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Depression Explaining the Great Depression, its Trade War, and failures of "New" Keynesian interest rate suppression policy without ideological clap trap, theory confirmation bias or political spin. |
"Understanding the Economic Basics &
Modern Capitalism: Market Mechanisms and Administered
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Wealth of Nations. Ricardo: Principles.
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FUTURECASTS online magazine |
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However, this does not mean that it is wrong
to use the extent of price increases to measure the scope of
inflationary forces - as long as this is not done simplistically
(as it almost always is). These statistics must be evaluated
in view of a variety of poorly measured factors. The evaluation
must recognize that the price statistics cover just a part of
the problem - and that even that coverage is very inaccurate. ? |
Monetary inflation is actually a tax by which government - by expanding the money supply - transfers wealth from its people to itself.
It also results in the transfer of enormous amounts of wealth from the hands of ordinary people to the hands of those speculators shrewd enough to take advantage of the price volatility inflation causes in the markets. |
Indeed, the measurement of inflation is
notoriously inaccurate. The government and many people have
a vested interest in these inaccuracies, because benefits due
under social security and other government programs - or under
labor contracts and commercial contracts - may be indexed to the
inaccurate figure. ? On the one hand, "price inflation" statistics are overstated because they don't reflect increases in the quality or variety of commercial goods and services offered - or increases in the productivity of productive assets produced. They are slow to reflect new products, which are often the beneficiaries of especially rapid increases in productivity (although this last weakness has been diminished somewhat in recent years - and indeed may well have been reversed). ? On the other hand, "real inflation" statistics are understated because they measure "price" inflation instead of the pressures that cause price inflation. They also generally omit asset price inflation, which is real inflation and enormously destabilizing. ? Prices would decline about three percent per year to reflect the increase in productive efficiency of our rapid technological progress - if government were not creating inflationary pressures. Indeed, except during the years of the gold rush and the Civil War, modest rates of price deflation - in excess of one percent per year - were the rule in the 19th century, when the dollar was tied to gold and the United States became a wealthy economic powerhouse. ? Today, even when there is little "price" inflation, stable prices just mean that government, by printing more money or otherwise expanding the money supply ("monetary inflation"), has appropriated for itself all the price benefits of each year's increase in productive efficiency. ? Monetary inflation is actually a tax by which government - by expanding the money supply - transfers wealth from its people to itself. Indeed, inflation is perhaps the most destructive tax that can be imposed - but unfortunately it is the easiest one for a government to impose on its people. It also results in the transfer of enormous amounts of wealth from the hands of ordinary people to the hands of those speculators shrewd enough to take advantage of the price volatility inflation causes in the markets. ? |
With productivity gains running in excess of three percent, and prices rising in excess of two percent, the real rate of inflation is already currently well in excess of five percent - representing a capital levy of five percent (as of the beginning of 2004). |
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The pertinent statistics are grossly inaccurate,
but even when very conservatively evaluated, inflationary forces
in excess of 5 percent are indicated. At current levels, the
forces of inflation have achieved considerable momentum and thus
are proving more troublesome to control and reduce than expected. Even
at current levels, the effort to bring inflation back under control
- to where price inflation can be contained below 2 percent -
is likely to cause some real economic distress. If inflationary
forces are allowed to get much stronger, the economy would begin
to revisit the problems of the 1970s. See, Meltzer, History of
the Federal Reserve, v. 2 Part VI, "Nixon Devalues the Dollar,
(1960-1973)," and Meltzer, History of
the Federal Reserve, v. 2, Part VII, "The Great Inflation
(1973-1980)." ? Indeed, the U.S. will soon begin paying for the monetary expansion loosed in the effort to deal with the recent (2001) recession. (Indeed, the Credit Crunch recession in 2008 was the result.) ? |
Defining "inflation:" |
From the foregoing analysis, it is clear that we must carefully distinguish several related but separate concepts. |
One of the unfortunate consequences of heavy reliance on debt financing is to turn the great benefits of price deflation into a severe threat to the debt-laden financial structure of the economy. |
This "cause"
is so dominant that it should be the first thing that comes to
mind when referring to "inflation" during peacetime.
