Love of Liberty : inflation

Demand Destruction = Poor Choice of Words

ChrisR — Fri, 08 Aug 2008 17:43:00 GMT

The term "Demand Destruction" strikes me as a bit absurd.

For example, let's say Bob & Joe are going to make a simple trade.

Bob produces apples and Joe gives haircuts.

The terms of the trade are 10 apples for 1 haircut.

Bob's supply of 10 apples are also his demand. Without the apples to exchange, Bob has no demand. He would have to either renegotiate the terms of the trade, or Joe would have to perform the haircut out of charity.

So if we were to apply the term "demand destruction" to this situation, would it be a good thing to destroy Bob's 10 apples? In other words, would it be good to destroy his demand?

No.

The thinking behind "demand destruction" is that a slowing economy will relieve rising commodity prices. This totally ignores monetary inflation as the cause of the higher prices.

Peter Schiff summarizes the current economic situation nicely in his latest column:

The benign outlook on inflation is rooted in the hope that a slowing economy will pop the commodities "bubble" and break the back of inflation. Despite these pronouncements, most rational observers understand that inflationary pressures are currently intensifying, not abating. Rising commodity prices are not the source of inflation, but merely the symptom of rampant monetary expansion from the Fed and other central bankers around the world. By all indications, the liquidity injections are about to shift into a higher gear. The recent housing bailout bill is the most inflationary legislation ever enacted and there is already talk of yet another economic "stimulus" bill. The new money creation needed to finance these schemes, together with exploding federal budget deficits, will not only reverse the recent declines in commodity prices, but send other consumer prices soaring as well.

It is also worth noting that a slowing economy does not, by itself, bring prices down. If it did prices in Zimbabwe would be falling. When combined with responsible monetary policy, a growing economy would tend to push prices lower (based on greater productivity and expanded supply).

Inflation "Targeting"

ChrisR — Tue, 29 Jul 2008 03:24:00 GMT

What if the Fed set a goal for themselves to contain inflation at 3%?

Let's assume (and this is a huge assumption) that government can control its spending to the point where 3% inflation is maintained.

Is this the ticket to success?

Well let's see:

Artificial booms would still exist.
Businessmen would still be mislead into thinking there are more savings then actually exist.
Business calculation would still be distorted.
Since the booms would contain malinvestments, those malinvestments would have to be liquidated....so busts would still exist.
There would still be a transfer of wealth from the poor to the rich.
There would still be an exchange of nothing for something.
Savers would still be penalized...and debtors rewarded.
Speculation (in order to stay ahead of inflation) would still be encouraged.

So is inflation "targeting" the answer?

I say no.

NY Times on Bernanke's Toughness

ChrisR — Thu, 10 Jan 2008 15:12:00 GMT

The New York Times has an article titled For Bernanke, a Question of Toughness. Here is an excerpt:

Is the Federal Reserve’s chairman, Ben S. Bernanke, too nice for the job?
That’s the view of many on Wall Street, who argue that with the stock market falling, unemployment rising and the economy flirting with a recession, Mr. Bernanke should be dealing with the situation more aggressively than he has so far.
Their quarrel is partly with the Fed’s reluctance to cut interest rates even more than it already has...
“Personally, I think we should be at 3 percent right now,” said James Glassman, a senior economist at JPMorgan Chase. “You ask anyone on Wall Street, ‘If Bernanke cuts to 1 percent or 2 percent or 3 percent, would that fix the problem?’ Most people would tell you that would certainly start the healing.”

It's interesting that cutting rates would somehow constitute Bernanke as acting "tough".

Major malinvestments have been made over the last 20+ years, thanks to the artificial rates and monetary inflation of the Federal Reserve. A recession is the liquidation of those malinvestments. A recession ushers in the return to a healthy economy. How can cutting rates and creating further imbalances be seen as acting "tough"?

If Bernanke really wanted to act "tough", he would remove all interventions, and let interest rates rise to the market level. Then the healing process would truly begin.

