Once again, inflation is not a result of rising demand by consumers or business enterprises. And the Fed's interest rate tinkering does not cure inflation.
In an article titled Tips for TIPS, a Wall Street Journal reporter, who should know better, writes:
For now, few people see inflation as a major threat. The world economy remains strong and the dollar has been sliding, making U.S. imports more costly. But tighter credit and a badly sagging housing sector are expected to hurt U.S. economic growth, and government data suggest that higher energy prices so far haven't had a broad impact on inflation. Indeed, investors believe that the Federal Reserve, which has cut short-term interest rates twice to quell market turmoil, will do so again.
Inflation is a general rise in the overall price level. And it results from only one thing: a deteriorating currency; that is, excessive money creation by banks, in particular, central banks.
The Federal Reserve has created an excessive money supply, and the recent cuts in the Fed's interest rates are intended to make the money supply still more excessive. The Fed will implement those cuts by open market and direct purchases of securities from financial institutions, paying for them with bookkeeping entries to create previously non-existent money.
In contrast to overall inflation, increased demand raises prices for specific commodities.
Let's take petroleum, for example. We have seen the price of oil, reflected in gasoline prices, rise and fall over recent years. But that is not general inflation. It is simply current and prospective demand exceeding current and prospective supply for that one commodity and its derivatives.
Absent ill-advised government intervention, when oil prices rise, some consumers and businesses will decide to curtail their use of oil and gasoline, feeling unwilling to incur the higher costs. The ratio of demand to supply will drop, and oil and gasoline prices will level off and eventually decline.
That's why the Fed's use of "core inflation" numbers to measure inflation is a sham. First, the Fed selects the price measurements to use in the core index. Second, movements up or down in specific commodity prices do not measure general inflation.
The other current Exhibit A price gyrations are home prices and private equity buyouts. The aberrant surge in prices paid by home buyers and private equity fund managers was fomented by the Fed's creation of massively excess amounts of dollars. When businesses and consumers have money coming at them in a flood of credit availability, from banks and mortgage lenders, they will spend and pay more than the underlying values.
Reviewing our nation's history will make it clear.
Except in wartimes, for more than 200 years, inflation was not a major factor in the United States. Until 1933, we were on one form or another of gold standard, which worked automatically to curb or expand the money supply in line with the economy's changes in real production of goods and services.
Price levels were remarkably stable until our first socialist President, Franklin Roosevelt, deliberately debased the dollar in 1933 and restructured the Federal Reserve in 1934 to facilitate the Federal government's massive deficit spending, funded by creation of money out of thin air by the Fed. This was the prescription of Keynesian economics, still the regnant dogma of the Democratic Party: for every hitch in the economy, more Federal spending.
The result has been unending inflation since 1933.
Today, regardless of higher or lower business activity and higher or lower consumer demand, inflation will continue to rise, probably at least by 2% per year, indefinitely. That inflation will be driven solely by the Fed's continual pumping up the money supply.
No interest rate manipulation by the Fed can quell inflation. The Fed can only encourage or discourage business activity and consumer spending with interest rate manipulation.
In the worst circumstances, which the Keynesian economics of the Democratic Party gave us in the 1970s, the economy sinks into the swamp of stagflation. Unemployment rose sharply; business activity declined; Midwest industrial plants closed, becoming the "Rust Bowl." Yet all the while prices rose, ultimately at annual rates exceeding 20%, with overall consumer and business demand flat on its back. Citizens' lifetime savings lost more than 50% of their pre-stagflation purchasing power.
Clearly this fiasco was the result of excessive government spending for President Johnson's Great Society and concomitant creation of phony money by the Fed.
Inflation finally was halted in the first Reagan administration, when the President encouraged the new Fed chairman Paul Volcker to do what had to be done: shrink the money supply.
In a PBS interview in more recent years, Mr. Volcker described it this way:
Well, the Federal Reserve had been attempting to deal with the inflation for some time, but I think in the 1970s, in past hindsight, anyway, [it] got behind the curve. It’s always hard to raise interest rates.
By the time I became chairman and there was more of a feeling of urgency, there was a willingness to accept more forceful measures to try to deal with the inflation. And we adopted an approach of doing it perhaps more directly, by saying, “We’ll take the emphasis off of interest rates and put the emphasis on the growth in the money supply, which is at the root cause of inflation” – too much money chasing too few goods . . .“so we’ll attack the too-much-money part of the equation and we will stop the money supply from increasing as rapidly as it was.”
And that led to a squeeze on the money markets and a squeeze on interest rates, and interest rates went up a lot. But we didn’t do it by saying, “We think the appropriate level of interest rates is X.” We said, “We think the appropriate level of the money supply or the appropriate rate of the money supply is X, and we’ll take whatever consequences that means for the interest rate because that will enable us to get inflation under control, and at that point interest rates will come down,” which, of course, eventually is what happened.
Since then the Fed has reverted to the old, completely discredited Keynesian belief that government planners can fine-tune the economy in order to attain full employment, price stability, steady GDP growth, all while expanding the money supply essentially without limit to finance ever-growing welfare-state expenditures and Congress’s massive pork-barreling.