"Clipping the coinage" was, historically, the first
method used, followed shortly by "debasing the coinage."
In the 1960s, the United States substituted baser metals for
the traditional silver content in its coinage. "Running
the printing presses" arose with the advent of paper money.
This was practiced most notoriously by the central bank of the
Weimar Republic, which tried to stay ahead of the loss of purchasing
power caused by price inflation by "maintaining liquidity
balances."
The pleasant delay between the cause (monetary inflation) and this effect (price inflation) can be extended by expending financial reserves of gold and hard currencies to support the value of the inflated money. After WW-II., the United States expended most of its huge hoard of monetary gold to extend this pleasant period for two decades.
Among other inflationary causes - besides monetary inflation
- are price controls and the expenditure of monetary reserves
- both of which ultimately inhibit the growth of supply and sustain
the period of artificially expanded demand. Of course, price
inflation is an important part of the estimate of real inflation.
However, so is the estimate of productivity growth - which would
beneficially lead to reduced consumer costs but for inflationary
forces.
In addition to the expansion of the money supply, this
includes such factors as price controls, and expenditure of substantial
percentages of monetary reserves (which tends to immediately
hold down price increases, and to ultimately increase financial
risks and interest rates throughout an economy). Business taxes
and import tariffs have an inflationary impact because they directly
decrease the productive efficiency with which the economy produces
goods and services. |
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To be functional, the definition of "inflation"
has to encompass that which is "inflationary" - the
economic forces that ultimately cause general and sustained increases
in price levels. It must NOT include the price increases themselves
- even though it is proper to use those price increases as one
of the important factors in measuring inflationary forces. It
must NOT formulistically confuse cause with just one of several
possible effects - no matter how important that particular effect
might be. ? |
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To begin with, not all price increases
are the result of the forces of inflation. General increases
in price levels can occur as a result of normal temporary cyclical
upswings and the higher credit utilization levels that normally
accompany prosperous times. General increases in price levels
can also occur as a result of supply disruptions caused by labor
unrest, political turmoil, or war, which can increase prices
only temporarily unless "accommodated" by an increase
in the money supply - which frequently happens. ? While price increases are the most usual result of the buildup of inflationary forces, and are invariably (although not theoretically unavoidably) its ultimate outcome, the buildup of inflationary forces can proceed for years, or even decades, before manifesting themselves in rising prices. Even when inflationary forces begin to cause problems, they can disrupt an economy in many ways other than by pushing prices higher. ? Generally, after an initial period of pleasant increased demand and broad economic stimulation, inflation manifests itself not just in rising prices, but in an increase in economic dependency on continued inflationary stimulation, and in a decrease in the purchasing power of credit. It may induce the imposition of price controls and the expenditure of reserves. The increasing economic dependency on continued inflationary stimulation obviously begins long before prices start rising. ? An increase in imports unaccompanied by an increase in exports is a vital factor during initial inflationary phases that undermines payments balances and ultimately forces currency devaluation. This is a key weakness in Keynesian palliatives widely ignored by Keynesian economists but emphasized by the publisher of FUTURECASTS for 40 years. See, Blatt, "Dollar Devaluation," (1967). ? Economic dependency and adverse credit shifts are far too complex to be fully expressed as equations or accurately reduced to mathematical terms or derived from our crude economic statistics. Distorted economic and financial flows - adverse impacts on international trade and payments balances - increases in nominal interest rates - and increases in perceived financial risks are among the early unpleasant effects of monetary inflation. ? However, this dependency and reduction in purchasing power is the reason why, even at an early stage, austerity policies - the cessation of the stimulatory policies that gave rise to the inflationary forces - will cause an economic slowdown. This is why inflation is so painful to stop. ? Inflation is like an addiction. The economy must suffer a painful decline in demand upon cessation of the stimulatory causes of inflation. Even though inflation is easy to stop as a theoretical matter, this is why it is so difficult to stop as a practical matter. ? |