Venezuela's New Currency

ChrisR — Tue, 01 Jan 2008 15:09:00 GMT

CNN/Money reports:

Venezuela launched a new currency with the new year, lopping off three zeros from denominations in a bid to simplify finances and boost confidence in a money that has been losing value due to high inflation...
"We're ending a historical cycle of ... instability in prices," Finance Minister Rodrigo Cabezas said Monday, adding that the change aims to "recover a bolivar that has significant buying capacity."

To begin with, I see no reason why knocking off three zeros will "boost confidence" in the currency. The only thing that may boost confidence is to stop the printing press. Individuals will then feel confident that the money they hold will not continually lose value. However such a move runs contrary to the idea of having a fiat currency in the first place. The whole point of fiat money is to remove all restraints on its creation.

Second, prices are not meant to be "stabilized." Prices provide valuable information as to the supply and demand of the good(s) in question. If prices are oscillating rapidly, they are merely reflecting the reality of the situation at hand. To artificially "stabilize" any price is to distort the situation even further.

The article continues:

"It was necessary to leave behind the consequences of a history of high inflation," Central Bank president Gaston Parra said in a televised year-end speech.

The only way to leave behind the consequences, is to eliminate the cause...which is the constant creation of money out of thin air.

Determining If The Recession Has Begun

ChrisR — Thu, 27 Dec 2007 15:02:00 GMT

In this article from Fortune, the author tries to make the case that you don't know you're in a recession until months after it starts. The author writes:

Investing successfully is about looking ahead, while determining whether we're in a recession involves looking behind. Way behind. We won't know that a recession has started until months after it's begun.

I will agree that investing successfully is about looking ahead. This is true.

However, I disagree that in order to determine if we are in a recession, we have to look behind.

The writer then goes on to state at which point he considers a recession to have arrived:

Now, exactly what is a recession? Opinions vary. Many people think that a recession is defined as two consecutive quarters in which "real" gross domestic product - GDP adjusted for inflation - declines. If you accept that definition, which I don't, you don't find out that a recession is underway until six months - two calendar quarters - after it has started. (Sorry, too late!) If you use what I consider the proper definition - a declaration by the National Bureau of Economic Research's business cycle dating committee that the economy has peaked - you may have to wait even longer. Nevertheless, I prefer the NBER version because it's the collective opinion of seven savvy people rather than a rote formula.

If you use either of the two above methods, then yes, you do have to look behind to see if we are in a recession. But I would advise against relying on government statistics to find out if the recession has arrived.

A recession is a natural consequence of an artificial boom. Without the boom, there would be no recession. So the starting point is the boom.

Artificial booms are created by an inflation of the money supply. The Federal Reserve, through the process of holding down interest rates below market levels, increases the money supply by creating money out of thin air. This new money sets in motion major malinvestments in the economy.

A recession is the liquidation of the malinvestments created during the boom.

If you understand this, there is no reason to rely on government statistics, or the opinion of "seven savvy people." All you need to do is ask a simple question: "Are the malinvestments being liquidated?"

If the answer is "yes", then a recession has come to the rescue. The cure to the artificial boom has arrived. Capital moves into more productive and efficient hands, and the time becomes ripe for investing in the markets. If the answer is "no", i.e., the malinvestments of the boom are not being liquidated, it would be wise to stay away from the markets.

No need to look back (or way back)...The answer as to whether or not the recession has arrived is here and now.

ECB's Contradictions

ChrisR — Wed, 19 Dec 2007 14:05:00 GMT

From CNNMoney:

European Central Bank president Jean-Claude Trichet warned Wednesday that the euro area's inflation surge was likely to last longer than expected - a remark suggesting the bank will stick to its tough stance on interest rates even amid the subprime crisis.
Trichet repeated that the bank would even move to raise rates to ward off inflation if need be, saying the central bank would not hesitate "to do whatever necessary" to avoid second-round effects - code for a wage-price spiral - that would keep inflation high.

OK...sounds good so far.

The ECB shouldn't be distorting interest rates in the first place. There's no need for anyone to have a "tough" stance on interest rates. But, second best would be to slow down or stop printing money out of thin air.

However, in the very same article, we find out:

The ECB on Tuesday opened its credit tap wide, pumping a record €348.6 billion - the equivalent of more than half a trillion dollars - into money markets to keep banks from Finland to France flush with the cash they need to operate.

