Interest About Inflation Seems to be Creeping Back

As usual, Paul Krugman has been going on about how we need more inflation. There is no surprise there, as this has always been his position (though one has to wonder how he feels about the woes of Argentina and Venezuela). Christina Romer has always come forward recently to discuss the need to further inflate the currency. Meanwhile, those of us separated from the Ivory Towers are left to deal with the real effects of currency inflation.

Barley. Think about how helpful lower food prices would have been with incomes crashing and people losing jobs. No, rising food prices are exactly what the farm lobby wanted.

Beef. These prices never fell. Looks like we're losing a lot of nutrition, and this is a population that is already starved for quality food.

Iron. Construction was hit particularly hard by the depression, due to malinvestment accumulating in higher goods industries. Think about what wonders lower prices of raw materials would have done to the failing industry.

Meanwhile, inflation rates in Argentina and Venezuela are near 25%. Is your income doubling every 2.8 years to keep up with that kind of inflation, not to mention your investments? Good luck with that.

What is Causing the High Gas Prices

Reading around the mises.org blog, I was looking for posts about oil markets. Specifically, I was looking for posts that tried to answer the contention that speculators are responsible for higher gas prices. The claim is often made that rising gas prices are due to speculators keeping the price of oil high in order to make money. Well, I found some answers to the contention, and I thought that I would post them here.

The first and easiest answer to find is that most of the rise in the price of oil is due to the Federal Reserve. Of course, blaming monetary inflation is not an uncommon phenomenon among Austrians, but it makes sense. Oil is traded in dollars, so when the supply of dollars goes up or is expected to go up, the price of oil goes up. This would be a direct result of inflation. With more bills and the same scarcity, the end result is a higher price.

What I found more interesting, though, was the indirect result of this inflation. Because of the inflationary policies of the Federal Reserve, nominal prices will tend to rise and the average real value of a bill decreases. This means that when you invest a fixed amount at the current time and expect payment in the future, you will get less in real terms than you expect because of inflation. This drives investment in commodities markets because their value will rise in nominal terms when the supply of bills increases. This kind of commodity speculation is not useful, but how can you blame investors for wanting a hedge against inflation? They are just trying to protect themselves. Commodity investment is supposed to be about predicting demand rises and supply shortfalls so that we can conserve those scarce resources better. When investment is driven by a fear of inflation, what is the purpose to the average consumer? But again, blame the government policies for that, not the speculators who are merely trying to protect themselves.

And probably my favorite explanation of all is the short and sweet one provided by someone called the Anti-Gnostic.

–Trillions in new dollars seeping out of reserves?
–Record levels of deficit spending?
–Supply chain disruption/uncertainty?
–Environmental restrictions?
–Competing consumption by government military operations?

–or–

–Speculators?

Must be the speculators.

St. Louis Fed Inflation Charts

If you've never played with FRED at the St. Louis Fed website, you are really missing out. Let me explain because I know that sounds a little strange. FRED allows you to look at economic data from the Federal Reserve. They have all kinds of data, like consumer price index, wages, GDP, etc. It is all very interesting. So today, as an example of the great things you can do with this program, I will post some intriguing graphs that I made with the program.

So then, it looks like inflation and unemployment are related. The red graph is CPI showing the percent change, and the blue line is total nonfarm employment percent change. So then, it looks like whenever CPI falls that unemployment rises and when CPI rises employment rises. I just have a few issues: 1991 and 2008. In these times we see the opposite being true. In 1991 when CPI rose unemployment fell anyway, and in 2008 when CPI fell unemployment did not really experience a change. In fact, rising CPI right after shows decreasing employment.

So there are a few flaws, but it generally looks pretty good, right? Well, if you have been following this blog you know that CPI understates inflationary changes and so I am not a fan of it.

This graph, I believe, is much more informative. It shows the percent change of M1 (a money stock) and percent change of total employment. Notice a trend? I see huge spikes in M1 during recessions and tremendous falls in employment anyway. Furthermore, look at the period between 1900 and 2000. When M1 was rising employment was rising. However, when M1 was decreasing, unemployment did not change. Is that a big problem? You bet, as the same problem is evident between 2000 and 2005.

Finally, a very simple graph. It shows inflation in food prices each quarter. Notice how food has rarely bee cheaper, and how the rise in food prices today is relatively high? And this is still using a CPI method that understates inflation. Should we be concerned? I think the graph shows that this is very worrisome.

Now I know that I presented some controversial conclusions, but my main point was to show what you can look up with these graphs and how useful they can be. They are fun, but just remember that correlation does not prove causation, the post hoc fallacy, and that government measures are seriously flawed and able to be tampered with. The only good conclusions in economics can come from a priori reasoning, so while this is enjoyable, remember that the basis of truth in economics comes from good reasoning, and empiricism can never show you causation, only theory can.

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Why is Inflation so Bad?

I intend to have a much more detailed answer to this question some time in the future, but for now I thought that I would try to answer the question in a somewhat limited fashion. The word inflation has a few different meanings. Today when most people hear the word they think about a general rise in prices, or about stagflation in the 1970s. It is easy to see why this definition is popular today. Price inflation hurts and it is obvious. It makes food and gas and all goods more expensive, and we feel the pinch directly. Back in the 1800s, though, the word inflation had a very different meaning. Rather than price inflation, it meant monetary inflation, that is, a general rise in the supply of money. Now this is interesting, because today monetary inflation happens and it happens to a great extent. No one is going to deny that fact. However, central banks think that they can get away with it because price inflation is not all that high. They think that they have fooled us.

I will not go into how price inflation is bad, because that is obvious. Monetary inflation, on the other hand, hurts us in a more indirect way. The easiest way to see this is with simple economic analysis. By the laws of supply and demand, we know that when supply has increased, price will decrease, all other things being equal. So when we have a higher supply of bills, therefore, the value of each of those bills will be lower. Now, some will point out that the all other things being equal stipulation is not always true, and granted, it usually is not true. However, the fact remains that the value of the bills is lower than they otherwise would be without that inflation. There is no way around that fact. Therefore, monetary inflation makes us poorer than we would be, and that is always true.

Though this seems bad, this is not the most sinister effect of monetary inflation. A more thorough analysis of the issues requires looking at the practical way that government have gone about instituting that monetary inflation. In the United States, at least, the monetary inflation comes about when the Federal Reserve purchases treasury bills (that is, the debt of the United States). The Federal Reserve, in essence, is lending money to the United States, but that money is newly printed (in effect). The government then goes out and spends this money, usually with new construction jobs. These jobs use up capital like machines and raw materials and labor. Now, inflationists like to say that this has no effect on interest rates. They are right, this aspect of the Federal Reserve does have no effect on interest rates. They then go on to say that capital markets are not affected. On that point, they are dead wrong. The new construction projects undertaken by the government necessarily use up capital, and this means that capital goods are more expensive for everyone. So even though interest rates have not gone up, businesses now need to get a bigger loan in order to cover the costs of their projects. Even if the price of capital goods has not gone up in time, they are necessarily higher than they otherwise would be. But why is this bad? Because government is necessarily less efficient than the private sector. They undertake projects based on what is politically favorable; they do not base it upon consumer demand. So the cost of the things we want, essentially, go up because the government is building things that we do not want as much. That makes us worse off.

So do not be fooled by Ben Bernanke prattling on about how prices are not rising, so his actions are not affecting us. He is lying. Monetary inflation is hurting us, both directly and indirectly. We are less wealthy than we otherwise would be without the inflation, and goods are more expensive than they otherwise would be because the price of capital has gone up. Just say no to monetary inflation. It is a recipe for destroying wealth.

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