A Collective
Pining for More Inflation
The John Law
school of economics remains alive and well. A recent article in the NYT informs
us that “In Fed and Out, Many Now Think Inflation Helps” [sic].
A few excerpts:
“Inflation is widely reviled as a kind of tax on
modern life, but as Federal Reserve policy makers prepare to meet this week,
there is growing concern inside and outside the Fed that inflation is not
rising fast enough.
Some economists say more inflation is just what the
American economy needs to escape from a half-decade of sluggish growth and high
unemployment.
The Fed has worked for decades to suppress inflation,
but economists, including Janet Yellen, President Obama’s nominee to lead the
Fed starting next year, have long argued that a little inflation is particularly
valuable when the economy is weak. Rising prices help companies increase
profits; rising wages help borrowers repay debts. Inflation also encourages
people and businesses to borrow money and spend it more quickly.
The school board in Anchorage, Alaska, for example, is
counting on inflation to keep a lid on teachers’ wages. Retailers including
Costco and Walmart are hoping for higher inflation to increase profits. The
federal government expects inflation to ease the burden of its debts. Yet by
one measure, inflation rose at an annual pace of 1.2 percent in August, just
above the lowest pace on record.
“Weighed against the political, social and economic
risks of continued slow growth after a once-in-a-century financial crisis, a
sustained burst of moderate inflation is not something to worry about,” Kenneth
S. Rogoff, a Harvard economist, wrote recently. “It should be
embraced.”
We have previously
commented on Mr. Rogoff's inflationist quackery. The idea that
inflation 'helps' the economy is based on the erroneous notion that it is
spending that drives economic growth. This is not only a theoretical error, it
is also disproved by historical experience. For instance, the historical period
in which US real economic growth reached its zenith were the decades prior to
the institution of the Federal Reserve, which were attended by mildly falling
prices (mildly falling prices are a natural feature of a progressing economy).
Of course the
assertion that the Fed “has worked for decades to suppress inflation” is
utterly ridiculous in light of the fact that the dollar's purchasing power was
more or less stable in the century before the Fed was founded and has declined
by more than 96% in the century thereafter. The central bank is not
'suppressing' inflation, it is the very engine of inflation.
Inflation properly
defined is an increase in the supply of money. This does not always have to be
accompanied or immediately followed by a widespread fall in money's
purchasing power, but it certainly alters relative prices in the economy, as
newly created money enters the economy at discrete points. The effect is always pernicious:
it redistributes wealth from late to early receivers of newly created money and
it leads to capital malinvestment and the associated boom-bust cycle.
This is not to say
that inflation doesn't have superficial attractions – there are good reasons
why so many people are in favor of it. In the short term, it may appear
to be beneficial, as it creates illusory accounting profits and can increase
'economic activity'.
If it is true that
Costco and Walmart are hoping for inflation to increase their profits, then
they are pinning their hopes on an illusion. A part of the profits businesses
make during periods of inflation are imaginary – the result of falsified
economic calculation. In reality, businesses are consuming part of their
capital without even noticing it.
For an excellent
analysis of how inflation ruins businesses as a result of capital consumption
due to the falsification of economic calculation we refer you to Fritz
Machlup's excellent study on capital consumption in Austria (pdf) in the
interwar years, which we have occasionally mentioned in the past. After the
first World War, a number of countries experienced very high inflation (the
most famous case is of course the total currency collapse of the Weimar
Republic), thereby providing us with excellent case studies that confirm what
economic theory has to say on the topic.
Since so many are
arguing that 'more inflation is needed', we cannot resist to once again post
Michael Pollaro's chart of the broad US money supply TMS-2 below. One should
not lose sight of the fact that monetary inflation has been quite extreme in
recent years, even by the standards of the pure fiat money regime.
Leaving aside the
fact that 'price indexes' attempt to measure something that is inherently
unmeasurable (i.e., the 'general price level'), it may be conceded that
consumer prices are not rising very fast at the moment. However, someprices
in the economy are definitely rising; similar to what could be observed several
times over the past two decades or so, the bulk of the price increases seems
concentrated in asset prices. Most economists as well as the monetary
authorities appear not to believe these price increases to be harmful, and yet,
we have seen the bursting of two asset bubbles in the past 13 years and the
fallout of the last one continues to weigh on the economy to this day. It seems
therefore odd that asset price bubbles continue to be ignored in this context.
Popular Fallacies vs. the Market Solution
The fallacy of
relying on price indexes to 'measure' inflation (i.e., to measure one of its
possible effects) and adapt the pace of monetary pumping accordingly has led to
large economic booms and busts many times since it has been adopted. The busts
are then lengthened and deepened by trying to fight the after-effects of the
collapsed boom with the same methods that have led to the problem in the first
place. And yet, if one looks at articles in the mainstream press such as the
one in the NYT that has prompted us to write this post, the discussion is
solely focused on the effect inflation may or may not have on consumer price
indexes. Even the critics of inflationary policies seem to concentrate
exclusively on this side issue. And of course those who promote inflation as a
cure for the economy's ills such as Mr. Rogoff, accuse the Fed of being 'too
meek', which is utterly bizarre in view of zero interest rates and $85 billion
of additional money creation every month. One wonders what exactly Mr. Rogoff
wants the Fed to do? Buy up everything that isn't nailed down with money from
thin air?