Pumping a record amount of credit does not equal a tough stance on interest rates.

Mises wrote in Human Action: "Action is the real thing. What counts is a man's total behavior, and not his talk about planned but not realized acts."

Fed Cranks Up The Presses

ChrisR — Wed, 12 Dec 2007 18:19:00 GMT

CNN/Money reports:

"One day after disappointing Wall Street with a quarter-point rate cut, the Federal Reserve announced a plan to inject billions of dollars into the financial system."

The fact that the Fed is working together with central banks from around the world indicates that the situation is worse than it appears. Unfortunately, inflating the money supply (which caused the mess in the first place) cannot fix the problem. It can only make it worse.

Ron Paul summed it up nicely (via LewRockwell.com blog):

"Inflationary monetary policies created the problems in the economy we are seeing, and these problems will be made worse, not better, by more inflation. And today's action by the Fed is very bad news for American workers and retirees who are about to get hit with yet another jump in prices.

"Make no mistake, the problems faced by the American people are not caused by unscrupulous mortgage brokers or the rising price of oil. These are symptoms of an economic disease caused by a spendthrift Congress enabled by loose monetary policy. Too many pundits praise the weak dollar as benefiting exporters, but they fail to see the harm done to thrifty, hard-working Americans.

"Rather than continuing to pursue a policy of easy credit and increasing debt, we need to return to a sound monetary system."

China Tightens Credit

ChrisR — Sat, 08 Dec 2007 19:23:00 GMT

The Bank of China has raised rates five times this year. And today (via Bloomberg):

China ordered banks to increase reserves by the most in four years to try to prevent the world's fastest-growing major economy from overheating.

With sound money, there would be no need for worries of "overheating." When one person trades his production for the production of another person, it would be impossible for economic activity to "overheat." Only with an expansion of the money supply can such a situation exist.

The above article continues:

China's consumer prices jumped 6.5 percent in October from a year earlier. Inflation is accelerating because of higher food, energy and labor costs. Faster inflation makes it harder for the government to prevent asset bubbles because people would rather put money in stocks or property than leave it in the bank to lose value.

Actually, rising prices are the result of an increase in the money supply. And the government does not prevent asset bubbles, it creates them with, once again, an increase in fiat money.

Money supply grew 18.5 percent in October from a year earlier, breaching the central bank's annual target of 16 percent for the ninth straight month.

It's safe to say there is plenty of malinvestment in China. Now that credit is tightening, we'll most likely be able to see where the malinvestment has occurred, i.e., what projects have been started that should have never been started in the first place.

Inflation in Venezuela

ChrisR — Thu, 06 Dec 2007 15:17:00 GMT

The process is so predictible:

The central bank increases the money supply
Prices rise
Government imposes price controls
Shortages occur

It's the classic one-two punch.

Venezuela is one of the latest countries to take a trip down inflation trail (via AP):

...inflation is beginning to eat away at Venezuela's economy despite efforts by President Hugo Chavez's government to put a cap on swiftly rising prices.
...rising prices come as shortages of basic goods from milk to toilet paper also become a growing aggravation for Venezuelans. "Food has gone up the most. The prices of these products, if you can find them, are in the clouds," quipped Jose Guevara, a 54-year-old shopkeeper, as he left a supermarket in downtown Caracas. "We've become experts at substituting one food for another."

Letting the Recession Happen

ChrisR — Sat, 01 Dec 2007 02:35:00 GMT

While Wall Street celebrates the possibility that the Fed may lower interest rates further, and inflate the money supply, Lew Rockwell points out the path that should be taken instead:

"...shouldn't we do something to address the credit crunch? Yes, and that is the following: let it happen."

Just let it happen.

This advice is hardly ever followed, even though many of the malinvestments from the previous boom would be flushed out, and the economy could then proceed on a better footing. Instead, creating further malinvestment is the choice du jour.

Murray Rothbard warned of prolonging the boom:

"It is clear that prolonging the boom by ever larger doses of credit expansion will have only one result: to make the inevitably ensuing depression longer and more grueling.”

The fact that this choice is celebrated, strikes me as kind of odd.