Need We Fear Inflation?
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Posted: 03/13/07
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Need We Fear Inflation?
By Thomas E. Brewton
Contrary to the popular understanding, higher wage rates and higher
oil prices do not cause inflation. They are symptoms of the real
danger.
News reports express concern that the tightening labor market and
increasing oil prices will lead to increased inflation. This is an
upside-down view of reality.
Inflation is nothing more nor less than an increasing ratio of money
to available goods and services.
Higher prices – rising wages or higher oil prices, for example –
result from two things.
First is excessive money supply creation and the resulting excessive
amount of bank credit pumped into the economy.
Second is a change in the balance between supply and demand. Wages
will rise whenever increasing business activity necessitates hiring
more workers, with the requisite skills and experience, than are
available in the needed locations. Oil prices will rise because
demand exceeds current or anticipated supplies in the locations where
oil is needed.
In either case, price increases are the result, not a cause.
Free markets are automatic and self-correcting. If wages rise,
businesses will decide either that the wage costs of increased
production will leave too little profit to warrant hiring more
workers, or the higher wages will induce more people to enter the
labor market to meet the increased demand. In either case, wages
will level off or decline.
This means that Congress's raising the minimum wage or imposing
threatened price controls on gasoline and heating oil do nothing
whatever to curb underlying inflation. Raising the minimum wage just
lowers the point at which businesses will stop hiring more workers.
Gasoline and heating oil price controls, as we learned again when
President Nixon tried them, will simply divert oil to other markets
without price controls.
This also means that Keynesian economic orthodoxy, as employed by the
Federal Reserve Board, is still as misguided as ever. Keynes
believed that business production and investment in expanded capacity
could be supported only by welfare-state transfers to consumers,
whose spending would lever up economic activity and employment. This
remains sacred dogma for liberal Republicans and liberal Democrats.
The problem is that government spending precedes increased
production. The rising ratio of money supply to goods imparts an
inflationary bias.
Moreover, unlike the automatic, free-market mechanism that reduces
demand to supply, or increases supply to meet demand, government
propensity to spend has no built-in limit, nor has ill-informed
voters' desire for more spending.
Debasing the dollar via excessive government spending, in historical
precedent, will be checked only when other nations refuse to accept
more dollars in payment for imports and begin demanding payment in
some other, sounder currency. We are moving closer to that point.
Only once in the post-World War II era has the Fed dealt
realistically with the real cause of inflation: excessive increases
in the money supply.
In the early 1980s, confronting our Great Society stagflation with
inflation in the teens, the Fed’s new Chairman Paul Volcker acted on
the economic reality that inflation is no more than too much money
chasing too few goods and services, that the way to curb inflation is
to control 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.
"......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.”
Interest rates rose to very high levels in the short run, but
inflation was broken and stagflation ended.
This was a classic illustration of supply and demand economics. When
the supply of money is decreased, the price of money – interest rates
– will rise until consumers are unwilling to pay the costs of
additional consumption, or businesses' costs rise enough to make
added production unprofitable. Either way, equilibrium between
demand and supply is restored and prices (including interest rates,
the price of money) stabilize.
Since then, unfortunately, the Fed has reverted to the old,
completely discredited Keynesian faith that government planners can
fine-tune the economy via government spending and interest rate
manipulation in order to attain full employment, price stability, and
steady GDP growth.
Rather than stabilizing the money supply, the Fed now indirectly
raises short term interest rates. The effect of higher interest
rates works its way backwards, from the Fed to businesses and
consumers, making production and consumption more costly.
This is upside-down. Interest rates in a free market, following the
law of supply and demand, will rise in reaction to increased
production that necessitates increased borrowing by businesses.
Instead, the Fed attempts to forestall increased production by
raising interest rates. The risk is that the Fed's arbitrary rate-
setting will either precipitate a recession, or allow inflation to
get out of hand.
Finding the correct balance point, about which former Fed chairman
Alan Greenspan often worried, requires more analytical brain power
than socialist state-planners possess. With 300 million consumers
and many thousands of businesses independently anticipating Fed
policy and future economic conditions, the world's largest
aggregation of supercomputers would be inadequate for the task, even
if there were enough analysts to input all the data on a real-time
basis.
By default, the Fed has to make an informed guess about where
interest rates ought to be. Which is why we read that some Fed
governors are worried about mounting inflationary pressures, while
the Fed Board votes to keep rates unchanged and Chairman Bernancke
tells us that "core" inflation is still not too worrisome.
Meanwhile, the real source of inflation – the money supply –
continues its unchecked growth as the Fed finances ballooning
government expenditures.
Keynesian and other liberal-Progressive-socialistic theories, as
history demonstrates, do not work as advertised, because they are
founded on a false theory of human nature. The underlying assumption
is that, after government taxes and spending have equalized income
among economic, ethnic, and social classes, the populace will happily
settle into homogenized equality, every person working to the best
of his ability, taking only what he needs.
Needless to say, in real life, since the New Deal when Presidents and
Congresses got the bit in their teeth and realized that unceasing
spending buys votes, there has been no turning back. We wallow in
the spoils system, with the Fed debasing the currency to "pay" for it.
Thomas E. Brewton is a staff writer for the New Media Alliance, Inc.
The New Media Alliance is a non-profit (501c3) national coalition of
writers, journalists and grass-roots media outlets.
His weblog is THE VIEW FROM 1776
http://www.thomasbrewton.com/
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