“The notion … that inflation is everywhere and always a monetary phenomenon is no longer a controversial proposition.” – Alan Greenspan, January 3, 2004
Caroline Baum recently noted that the Fed just doesn’t get the credit it deserves for the effect it has on overall economic conditions at any point in time.[1] And, as I often do (because Ms. Baum is a rare bird for my brain) I agree with her completely.
For example, out of the multitude of economic indicators we Wall Street natives pant and chant over, none is less apt to link “get the credit it deserves” and “Federal Reserve” in many people’s mind than inflation. I hope to show that when it comes to inflation, the Federal Reserve Bank deserves every bit of the credit.
Inflation is widely talked about but little understood. Apparently, even the very word “inflation” has lost its scientific rigidity, turning all mushy definitionwise.[2] A multitude of its effects are said to be its cause; an absurdity in logic, but what can we expect from mere mortals?
Considering the fact that a man with a reputation for a deep understanding of economics, such as Federal Reserve Chairman Ben Bernanke, can blame oil for inflation (”a significant increase in energy prices can simultaneously slow economic growth while raising inflation”[3]) in direct contradiction to such notable — and correct — scholars as Federal Reserve Chairman Ben Bernanke (”the main reason for high inflation rates is the rapid rates of money growth”[4]) it is clear that when it comes to the subject of inflation we’re all in a serious intellectual slump. How can we “fight” inflation if we pretend not to have even a clear idea of its cause?
Despite such obfuscation, we have established, straight from the harsh school of repeated experience, that inflation is everywhere and always a monetary phenomenon. Not even the best minds that our Ivy League schools can timestamp fail to concur with this economic axiom. A man who debates it is a man who will proclaim the Earth to be flat.
Repeat after me: there is no debate that inflation is always and everywhere a monetary phenomenon.
Even if we’re all dead and not around to live with the inflation that an ever distant “long run” is sure to bring, it is caused by the growth in monetary aggregates, or, as Mr. Greenspan puts it, the “persistent over-issuance of money.”
And it should be superfluous for me to mention that since the Federal Reserve Bank, as per its website, “conduct(s) the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of … stable prices”[5] that if inflation is always and everywhere a monetary phenomenon than it follows that the organization that “conduct(s) the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of … stable prices” is directly responsible for inflation.[6]
Murray Rothbard once wrote of “the widely held misconception among historians that central banks serve, and are looked upon, as restraints upon state or private bank inflation.”[7] Yet this misconception seems to be widely held today amongst non-historians, too. Recently a colleague of mine, a man newly timestamped with college accreditations in the study of finance, said to me “inflation just happens; the Fed is there to fight it.” Unfortunately, this opinion of inflation and the Fed puts him with the solid majority of our peers.
I would have disagreed with him in public, but if I did, my fellow Wall Street employees would think me a lunatic. It seems widely to be believed that many things cause inflation: oil, greedy businessmen, greedy unions, hurricanes, a rising level of aggregate demand versus supply, all food products, and those kids who run the iced tea stand during summer. Anything and anyone at all, seemingly, but the people who control monetary policy at the Federal Reserve Bank.
But such beliefs are wrong because “the notion … that inflation is everywhere and always a monetary phenomenon is no longer a controversial proposition,” as the Greatest Central Banker of All Time and our current head central banker agree. And I agree with them.
You should, too.
From front to back, not one economist I have personally spoken to or read denies that inflation is, and always has been, a monetary phenomenon. Yet a person reading the voluminous research put out by Wall Street banks could be forgiven for taking away the belief that anything but the Federal Reserve Bank causes inflation.
No matter how many PhDs wax eloquent over oil’s inflationary effect, they are just plain wrong. Oil has no power to cause inflation. Wages have no power to cause inflation. That power resides with, and only with, the people who control the money supply: the Federal Reserve Bank employees.
The Greatest of the Greatest Central Bankers of All Time
“A Federal Reserve chairman is judged not by the standards he sets for scientific analysis, but by how well he achieves price level stability.” – Kevin L. Kliesen, Economist, St. Louis Fed
Being a big believer in holding our public servants accountable, I would like to see which one of the past thirteen Fed chairmen was top dog in “maintaining a stable price level.”
Whether or not we agree with the wisdom — or even the possibility — of “maintaining a stable price level,” it would be interesting to know the Fed chairman who best fulfilled his stated mission. For this, I will use the following very scientific criteria which I thought up while washing the dishes.
I will only include Fed governors who served at least two years. I used two years because that seems like enough time for even a man of angelic intentions to really screw things up. Second, we will bow to the wisdom of Hopper, Kevin Spacey’s character in A Bug’s Life, who tells the ant queen-to-be “first rule of leadership: everything is your fault”. Since the Fed chairman is the guy who sits at the head of the table, “the buck erodes with him.” Last, we’re going to use the CPI numbers as put out by the Bureau of Labor statistics.
