The View From 1776
Thursday, October 07, 2010
We Already Have Inflation
In the short run, there is a distinction between prices and inflation. Inflation is over-expansion of the money supply; rising prices are the after-effect.
Liberal-progressives, led by Democrat/Socialist Party nomenklatura, deliberately focus on prices, instead of increases in money supply that lead eventually to higher prices. Politicians, more concerned with getting re-elected than with the nation’s welfare, tell the voters that easy credit and more money help them. When prices subsequently rise, those politicians blame business, knowing that most voters will not make the connection with earlier, government-induced money supply inflation.
An example of political three-card-monte misdirection by politicians, though not entirely an effect of money-supply inflation, is our periodic spikes in gasoline prices. Failing to discern the years-long pattern of supply and demand, politicians and the general public attribute rising gasoline prices to blood-sucking oil companies and evil businessmen.
The facts are quite different. Environmentalists have, for more than 30 years, blocked construction of new oil refineries. In the short run, at peak gasoline demand during good business conditions, gasoline demand exceeds supply, and prices go up. The price-spike is augmented when, as now, the effects of money-supply inflation spook the commodity markets. Oil companies have almost nothing to do with gasoline price increases, which are the effect of deliberate, bull-headed environmentalism.
In the background, liberal-progressive Keynesianism also plays a significant role in rising gasoline prices. The Fed’s deliberate targeting annual inflation of 2% or more steadily debases the dollar. Most international transactions in petroleum are denominated in dollars. Measured in ounces of gold, the price of oil has risen very little; measured in dollars, our oil import prices have soared, because of the Fed’s inflationary policies.
As Paul Volcker, the only Fed chairman who actually stabilized the dollar and stopped inflation, noted at the time (early 1980s), inflation is excessive money creation. He finally stopped inflation by ignoring Keynesian preoccupation with setting target interest rates (Fed Chairman Bernanke’s pre-occupation). Instead, as he testified, Volcker just let interest rates soar and concentrated on pulling excess reserves out of the banking system. The short-run price was a severe economic recession. But, after inflation had been killed, lower and stable interest rates combined with President Reagan’s tax cuts to produce one of the nation’s longest and biggest business expansions.
Interest rates (the price of money) and the prices of goods will always go up after an initial drop when the money supply is increased faster than increases in production of goods and services that people want (not “green” products, for example, that liberal-progressive governments tell them that they must take).
Even Fed chairman Bernanke is aware that, when production finally begins to accelerate and businesses once again turn to banks for increased loans, inflation will begin to explode if the Fed doesn’t manage an almost impossibly delicate transition to tighter money (draining trillions of dollars of fiat money out of banks’ reserves) without killing the nascent business recovery with rising interest rates.
The difficulty that the Fed will confront as business finally begins to recover and employment begins to rise is that interest rates (the price of money) will get a double push. Our banks, institutional investors, and the international money markets will begin to raise interest rates as loan demand rises. At the same time, bond markets (long-term credit) will push the yield curve sharply upward to compensate for the fact that bond principal repaid 10 to 20 years in the future will be of much lesser value, because of inflation. In the 70s, some long-term, tax-free municipal bond rates went into the 10-14% range.
Remember that all through the Nixon and Carter presidencies the Fed was pumping up the money supply. After about five years, all hell broke loose as we moved into stagflation: high unemployment, decreased GDP, and double-digit inflation. Keynesian economists on the President’s Council of Economic Advisors were, until that time, being lauded for their mastery of Keynesian macroeconomics. Today’s pattern is distressingly congruent with the 1960s-70s one.