The Snake Oil of Inflation


Janet Yellen recently gave her first press conference as the new Fed Chair-person. Being the stalwart Keynesian that she is, emphasis was given on the Fed’s targeted inflation rate. One of the problems here being in how modern economists define inflation. Over the course of history inflation has gone through a type of metamorphosis as to what is actually being inflated.

Definition of Terms

Ludwig Von Mises said it best when he stated at a 1979 lecture,

“Unfortunately, in the United States, as well as in other countries, some people prefer to attribute the cause of inflation not to an increase in the quantity of money but, rather, to the rise in prices.”

Economic Policy: Thoughts for Today and Tomorrow

This convenient definition removes the burden from the entities that are actually doing the inflating. As if some external force, usually a “market failure” or corporate greed, is to blame when rising prices get out of control. Let us be clear, inflation refers to an increase in the supply of money and credit. Period. The term was used in reference to an inflating balloon. Like a balloon, the inflation of money begins at one central point and expands outwards in all directions. That central point is of course, the central bank. As the central bank begins to inflate money, it’s member cartel banks begin to loan out the new money. In a fractional reserve banking system, such as ours, that new money is loaned out at a ratio of 10:1. At least it used to be 10:1. Now, no reserve is required. A bank could actually create credit without any Federal Reserve requirement. That means that member banks can loan out money that doesn’t even exist. Not even one tenth of the new credit is backed by any money on reserve. This new credit, which is earning interest, is backed by nothing! In all honesty, this credit is backed by the government’s ability to bail out the banks at the first sign of trouble with borrowed money from, you guessed it, the Fed. Or, the banks could do a “bail-in” where depositors are required to pay for risky banking speculations that have gone bad. Either way, the moral hazard by removing the market discipline and socializing losses is still quite egregious.

In the 19th century, farmers would bring there grain to Chicago to be stored in silo facilities which would, in turn, issue a warehouse receipt for the grain that was in storage. This warehouse receipt was as good as the real grain when traded on the Chicago Futures Market.  Some warehouse proprietors realized that the owners of the grain would almost never ask for all of their grain back at once. So, they began to trade other people’s grain on the market. They became quite rich in the process and raised some suspicion. Before long, these proprietors were charged with theft and imprisoned for their crimes.  But this is exactly what fractional reserve banks do everyday and somehow, it’s legal. Worse, today’s lax standards allow the banks to create credit money without any grain in the silos.

So far it has been Fed policy to pay interest to the banks, asking them not to loan out the 4 trillion plus of new money on reserve. Had this not been the case, the gargantuan amount of new credit money that fractional reserve banking would produce would throw the United States economy into a devastating hyper-inflationary cycle. The dollar would lose it’s coveted world reserve status and be worth exactly what it is, an empty promise.

Targets

Before Yellen took over as Chair-person, Ben Bernanke had set the target inflation rate at 4%. That is, his goal was to get “the price level” at a 4% rise in prices, month after month. In times past the target rate was the ceiling, not the goal. As Keynesians do, they invent new economic terms to suit the situation. Alan Greenspan was a master at it. We get “animal spirits”, “aggregate demand” and here “the price level”. Just what is “the price level”? As Mises put it in that same 1979 lecture, the term “price level” should never be used,

“When people talk of a “price level,” they have in mind the image of a level of a liquid which goes up or down according to the increase or decrease in its quantity, but which, like a liquid in a tank, always rises evenly. But with prices, there is no such thing as a “level.” Prices do not change to the same extent at the same time. There are always prices that are changing more rapidly, rising or falling more rapidly than other prices.”