I will grant to all the fact that the CPI numbers, vague and arbitrary to begin with, have also been massaged, hedonically adjusted, scrubbed, bent, and twisted, leaving their accuracy even more in doubt.[8] John Williams’ Shadow Government Statistics website claims that “changes made in CPI methodology … have understated inflation significantly,” and judging by the historical behavior of politicians and their well documented habit of lying, this claim holds much merit on its face.
So why am I using CPI? Because, even using it, the Fed’s “inflation fighting” reputation and the widely held belief that a central bank is designed to “maintain a stable price level” does not bear the light of day. Fed officials “fight” inflation in the same manner that Ted Bundy “dated” women; they pummel the dollar into a pulp, then do their best to avoid blame.
If you had hired the Fed to “maintain a stable price level” in 1913, I believe that right now, circa 2006, you could take them to court and sue them for violation of their fiduciary duty. (And win.) Since its creation, the Federal Reserve — our country’s fourth try at a central bank — has taken the dollar and reduced it to five cents.[9] Which Fed chairman had the biggest hand in this fiasco?
Since — as the huge post-Katrina budget hikes given to FEMA prove[10] — failure is the health of the state, the winner of the Greatest Central Banker of All Time goes to the man who destroyed the dollar’s value more than any other of his brethren. So take a bow Marriner Eccles, Fed chairman from November 1934 to January 1948. Benjamin Anderson described him as an “extreme Keynesian,” and since, as W.H. Hutt wrote “to consider the consequences of Keynesian policies, one can hardly avoid discussing the phenomenon of creeping inflation,”[11] this is hardly a surprisingly choice.
A Utah banker who never attended college or studied economics,[12] Mr. Eccles’s family banks, being run on a fractional reserve basis, suffered under the ever-present threat of bank runs during the Great Depression’s early years. Once, after being barely saved by the timely arrival of a cash-laden armored car, he insisted his nervous depositors not worry because there was “plenty more where that came from.” Once he ascended to the Fed chairmanship he made good on that promise. By the time he was through printing “plenty more,” the dollar’s value had plummeted over 46%. Congratulations, Marriner Eccles, you win the gold.
The silver medal goes to current crowd favorite Alan Greenspan, who reduced the value of a dollar by 44% during his tenure. Unlike Mr. Eccles, who could at least point to the Great Depression, the New Deal, and a world war as excuses, Alan Greenspan’s massive “stimulation of aggregate demand” took place during a period of prosperity and good times. Never one to stop spiking the punch bowl, Alan Greenspan will go down in history as the man who during his tenure increased the money supply greater than the sum of all his predecessors combined. So while he must settle for the silver, it’s not for lack of effort.
Taking the bronze is poor, sad Arthur Burns, who was sacked by Jimmy Carter of all people. A man widely despised within the Fed for a charmless combination of authoritarianism and arrogance, Mr. Burns engineered a 42% destruction of the dollar’s value despite having less than half the tenure of Mr. Greenspan and Eccles — but sadly for him, time in office is not an element in our award decision.[13] Mr. Burns introduced America to the fun times of “stagflation,” catching America’s economists — he included — completely flat-footed.
So how does newly minted Ben Bernanke look in his chances to crack the above, esteemed list? Judging by his book Inflation Targeting in which he states that “periods of very rapid inflation are clearly destructive. But whether more moderate inflation (below, say, 10% per year) is harmful, is more controversial,” I’m fairly confident he has a decent shot. Leave such a man at the helm of the giant printing press long enough, and I am sure that he can topple even the great Mr. Eccles. So best of luck to Ben Bernanke in his quest for the gold; when it comes to engineering inflation he certainly has the right attitude. Let’s see what he does with it.
Freeze Frame
“I’ll stop the world and melt with you.” – Modern English
Not that the good people of the Federal Reserve like inflation. Their stated mission is to “maintain stable prices”, stable being defined by Webster’s as “not changing or fluctuating.”[14] But why would anyone want to create an economic world where prices stay stable? As Benjamin Anderson wrote, “prices have a job to do.” Prices are like the road signs we follow when driving in unfamiliar territory. They tell us where to go in terms of production. They come about naturally, they are what they are, and no grandstanding, moralizing, or wailing will change them. Experience has shown us, repeatedly, that to set a price by decree will do no more than cause a scarcity or glut.
Arbitrarily decreeing a price for money and credit is as foolish and destructive as decreeing the price of any product. Playing with prices, especially on such a massive scale as the central planning of short term interest rates entails, is tantamount to tampering with the safety valve on a boiler. Prices and safety valves are there for a reason — we disrespect them at our peril.