“Critics, including Professor
Rogoff, say the Fed is being much too meek. He says that inflation should be
pushed as high as 6 percent a year for a few years, a rate not seen since the
early 1980s. And he compared the Fed’s caution to not
swinging hard enough at a golf ball in a sand trap. “You need to hit it more
firmly to get it up onto the grass,” he said. “As long as you’re in the sand
trap, tapping it around is not enough.”
All this talk has prompted
dismay among economists who see little benefit in inflation, and who warn that
the Fed could lose control of prices as the economy recovers. As inflation
accelerates, economists agree that any benefits can be quickly outstripped by
the disruptive consequences of people rushing to spend money as soon as
possible. Rising inflation also punishes people living on fixed incomes, and it
discourages lending and long-term investments, imposing an enduring restraint
on economic growth even if the inflation subsides.
“The spectacle of American central bankers trying to
press the inflation rate higher in the aftermath of the 2008 crisis is
virtually without precedent,” Alan Greenspan, the former Fed chairman, wrote in
a new book, “The Map and the Territory.” He said the
effort could end in double-digit inflation.
The current generation of
policy makers came of age in the 1970s, when a higher tolerance for inflation
did not deliver the promised benefits. Instead, Western economies fell into
“stagflation” — rising prices, little growth.
Lately, however, the 1970s have seemed a less relevant
cautionary tale than the fate of Japan, where prices have been in general
decline since the late 1990s. Kariya, a popular instant dinner of
curry in a pouch that cost 120 yen in 2000, can now be found for 68 yen, according to the blog Yen for Living.
This enduring deflation, which policy makers are now
trying to end, kept the economy in retreat as people
hesitated to make purchases, because prices were falling, or to borrow money,
because the cost of repayment was rising.
“Low inflation is not good for
the economy because very low inflation increases the risks of deflation, which
can cause an economy to stagnate,” the Fed’s chairman, Ben S. Bernanke, a
student of Japan’s deflation, said in July. “The evidence is that falling and
low inflation can be very bad for an economy.”
(emphasis added)
There are
certainly a number of problems ailing Japan's post bubble economy. Lower prices
for popular instant dinners are definitely not among them. It is this one
sentence that immediately makes clear how little sense all this belly-aching
about 'deflation' (in the sense of falling consumer prices) really makes. Are
not consumers much better off when they have to pay less rather than more for
goods and services?
When assessing
Japan's economy, its biggest problems are too much government spending and a
raft of stifling regulations, but certainly not falling consumer prices. The
idea that Japan is 'worse off' because the domestic purchasing power of the yen
has slightly increased is absurd. As anyone who has visited Japan can attest
to, there is absolutely no reason to suspect that Japan is anything but a rich
country. It has an enviably low unemployment rate and is the world's biggest
creditor. The fact that credit expansion ex nihilo has slowed
down in Japan is not a bad thing, it is a good thing (of course the BoJ is
currently busy implementing an inflationary policy as well).
It is simply
untrue that falling prices lead to 'economic stagnation'. We would be very
curious to hear Mr. Bernanke explain the fact that the US economy never grew faster
in real terms than in the 'deflationary' decades prior to the founding of the
institution he heads. He probably can't explain it – his studies of
economic history don't seem to go back further than 1929, so there is no reason
for him to attempt to reconcile this evidence with his theoretical views.
No matter what the
inflationists assert, it is not possible to create wealth by printing more
money – the exact opposite is true. As Murray Rothbard pointed out, if one
thinks the position of money in the economy properly through, it becomes clear
that society at large cannot gain anything if its supply is increased – in this
respect, money is different from every other good and service that is produced.
We are sure that
if one were to ask Mr. Rogoff or Mr. Bernanke how it comes that places like
Zimbabwe, Venezuela or Argentina are not the richest countries in the world,
they would argue that they 'inflated too much'. But what exactly is 'too much'?
How can they possibly know? How can Mr. Rogoff be certain that we need an
annual decline in the exchange value of money of 6%? Why not 4% or 7%? And how
does he propose to measure it, given that it is not possible to gauge the price
effects of inflation independently of the supply of and demand for money?
If there were a
free market for money, unexpected sudden increases in the demand for money (due
to exogenous events like e.g. the threat of war) would likely also see a
reaction from the supply side. However, the increase in resources devoted
to obtaining a larger supply of the money commodity (in a free market, money
would be a commodity with a pre-existing use value) would be strictly guided by
the wishes of consumers. Moreover, even if the money supply were completely
fixed, a demand for higher cash balances would simply lead to adjustment by
raising money's purchasing power until the higher demand was satisfied (we are
assuming that if a free market in money were to obtain, the entire economy
would likely be unhampered; prices and wages would be free to adjust).
Given the enduring
popularity of inflationary policies, we suspect that lessons that should have
been learned long ago will have to be relearned – the hard way.
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