Stealth Inflation

Central bankers have managed to obscure the effects of money printing. But market efficiency gains can’t hide the problems forever.   

Six years into recovery and the economy worldwide is punk, despite central bankers’ belief they can inject just the right amount of liquidity to get things going healthily. Instead of Waterpiks, though, they have been administering monetary stimulus with a firehose. The Federal Reserve and its counterparts in Frankfurt and Tokyo claim they’re saving our bacon. But they can’t get the economy to quicken its step. Money creation continues apace, with calls for more.

More central bank money has not translated into higher prices at the store, at least the way the government counts it. But prices at the brokerage house are a different story. The S&P 500 hits new highs seemingly every week, as “Small Investors Jump Back Into the Trading Game,” according to The Wall Street Journal.

Rookie Fed Chair Janet Yellen has admitted the Fed’s actions (buying 71 percent of the Treasury’s net issuance last year) on interest rates “do matter to the valuation of all assets … stocks, houses and land prices. And so I think it is fair to say that our monetary policy has had an effect of boosting asset prices.” However, the new chairwoman insists, “valuations are not in a bubble territory.”

What the Fed has done for asset prices, it can’t, for the moment, seem to do for goods, services, and especially wages.  Real wages began to fall just after Nixon ditched what remained of the gold standard. Real wages, writes Paul Vigna for the Wall Street Journal, “peaked in 1973, fully 40 years ago. Apart from brief lapses, like in the late 1990s, wages have been falling for a generation.”

Yellen told Congress repeatedly in her coming out hearing on Capitol Hill that the inflation rate needed to be raised to two percent a year or higher. Striking the same tone over at the Associated Press, Christopher Rugaber writes, “Super-low inflation has likely slowed growth from the United States to Japan to Europe. It’s why the world’s central banks would like prices to rise.”

Some would say central banks are already generating plenty of price inflation. While government statistics claim prices are rising only one percent, economist John Williams who constructs price indices the way the government used to do it, says consumer prices are rising at 5% using the 1990 formula or almost double that rate using the 1980 methodology.

Rugaber mentions the price of TVs and breakfast cereal have dropped and guesses “low inflation is surely preferable to runaway inflation.” But ex-Fed Chair Ben Bernanke once said he worries as much about inflation that’s too low as too high. The “masters of the monetary improv,” as Jim Grant calls the Fed heads, think they can make the porridge just right.

The AP scribe equates more money with faster growth and believes consumers will delay purchases if prices aren’t rising. He repeats the common misconception that consumer spending is the primary driver of the economy. Debt becomes more expensive without inflation eating away at the principal over time, he frets. And the ultimate problem with low inflation is it may turn into deflation, when everything goes down in price.

In Chapter 2 of Making Economic Sense, Murray Rothbard lists ten great economic myths, number seven being that allowing prices to fall is unthinkable, because it’s sure to cause a depression.

Rothbard reminds us that, on the contrary, prices generally fell from the beginning of the industrial revolution (mid-eighteenth century) until the start of World War II. Increases in productivity and output in free markets pushed prices down. “There was no depression, however, because costs fell along with selling prices,” Rothbard explains. Wage rates for the most part did not fall and so real wages (standard of living) rose. Only war years were the exception.

Now in the tech revolution, Amazon is a super virtual store with a “margin-crushing, bookstore-demolishing, customer-pleasing merchandising strategy [that] is a visible source of price deflation,” writes Grant’s Interest Rate Observer.

So each and every day Jeff Bezos battles Janet Yellen. However, no matter how much money, time, and aggravation Amazon saves consumers, Yellen’s operation continues to exchange nothing for something, as economist Frank Shostak puts it. “The increase in money supply — i.e., the increase in inflation — is going to set in motion all the negative side effects that money printing does, including the menace of the boom-bust cycle, regardless of the increase in the production of goods,” he explains.

So while Yellen and company huff and puff, trying to blow up consumer prices, it is Amazon shares that reflect the Fed’s handiwork: They trade at 640 times trailing earnings . The S&P 500 P/E is closing in on 20, while its historic average is 15.5.

To change the common meaning of inflation from an increase in the supply of money to the inevitable consequence of such an increase—the rise in prices—was an important semantic trick, explained Ludwig von Mises. When prices rise, government can blame manufacturers and merchants. If prices don’t rise in the short term, the central bank can continue to create money with impunity.

If the world becomes more efficient and prices decrease, that’s called progress. This is much different than “too few dollars chasing too much debt,” creating a “credit event.” Tragically, central bankers do not distinguish between the two and insist on pushing back, “by the means of creating more debt,” writes Grant’s. “They are not fighting fire with fire. They are fighting fire with gasoline.”

Maybe the inflated stock prices make sense. Corporate profits hit an all-time high in the third quarter at $1.75 trillion, up nearly 19 percent from a year ago. Profits accounted for 11.1 percent of the U.S. economy in the third quarter, compared with an average of 8 percent during last decade’s boom.

But how real are these profits, made during a time when the Fed’s balance sheet grew from less than $900 billion to over $4.1 trillion? Mises explained, “It would be a serious blunder to neglect the fact that inflation also generates forces which tend toward capital consumption. One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of illusory or apparent profits.”

Obtaining credit to start or expand a small business that would create jobs has been difficult. The Fed’s zero interest rate policy has done nothing for Main Street with savers being punished for their thrift with tiny yields.  Meanwhile, as Rothbard taught, government and its friends receive newly created money first. Wall Street tops the list and margin debt has soared to a record $444.9 billion. Rothbard explained in America’s Great Depression, “While a stock market loan is no more inflationary than any other type of business loan, it is equally inflationary, and therefore credit expansion in the stock market deserves censure in precisely the same way, and to the same extent, as any other quantity of inflated credit.”

While Wall Street scoops up cheap, new money, rank-and-file workers are near the end of the line. Those not highly skilled have little bargaining power on the job and while hedge funds borrow for basis points, the poor and unskilled borrow at double-digit credit card rates at best, and triple digit pay-day loan rates at worse. Wages never catch up to prices.

With the Amazons and Walmarts of the world bringing us everyday low prices the Fed’s inflationary binge has been hidden from plain view, with the liquidity pushed into to asset prices. Rothbard explained the same thing happened in the 1920s. “The fact that general prices were more or less stable during the 1920s told most economists that there was no inflationary threat and therefore the events of the great depression caught them completely unaware.”

This tug-of-monetary war reminds me of economist Peter Boettke’s three horse race.  His Adam Smith horse drives prosperity through gains from trade. The Joseph Schumpeter horse provides constant innovation from technology. The third entry, the stupid horse, is government.   While Wall Street makes hay with the Fed’s socialist interest rate engineering and bail outs, Main Street survives because of price-crushing, customer-satisfying capitalist merchants. In the end the consumer will win, because, as Ludwig von Mises taught us, socialism can’t survive, because it can’t calculate.


One Response to “Stealth Inflation”

  1. 1st Family Virginia says:

    Socialist may not be able to calculate but they can shoot and are not afraid to. Therefor, they can do untold damage before they collapse, just witness Venezuela.

    Of course this is why they push for gun control as soon as they get power. Otherwise they are afraid someone might shoot back. Alas, as a pacifist, I must try to persuade the illiterati of their mistake.

    Good effort, I will use some of your arguments.

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