Even measuring a “price level” to keep “stable” has proven an impossible task. The inputs are far too numerous to track, and you must subtract all market goods which have joined the dodo bird, then add those which have blossomed anew, while making sure that you properly weight the basket to take into account every human being’s ever changing valuations, and then and only then can you go to the econometrician’s ball.
That hasn’t prevented armies of statisticians from trying, God bless their hearts, but no human being has yet been able to climb that statistical Everest. And due to the endless, ever changing variables, accurately measuring a general level of prices using mathematics is about as likely to come about as measuring how insane a man is by mathematically tracking his various body movements. We are not that smart.[15]
I freely admit I got this belief from a man of far greater reputation than I, John Maynard Keynes. In his opus General Theory he writes of “the well known, but unavoidable, element of vagueness which admittedly attends the concept of the general price level”[16] and therefore any attempt to compare price levels from one period to the next is “unsuitable for differential calculus.”[17]
Furthermore, if we would like a stable price level, why then do we cheer and clap over rising productivity numbers? More goods produced by the same amount of input causes a fall in prices. In addition, it frees up capital and labor to produce other useful, heretofore unavailable things for the consumer.[18] It makes your dollar buy more stuff. So everyone is right to cheer for rising productivity. Yet at the same time the same people who are cheering rising productivity are explicitly calling for a monetary policy to “maintain a stable price level” — a policy that, should it succeed to perfection, would destroy the very gains that rising productivity gives to the working masses.
Why on earth would we want to deliberately squander a rising standard of living? No man refuses a raise at his job, yet we cheer on the very men who are deliberately stripping from us the benefits of productivity, God’s pay-raise for us mortals. Why do we do this?
The great historian Robert Conquest once wrote, “Reliance on reason alone is irrational. It neglects the instinctual or deep-set elements of the real human being”.
So there you have it. We do it because, deep down in our genetics, we’re all crazy as loons.
Lesson Never Learned
“Although the gold standard could hardly be portrayed as having produced a period of price tranquility, it was the case that the price level in 1929 was not much different, on net, from what it had been in 1800.” – Alan Greenspan, December 19, 2002
Judging by the numbers (the deliberate destruction of the dollar’s value by 95% since 1913) and what history warns of fiat currency, it would seem only natural for our intellectuals in the field of economics to look at the central bank’s policy of inflation and re-examine its desirability. At this moment, a policy of “stabilizing prices” by deliberately destroying any and all benefits from increased productivity (or anything else for that matter) is widely hailed as beneficial by everyone but me and a few guys in Auburn.[19]
I cannot agree with those who argue for higher prices, which are a reflection of scarcity. I root for lower prices, which are a reflection of progress.
Inflation makes rational forecasts difficult if not impossible for the economy’s only engine of growth: the entrepreneur. Thomas Jefferson once bemoaned the difficulty inflation was creating on his business decisions, writing to a friend “we have now no measure of value. I do not know, therefore, whereabouts I stand in the scale of property, nor what to ask, nor what to give for it.”[20] Ben Bernanke writes in his Inflation Targeting “making it difficult to assess both current relative prices and the future price level, inflation can also distort the decisions of firms about production and investment.”
So not only does inflation introduce the negative feature of higher prices tomorrow, it also introduces confusion and strife today. This doesn’t strike me as an intelligent policy. This is not progress; progress entails making life easier, not harder. Inflation spreads the latter condition throughout an entire economy for everyone.
The French economist and wise ass Bastiat divided all economists into “good” and “bad” judged solely on whether that economist judged policy with any view of its long-term effects. Since no good economist, and no good parent, denies that any policy (or choice of behavior) must be judged on its long-term effects — because not thinking past tomorrow is the mark of a savage — inflation as a policy is distinctly anti-progressive and reactionary. When it comes to inflation, we on Wall Street are not looking past what current stage of the business cycle we’re in. We are dangerously short-term in our thinking.
We should not want a stable price level, but a stable currency.[21] Prices will take care of themselves. The cry that a currency needs to be “elastic” in order to stimulate aggregate demand is based on the fallacy of “overproduction,” this theory being commonly ascribed to Karl Marx. Like most of Marxist dogma, Karl Marx never agreed with the theory, writing in his Theory of Surplus Value “the excess of commodities is always relative, that is, it is an excess at certain prices.”[22] Allowing prices to freely adjust is what clears the market, not counterfeiting dollars.