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An obvious example of reduced purchasing
power occurs under price controls. With prices fixed at official
levels, economists and politicians can - and routinely do - ignore
obvious decreases in purchasing power and claim that there is
no inflation. ? |
For many years, a substantial proportion of
our economists made the ridiculous assertion that WW-II price
controls kept inflation at about one tenth of the actual loss
of purchasing power that took place during that period. Prices
on the black (free) markets, and the ultimate surge in prices
in the year after prices were set free, more accurately reflected
the real extent of inflation during WW-II (about 50 percent in
just four years). |
Reserve currencies:
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A general liquidation of savings and reserve
assets is another way in which inflation can manifest itself
with or without rising prices. For two decades after WW-II, the
United States was able to ignore the inflationary implications
of its inflationary economic policies by selling off its huge
holdings of gold. Just as boiling water carries off heat and
prevents any further temperature increases within a pot, the
sell-off of reserve assets dissipated inflationary pressures
and temporarily shielded consumer prices from those pressures. ? |
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Of course, when reserves ran low,
it became obvious that the credit of the United States had suffered
a substantial albeit not precisely measurable decline in purchasing
power. During those two decades before the exhaustion of gold
reserves, inflationary forces were permitted to build to a prodigious
extent - hidden from public view - and generally ignored by politicians
and economists alike. |
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Even when inflation manifests itself in rising
prices, the measurement of the general impact is far from
simple. Rising interest rates - reduced price/earnings ratios
for equity investments - increasing international payments and
trade deficits - the loss of economic flexibility, stability
and resiliency - the growth in debt levels and a shift from long
term to short term financing - the perception of a general increase
in financial risks - the increasing emphasis on short term results
- all significantly reduce a nation's financial health and economic
prospects in ways that can't be precisely measured. They are
all among the many faces - the many effects - of inflation. ? |
In the private sector, high interest rates
have their most dramatic impact on equity investments - both
stock market and private. High interest rates undermine equity
investments in several ways. ? One of their most important impacts is as a direct competitor for the investor's dollar. By increasing the difficulty of raising equity capital, high interest rates directly undermine financial stability and slow the growth of economic capacity needed to meet inflationary demand. They reduce price/earnings ratios. ? High interest rates obviously increase economic costs and risks both for the individual business and the economy as a whole. In addition, high interest rates obviously reduce incentives for long term economic projects. ? High interest rates reduce borrowing for consumption, production and investment purposes. Ultimately, efforts to keep interest rates down by means of rapid money supply increases MUST lead to higher interest rates than would otherwise occur. ? |
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Inflation is a process, not a thing. The real
problem is thus to define those factors that cause inflation
- those factors that are "inflationary." ? |
That which increases demand without immediate
relationship to supply, and that which reduces supply without
immediate relationship to demand, is "inflationary." ? Also, that which prevents or inhibits the growth of supply to meet increased demand, and that which prevents or inhibits the reduction of demand to conform to a supply reduction, is "inflationary." Such government policies as expansion of the money supply, restraints on international or domestic commerce, and controls on prices, profits, rents or interest, all fit this definition. ? |
So, then, what is the functional definition of "deflation?" |
The causes of "deflation:"
When prices decline due to productivity increases, the declining prices powerfully increase purchasing power and demand even as the productivity gains increase supply.
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Deflation is a process, not a thing.
