challenges we’ve had in terms of shipping constraints and other difficulties are starting to ease.” — Raphael Bostic, president and CEO of the Federal Reserve Bank of Atlanta, speaking at the Jackson Hole Economic Symposium in August 2022.

In November 2021, I argued that in August 2022 supply chain issues would start to ease. It happened in August. I needed to hear affirmative comments from Mr. Bostic after the stock market collapsed on Friday August 26th. Fed Chairman Jerome Powell spoke at the Jackson Hole Economic Symposium. He warned of “some pain” ahead as he used his tools “forcefully” to bring down inflation. Stock prices didn’t like Mr Powell’s warning that the Fed would “carry on until the job is done”.

It is essential to take into account the relief in the supply chain cited by Mr. Bostic, as this has been a significant component of the price increase. Container shipping cost has decreased significantly. This means manufacturers and retailers have more room to charge lower prices while maintaining a profit.

Graphic courtesy of Freightos.

The Federal Reserve Bank of New York has constructed the Global Supply Chain Pressure Index (GSCPI). The GSCPI is almost two standard deviations worse than usual (that’s a lot). However, it is considerably down from its all-time high of 4.3 standard deviations in December 2021 and is trending lower.

Supply chain relief means the Fed has less wood to cut to bring inflation back to its target level of 2%. This is good for the economy and for stock and bond investors. Not that inflation will normalize any time soon. This is especially true of year-over-year inflation, which many investors focus on.

It looks like used car prices peaked around January 2022. This means that deflation, not inflation, has been in place for used cars for most of the year. However, the year-over-year price decline will not appear in effect until January 2023. Airfares have fallen since June 2022, but year-over-year figures could still show a slight inflation, not deflation, until June 2023.

I expect the stock market to take a hit as we approach the November 8, 2022 midterm election schedule. The good news is that inflationary pressures should ease further by then. Lower stock prices and lower inflation are fostering a more favorable investment climate. A year-end rally is in the cards, but I wouldn’t be surprised if the S&P 500 fell back into the 3,785-3,902 range for the first time.

Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing over $700 million in investments. Unless specifically identified as original research or data collection, some or all of the data cited is attributable to third-party sources. Unless otherwise stated, any mention of specific securities or investments is for illustrative purposes only. The adviser’s clients may or may not hold the securities in question in their portfolios. The Advisor makes no representation that any of the securities mentioned have been or will be profitable. Full disclosures: Direct inquiries to Allen at [email protected]

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