While I understand that inflation brings certain short-term benefits,[23] I can’t see how that sum outweighs its long-term (and short-term) detriments, and only long-term considerations determine whether a policy is reactionary or progressive. The hallmark of progressive man is that he looks past tomorrow, he thinks about the future. Inflation is a heartless reactionary policy that says the future (and all our children) be damned.[24]
While many talk about the effects of inflation, none talk about the possibility that any group of men given the power to counterfeit money out of thin air would maybe, just maybe, be even a little bit tempted to abuse such power.[25] Even Alexander Hamilton, who enthusiastically endorsed the idea of a central bank, warned against government printing paper money:
“Paper emissions … are of a nature so liable to abuse, and it may even be affirmed so certain of being abused, that the wisdom of the government will be shewn in never trusting itself with the use of so seducing and dangerous an expedient.”[26]
Some will say that I am too untrusting of our public servants, that the men who run the Fed are, without exception, first-class minds. First-class minds in positions of power make me nervous. F. Scott Fitzgerald wrote in Dalyrimple Goes Wrong “first class minds never believe anything until they’ve experienced it”; in other words, they ignore history and all its warnings because they’re smarter than all that. It is always different this time because the best minds (ever!) have descended from heaven to pave our smooth road ahead. Arrogance and a willingness to heed advice rarely go together.
Experience is a harsh mistress, and I don’t want to date her. With the Fed’s policy of deliberately manufacturing inflation we are playing with fire. If all I’ve read in history books about the horrors of a currency’s collapse is true, I hope that, should that day come, I can view the fireworks from a nice comfortable coffin. I pray that Mr. Bernanke, and whoever follows him at the Fed, will be kind enough to give me six feet worth of time.
I can’t save a cent
It takes all of my money
I got the blues
Got those inflation blues– B.B. King
Notes
[1] From the Direct Quote Department: “What’s so curious, given our obsessive relationship with the Fed, is how little credit it gets for affecting economic outcomes.” Caroline Baum, Just What I Said (Bloomberg Press, New York, 2005), p 1.
[2] Before I have to read any long, angry e-mails, allow me to explain my usage of the term “inflation” as per the popular, if incorrect, definition. I am fully aware that inflation as defined by economists is “growth in the monetary aggregates” but since everyone and their brother uses the incorrect definition I will, too. If you want to fight the wind go right ahead; leave me out of it.
[3] Remarks by Chairman Ben S. Bernanke Before the Economic Club of Chicago, Chicago, Illinois June 15, 2006.
[4] Ben Bernanke and Andrew Abel, Macroeconomics, (New York: Addison-Wesley, 1998), p. 239.
[5] Federal Reserve Board Mission Statement.
[6] While we’re on the subject of the Fed’s mission statement, in a recent speech (February 16, 2006) St. Louis Fed president William Poole said “the Fed has stated for many years that a key monetary policy objective is low and stable inflation”. Maybe the Fed Reserve Bank of St. Louis has its own mission statement that differs from the rest of the reserve banks. If you see Mr. Poole at a party, ask him for me.
[7] Murray Rothbard, A History of Money and Banking in The United States, (Auburn, AL: Ludwig von Mises Institute, 2005), page 71.
[8] In a November 13, 2003 column Caroline Baum quotes a former New York Fed research director, “If central bankers threw out all the data that was poorly measured, there would be very little information left on which to base their decisions.” So if they can do it, why not me?
[9] The first two were the First Bank of the United States (1791-1811) and the Second Bank of the United States. (1816-1836) Name the third, win valuable prizes!!!!!
[10] From the OMB website. The proposed 2007 budget includes an increase of $522 million for FEMA. Congratulations FEMA on a job well done!
[11] W.H. Hutt, The Keynesian Episode: A Reassessment (Liberty Fund, Indianapolis, 1979), p 121.
[12] Naturally, this made him a shoe-in for the job of Fed Chairman.
[13] You can hyper-inflate or you can stop the printing presses, it’s all up to you. Time is immaterial.
[14] See Merriam-Webster Online.
[15] And as proof of humanity’s lack of omniscience, I give you Milli Vanilli’s Grammy award.
[16] John Maynard Keynes, The General Theory, (Harcourt Brace & Co, New York, 1964), p.39
[17] Ibid, p. 40
[18] Like the iPod, a product which proves that God loves us.
[19] Before you send that e-mail, please understand that I’m exaggerating.
[20] Letter to Nathaniel Macon, January 12, 1819. This was during the period of America’s second go-round with central banking, from 1816 to 1836.
[21] With the dramatic fall in the price of computers over the past decade, more Americans can now download unmentionable things from the internet than ever before. Now that’s progress!
[22] My italics.
[23] Which politicians consider above all others — yet another reason to separate economy and state.
[24] Not to mention the elderly living on a fixed income, whose aggregate demand for cat food is stimulated by inflation.
[25] Would I? Oh you betcha!!!!!
[26] Alexander Hamilton, Writings (New York: Columbia University, 2001), p.593