For more on this subject, read:
Ben Bernanke and the "Barbarous Relic"
Democrats, the Fed, and Milton Friedman
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Read more articles by Thomas E. Brewton
I have seen our nation export jobs by the millions due to inflation and little regard to productivity. Everyone wants the raise because they've been there for x amount of years, forget that that raise has to come out of someone else's pocket. FDR started us down the slippery slope that we are speeding into fiscal oblivion. Anyone who has studied his policies will tell you that it was his policies that extended the depression. We now have a series of socialism that is doing its thing, implosion. I feel little can be done to stop it since everyone wants the other guy to suffer, not him. Normal human nature. What needs to be done is to unleash the free market without any tinkering by the Fed. Sadly I am a dreamer to think this would happen and I know it.
Comment by hvance | December 13, 2007
It's been ironically amusing to see people like Brewton castigated as over-zealous "inflation hawks" for the past couple of years, only to watch the U.S. dollar fall to dung around our ankles. The Fed no longer even publishes M3 money supply data. It'd be nice if the Fed was run by unbiased economists instead of political hacks and partisan ideologues.
Comment by Patrick Mulligan | December 14, 2007
OK, as an anti-flaming measure, let me state my bonafides as a supporter of the Austrian school. Ludwig von Mises, Friedrich von Hayek, Murray Rothbard, and Henry Hazlitt are all members of my pantheon of heroes. I'm as anti-Keynesian as you can get.
But here's the rub. How do you return a currency from being fiat currency (no backing) to representative currency (value fixed by some amount of precious metal), when every other country on the planet is using fiat currency and loving it?
Let's say for the sake of argument, that I win the 2008 election and among the first things I do in office is abolish the Fed and peg the value the Dollar to some amount of gold. Does anyone think that the Europeans or the Asians will stop their printing presses because we do? And let me make this clear, the day after my glorious triumph of repealing the hated Federal Reserve Act, the other nations of the world would immediately begin demanding that all debts and exchanges with the U.S. be made good in gold. What do you think that would do to our almost non-existent gold supply? They'd ruin us, literally, overnight (And with a gleam in their Jew-hating, Socialist Utopian eyes too.)
Another thing to consider is that gold, silver, platinum, or whatever other member of the Platinum group metals you can think of are RARE and FINITE. The expandability of our economy is not. It can, and will, continue to create more and more wealth, and more and more added value, that will have to be backed with a relatively small and limited amount of metal. If you carry this to it's logical end, eventually a Dollar would be backed by a microscopic speck of metal that would be astronomically valuable. Dollars would become increasingly valuable, with a corresponding deflation, until you could buy a mansion with a quarter. How would you make change for that - keeping in mind that a penny would buy a car? I'm using an extreme example, but a very real problem in that you'd have to create ever smaller partial currency denominations to be able to make change for Dollars that keep getting more valuable. And at the rate our economy creates wealth, it would happen a lot sooner than you might imagine.
Oh, and remember the scenario about other nations demanding payment in kind (meaning they'll only accept gold)? Well, how would you finance a war or other national emergency where the government has a legitimate and urgent need for LARGE amounts of money? You can't just go out and mine more gold, and because other nations will only accept gold for payment, you can't just go purchase gold from those that do have the mines. "Sure, we'll sell you 10 tons of gold. That'll be 10 tons of gold, please."
I could go on, but I think I've made the point.
Am I for ending the growth in the money supply? Absolutely, and then some. Do I believe that we need to return to representative currency? Ditto! Do I think we should peg it to a certain amount of precious metals? No. It is not a workable solution. Do I have the answer? No, which is why I will not win the 2008 election. That, and my declared position to place all Liberals in detention camps.
I don't have enough knowledge of economic and monetary theory to know if it possible to fix a currency without a backing, but we need some other means of fixing value that does not require rare metals. Personally, I held high hope that electronic exchange of money would increase the speed of money through the economy so much that it would have an anti-inflationary effect, but it doesn't seem to have a measurable impact on inflation.
Regards.
Comment by Julian Cate | December 14, 2007
"How do you return a currency from being fiat currency (no backing) to representative currency (value fixed by some amount of precious metal)"
That's a pretty drastic step that would be extremely difficult to achieve anyway. I don't even see it really being advocated in this article, so much as fondly remembered. You're missing the point of the article. The point isn't to revolt against the Fed, it's for the Fed to be as responsible as it can be in controlling our fiat money supply. Because at the rate they're going now, the opposite phenomenon of what you describe will take place: we're going to have to print higher and higher denominations of currency to use as the dollar loses value, until a small condo costs 200 million dollars and a new car costs 20 million. What you seem to perceive as our economy creating wealth is more often simply rising prices as a result of inflationary debasement of our currency. We have more money now floating around in our economy, and every dollar of it is worth a fraction of what it was is X number of years ago. Our money supply is growing at a vastly disproportionate rate to our actual economic output.
It is possible, since you asked, to fix currencies to something other than gold. Money is nothing more than a medium for exchange and store of value. It can be anything that people place value in and recognize for the repayment of debts. So you can tie money to any tangible good that reinforces those qualities. You can theoretically fix a currency to the value of just about any other medium: another country's currency, gold, or any precious metal, the value of some commodity, or dirt and rocks, if people placed value in them.
Comment by Patrick Mulligan | December 14, 2007
Julian, When I saw your anti-Keynesianism statement it made my day. Kind of tells one how boring I am. Yes, you can fix a currency with no backing, such as gold, etc. It is done with productivity and no taxes on the factory that produces the product. We can become the world's industrial giant that we once were if it wasn't for our punitive tax system and creeping socialism. I know this topic isn't on taxes but the Fair Tax Act by Rep. John Linder would return us to the hammer as opposed to the nail.
Comment by hvance | December 15, 2007