The real problem is thus to define those factors that cause deflation
- those factors that are "deflationary." ? PRICE INCREASES ARE OBVIOUSLY DEFLATIONARY - NOT INFLATIONARY. ? Price increases powerfully induce increases in supply and decreases in demand - which tend to diminish and even throw into reverse the forces pushing prices up. ? Productivity increases are not deflationary even when they cause prices to decline. Productivity increases stimulate both supply and demand in ways that can be balanced and healthy for economic growth. When prices decline due to productivity increases, the declining prices powerfully increase purchasing power and demand even as the productivity gains increase supply. However, the impact of the price declines on a heavily indebted economy can be deflationary. But that is a function of the debts, not of the productivity increases or the productivity induced price declines. ? Processes of inflation and deflation will generally be at work at the same time. By the time inflation manifests itself in rising prices, it is powerful enough to overcome the reemployment of unemployed labor and productive assets. It is powerful enough to overcome the balanced processes of productivity gains as well as the deflationary processes caused by the inflation - including ultimately increases in unemployment of labor and capital assets. ? Ultimately, there is no tradeoff between inflation and unemployment. Chronic inflation ALWAYS ultimately causes unemployment of labor and capital assets. It is only in the short run - which for most nations is just a few years in duration - that inflationary policies such as those advised by Keynes can reduce unemployment. ? |
Because of self-correcting market mechanisms, only government can cause runaway inflation or chronic depression. |
We must carefully distinguish causes from
effects. The causes of inflation cause the effects that,
although naturally associated with inflation and responsible
for much of its economic pain, are actually deflationary and
must inevitably - if permitted - quickly bring inflation to an
end and help restore the basis for healthy economic growth. Similarly,
causes of recession cause the effects that, although naturally
associated with recession and responsible for much of its economic
pain, are actually stimulatory and must inevitably - if permitted
- quickly bring recession to an end and help restore the basis
for healthy economic growth. Unfortunately, however - as stated above - an
economy heavily dependent on debt financing rather than equity financing,
and heavily dependent on debt financing for consumption rather than for investment, may
collapse as a result of price deflation. This can effectively eliminate price
deflation as a powerful self-corrective mechanism for increasing purchasing
power and demand and mitigating recessions. Today, a heavily indebted world
fears price deflation. ? Because of these powerful correcting mechanisms in the private markets, only governments cause runaway inflations - as the United States government did in the 1970s. Because of these powerful correcting mechanisms in the private markets, only governments cause chronic depressions - as the United States government did during the 1930s. ? |
Inflation never "runs away." Only
by stupidly persisting in expanding the money supply do governments
overcome the deflationary impact of price increases and impose
chronic inflation on an economy. ? Whenever capitalist systems suffer chronic inflation - or suffer chronic recession or both together (stagflation - or even worse - inflationary depression) -- IT IS ALWAYS CAUSED BY GOVERNMENT POLICIES. ? |
Monetary expansion ("Monetary policy"): |
Chronic price increases cannot occur
without such stupid government policies as those that artificially
increase demand and/or reduce supplies - invariably featuring
some method of increasing the money supply and/or artificially
holding prices at less than market levels. ? |
Of course, rising prices hurt - while
increases in spending financed with newly created money is quite
pleasant. That's why political leaders have opted for inflation
so often, despite its noxious long term impacts. ? However, those rising prices are the natural way in which demand is curtailed and increased supplies are induced. They may be the natural effects of past inflationary policies - but they are clearly anti-inflationary. They will always bring inflation to a quick, natural halt, unless the unavoidable accompanying pain induces the government to "accommodate" inflation by pursuing further temporarily pleasant monetary expansion or other inflationary policies. ? |
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Controls on prices, profits, rent, and interest:
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Controls on prices, profits, rent, and interest
below market rates are other commonly employed inflationary policies.