Since the horrendous inflation of the 1970s the Fed has gotten a little wiser about the public image of rising prices. They have devised different indexes to measure prices. The methodology of measuring these prices have changed since the 1970s and early 1980s. If highly demanded goods, that rise faster in price than others, (food, energy and clothing) were eliminated from the index then the illusion of a slower rise in prices could be achieved. So that’s exactly what the Fed economists did. Until January of this year “inflation” that is “the price level” was upward in the 2% range. But, in January the Fed economists decided to chain weight the price index. This lowered the figure to around .7%. Typically, when the government doesn’t like the outcome, they just change the definitions and methodology. Why is it so important to keep these numbers so low? To answer this is to understand who benefits from an inflating money supply.

Follow the Money

As Mises explained earlier, prices don’t rise equally. They are impacted by the new money and credit according to who gets it first. In our case, the central government, the financial banks and their friends are first in line. The Wall Street banks buy into the asset markets and stock markets while prices are still relatively lower. This new demand causes prices for those assets to rise, inflating the valuation of their portfolios. As these prices rise other investors see what appears to be a bear market and get in on the rising tide. This inflates the price for these stocks and assets even more. Note, that only the prices are rising. This new “wealth” is on paper only. The actual values as measured in a P/E Ratio (price to earnings) aren’t rising. The larger corporations, hedge funds, brokerage houses and so on get the money next. The corporations, in order not to appear left behind, purchase their own shares to inflate their respective share prices. Remember, in all of this fervor no real economic activity is happening. Only nominal goods and services that consumers demand are being produced. Only nominal new private sector jobs are being created. Only computer entries, trades, commissions and fees are shuffling around. The stock market ascends to new highs, asset prices are pumped ever higher and Main Street is forgotten. This giant stock market bubble is a classic Austrian Business Cycle in the making. As always, all bubbles must go bust.

The government, on the other hand, has entered the market directly. With their trillion dollar budgets they become the highest marginal buyer. Whatever goods and services the government demands creates higher prices. The cycle continues as contractors and government employees receive their money and enter the market buying goods and services. Until now the average Joe, who hasn’t received any raise in his wages, can only observe ever more prices going up all around him. The average wage earner is the last car in this inflationary train wreck. Obviously, Main Street receives no benefit from rising prices and stagnant wages.

Meanwhile, the business networks brag about their rising portfolios and talk about a jobless recovery. They have fooled themselves into believing that the worst is behind us. The Fed Chair-person explains to congress how dangerous falling prices can be in a deflationary period. The business media targets people like Peter Schiff, Marc Faber, Jim Rogers, Jim Grant and all of the Austrian economists because they still believe the worst is yet to come. The military has an ordnance with a non-nuclear yield of 11 tons of high grade explosives called the MOAB (Massive Ordnance Air Blast aka Mother of All Bombs). The Keynesians at the Fed and our leading universities have created their own MOAB (Mother of All Bubbles) which will destroy much more than any bomb.

There is now no mystery as to why the mainstream peddles their snake oil of inflation to the economically ignorant public. It is much simpler to blame corporate greed, exploitation, capitalism or whatever public education has been feeding generations of Americans. Those who receive all of the benefit from an inflationary system also owns the media outlets. Thus they control the message.

Conclusion

What Austrian economists fear is the boom, understanding that the bust will come and real people will get hurt. They know that during the bust, if left alone, the free market will rearrange capital into those areas of the economy where it will be better utilized.  Prices will fall in those markets that must clear goods that were wrongly produced, giving some relief for wage earners. But, we know that the Keynesians in charge will not let that happen. They will interfere with the natural market process again and again. In so doing they will channel wealth from the lower wage earners up the food chain to the top. The inflationary, debt based monetary system of fiat currency is the world’s largest pyramid scheme. There are only a few receivers at the top and a large amount of payers at the bottom. They will stop at nothing to keep the scheme going. They’ve fought world wars for it, toppled governments and starved developing countries. There is one thing for certain, like the laws of nature, the laws of economics will not be mocked. Like all pyramid schemes, this one too will run out of steam and fail. What concerns me is how that failure will play out. Understanding human action, the prognosis is not good.

[This article first appeared on The Libertarian Liquidationist]

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