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Barry and George and Ben. Oh My!
Peter Schiff has a new article out cataloguing the misery that is coming down the pike. In 1979, Milton and Rose Friedman wrote a book called Free to Choose: A Personal Statement. In it the Friedmans decribed the causes and remedies for inflation.
Five simple truths embody most of what we know about inflation:
1. Inflation is a monetary phenomenon arising from a more rapid increase in the quantity of money than in output (though, of course, the reasons for the increase in money may be various).
2. In today’s world government determines – or can determine – the quantity of money.
3. There is only one cure for inflation: a slower rate of increase in the quantity of money.
4. It takes time – measured in years, not months – for inflation to develop; it takes time for inflation to be cured.
5. Unpleasant side effects of the cure are unavoidable.
As Schiff notes in his article, the massive amounts of spending by GWB and Obama, abetted by Bernanke’s keeping interest rates exceptionally low, have conspired to increase the amount of money available in the market. As the Friedmans point out, any time the money supply increases at a rate faster than the supply of goods on which to dispose of that money, inflation results. Furthermore, as the Friedmans point out, it takes years to feel the effects of the government’s policies. Once the die is cast, however, the outcome is inevitable.
Like a doomed Greek hero, Bernanke believes he can avoid his fate. But, like Oedipus, no matter what gyrations Ben attempts his Uncle Sam is doomed. Moreover, the question that Schiff poses is whether Bernanke will have the balls to face down his government masters to impose the only solution that might work to fend off the approach of the Inflation Monster. As the Friedmans point out, government never takes responsibility for its role in creating the monster:
No government is willing to accept responsibility for producing inflation, even in less virulent degree. Government officials always find some excuse – greedy businessmen, grasping trade unions, spendthrift consumers, Arab sheikhs, bad weather, or anything else that seems even remotely plausible.
Moreover, the government actually benefits from high inflation. To give one example, today we have sold billions of dollars of debt to the Chinese. We take money from the Chinese, which is worth a dollar today to finance whatever projects we want to spend teh money on. In ten years, after a serious inflationary period, we pay them back with dollars which are worth very much less. The Chinese have been screwed and the government finds that it has borrowed money for nothing or better than nothing – they have paid us to finance our spending.
In the face of the large benefits to the government, does anyone really believe that Bernanke will be able to stand up to whoever sits in the Oval Office and tell him no? Sure, the consumer will have felt the pinch and may be hurting. But, the cure for inflation causes the economy to slow down. Would a president want to slow the economy when the people are feeling their economic woes so strongly? Not likely. And despite Ben’s assurances, it is likely he will not have the fortitude to face down the president, the people, and tell them, “This is for your own good. Take your medicine. It will make you better, even if you feel worse for a while.”
This country is in for some tough times ahead. GWB started it. Obama made it much worse and appears intent on heaping even more coal on the fire. The Friedmans liken an inflationary period to binge drinking:
A more instructive analogy is between inflation and alcoholism. When the alcoholic first starts drinking, the good effects come first; the bad effects only come the next morning when he wakes up with a hangover – and often cannot resist easing the hangover by taking “the hair of the dog that bit him.”
The parallel with inflation is exact. When a country first starts on an inflationary episode, the initial effects seem good. The increased quantity of money enables whoever has access to it – nowadays, primarily governments – to spend more without anybody else having to spend less. Jobs become more plentiful, business is brisk, almost everybody is happy – at first. Those are the good effects. But then the increased spending starts to raise prices; workers find that their wages, even if higher in dollars, will buy less; businessmen find that their costs have risen, so that the extra sales are not as profitable as they anticipated, unless they can raise their prices even faster. The bad effects start to emerge: higher prices, less buoyant demand, inflation combined with stagnation. As with the alcoholic, the temptation is to increase the quantity of money still faster, which produces a roller coaster was have been on. In both cases, it takes a larger and larger amount – of alcohol or money – to give the alcoholic or the economy the same “kick.”
The parallel between alcoholism and inflation carries over to the cure. The cure for alcoholism is simple to state: stop drinking. It is hard to take because, this time the bad effects come first, the good effects come later. The alcoholic who goes on the wagon suffers severe withdrawal pains before he emerges in the happy land of no longer having an almost irresistible desire for another drink. So also with inflation. The initial side effects of a slower rate of monetary growth are painful: lower economic growth, temporarily high unemployment, without, for a time, much reduction of inflation. The benefits appear only after one or two years or so, in the form of lower inflation, a healthier economy, the potential for rapid noninflationary growth.
It will be interesting to see if Bernanke has the wherewithal to resist the urge for a little nip when the hangover comes. His previous track record with the subprime fiasco indicate that he may have good intentions, but his judgment is not always sound. Bet on the occasional shot…just to get us through the night.
Update:
Somewhat related is this latest from the Southern Avenger who posts at TakiMag.