They, too, are initially pleasant, but ultimately have a multitude
of ill effects. They allow demand to remain high and deter production
increases. They lead to gross distortions in economic and financial
flows that materially and cumulatively reduce the economy's productive
efficiency. They may inhibit investment - leading to stagnant
capital growth (stagnant "capitalization"). Maintenance
of affected assets may be rendered impractical - leading to decapitalization
as productive assets are "milked." ? Various black (free) markets and subterfuges proliferate that actually lessen the harm done by the controls. However, the entire control system must become unmanageable for any democracy and a severe constraint on living standards for a despotism. ? Blocks of abandoned structures in the hearts of many American cities in prior decades provided mute but eloquent testimony concerning the ultimate destructive impact of rent controls and other policies that render assets relatively unprofitable. |
Without continuous monetization of a substantial portion of the debt, massive increases in government spending and borrowing would fairly quickly drag an economy into depression. |
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Certain "supply siders" have,
in recent years, done much to poke holes in the nonsense incorporated
in conventional Keynesian economic wisdom about "monetary"
and "fiscal" policy. However, some have adopted some
nonsense of their own. ? |
They criticize the central bank whenever it restricts the growth of the money supply and
allows interest
rates to rise. They claim this prevents the economy from growing
its way out of its problems. They assert that the central bank
should not be concerned with inflation until the rate at which
prices are rising actually begins to accelerate. This is like
putting off treatment of ill health because: - "Death is
nature's way of saying, it's time to slow down." ? Unfortunately, history has been invariably unkind to those nations that have attempted to inflate their way out of inflation - or out of any other problems. As stated, the initial economic stimulation is always pleasant - and always addictive because it is initially pleasant but ultimately very painful to stop. Massive international payments imbalances, the expenditure of financial reserves, rising prices and interest rates, and the flight of capital out of the country, invariably follow - ultimately building to the point of economic and - sometimes - political crisis. ? These supply-siders have forgotten that interest rates react to market interference in the same manner as any other prices. The surest way to get higher interest rates is to try to push them down. ? |
So, now we can see what there is to worry about. |
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Bluntly stated - stopping inflation ("austerity")
hurts - and the worse the inflation is permitted to get,
the more the remedy will hurt. ? |
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Inflation can exist for months or years
before manifesting itself in rising prices, and the worse it
is permitted to get, the more difficult and painful the cure.
If Greenspan (now Bernanke) waits until inflation manifests itself in even higher
rates of price increases, he will have to put the nation through
a real recession to regain control. Already, by waiting until the dollar has
weakened in international markets, the Federal Reserve has begun to lose
much of its financial strength and ability to influence national
and international financial and economic trends. The Fed can
only be as strong as the dollar. ? |
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Most government policies designed to mitigate
the pain of rising prices are themselves inflationary and inevitably
cause even more pain in subsequent periods. ? |
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These basics must be kept in mind when considering
the black-is-white world of much political and academic propaganda
- which the press invariably accepts without criticism or the
remotest indication of understanding. The reason why so many
people choose to deny reality is obvious. Curing inflation must
hurt, and almost everything the politicians do to mitigate the
pain will only make matters worse. No nation can indefinitely
live with more than the lowest levels of inflation. "Soft
landings" by means of mild levels of austerity are difficult - always impose a considerable drag on economic
performance - and
are slow to achieve results. ? The politicians must have scapegoats when price increases reach painful levels. They must hide their own responsibility for the policies that have led to the turmoil. Thus, the rising prices that could stop the inflation are branded "inflationary," and "greedy" businessmen are blamed for increasing prices - while the inflationary policies that caused the price increases - the monetary expansion and various controls on prices - are all too often continued. ? Economists who provide intellectual cover for inflationary policies (the "Keynesians") are honored and employed in high advisory positions in government. ? When allocating blame for inflation, cause must be carefully distinguished from mere effect. Those government policies that increase demand without increasing supply, or that restrict supply or decrease productivity, are "inflationary." These government policies must bear all the blame for the rising prices, loss of purchasing power, slow or nonexistent productivity growth, capital flight, stagnant capitalization or decapitalization, stagflation or inflationary depression, and all the other ills that inflation causes. ? Cyclical recessions can occur normally in a capitalist system due to the cumulative impact of the natural imperfections of private economic decision makers - although it is difficult to think of any recession in history where government policy mistakes did not play the primary role. However - only governments can cause inflation. |
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Copyright 2004 Dan Blatt