Where Is the Inflation?
Critics of the Austrian School of economics have been throwing barbs at Austrians like Robert Murphy because there is very little inflation in the economy. Of course, these critics are speaking about the mainstream concept of the price level as measured by the Consumer Price Index (i.e., CPI).
Let us ignore the problems with the concept of the price level and all the technical problems with CPI. Let us further ignore the fact that this has little to do with the Austrian business cycle theory (ABCT), as the critics would like to suggest. The basic notion that more money, i.e., inflation, causes higher prices, i.e., price inflation, is not a uniquely Austrian view. It is a very old and commonly held view by professional economists and is presented in nearly every textbook that I have examined.
This common view is often labeled the quantity theory of money. Only economists with a Mercantilist or Keynesian ideology even challenge this view. However, only Austrians can explain the current dilemma: why hasn’t the massive money printing by the central banks of the world resulted in higher prices.
Austrian economists like Ludwig von Mises, Benjamin Anderson, and F.A. Hayek saw that commodity prices were stable in the 1920s, but that other prices in the structure of production indicated problems related to the monetary policy of the Federal Reserve. Mises, in particular, warned that Fisher’s “stable dollar” policy, employed at the Fed, was going to result in severe ramifications. Absent the Fed’s easy money policies of the Roaring Twenties, prices would have fallen throughout that decade.
So let’s look at the prices that most economists ignore and see what we find. There are some obvious prices to look at like oil. Mainstream economists really do not like looking at oil prices, they want them taken out of CPI along with food prices, Ben Bernanke says that oil prices have nothing to do with monetary policy and that oil prices are governed by other factors.
As an Austrian economist, I would speculate that in a free market economy, with no central bank, that the price of oil would be stable. I would further speculate, that in the actual economy with a central bank, that the price of oil would be unstable, and that oil prices would reflect monetary policy in a manner informed by ABCT.
That is, artificially low interest rates generated by the Fed would encourage entrepreneurs to start new investment projects. This in turn would stimulate the demand for oil (where supply is relatively inelastic) leading to higher oil prices. As these entrepreneurs would have to pay higher prices for oil, gasoline, and energy (and many other inputs) and as their customers cut back on demand for the entrepreneurs’ goods (in order to pay higher gasoline prices), some of their new investment projects turn from profitable to unprofitable. Therefore, you should see oil prices rise in a boom and fall during the bust. That is pretty much how things work as shown below.
As you can see, the price of oil was very stable when we were on the pseudo Gold Standard. The data also shows dramatic instability during the fiat paper dollar standard (post-1971). Furthermore, in general, the price of oil moves roughly as Austrians would suggest, although monetary policy is not the sole determinant of oil prices, and obviously there is no stable numerical relationship between the two variables.
Another commodity that is noteworthy for its high price is gold. The price of gold also rises in the boom, and falls during the bust. However, since the last recession officially ended in 2009, the price of gold has actually doubled. The Fed’s zero interest rate policy has made the opportunity cost of gold extraordinarily low. The Fed’s massive monetary pumping has created an enormous upside in the price of gold. No surprise here.
Actually, commodity prices increased across the board. The Producer Price Index for commodities shows a similar pattern to oil and gold. The PPI-Commodities was more stable during the pseudo Gold Standard with more volatility during the post-1971 fiat paper standard. The index tends to spike before a recession and then recede during and after the recession. However, the PPI-Commodity Index has returned to all-time record levels.
High prices seem to be the norm. The US stock and bond markets are at, or near, all-time highs. Agricultural land in the US is at all time highs. The Contemporary Art market in New York is booming with record sales and high prices. The real estate markets in Manhattan and Washington, DC, are both at all-time highs as the Austrians would predict. That is, after all, where the money is being created, and the place where much of it is injected into the economy.
This doesn’t even consider what prices would be like if the Fed and world central banks had not acted as they did. Housing prices would be lower, commodity prices would be lower, CPI and PPI would be running negative. Low-income families would have seen a surge in their standard of living. Savers would get a decent return on their savings.
Of course, the stock market and the bond market would also see significantly lower prices. Bank stocks would collapse and the bad banks would close. Finance, hedge funds, and investment banks would have collapsed. Manhattan real estate would be in the tank. The market for fund managers, hedge fund operators, and bankers would evaporate.
In other words, what the Fed chose to do ended up making the rich, richer and the poor, poorer. If they had not embarked on the most extreme and unorthodox monetary policy in memory, the poor would have experienced a relative rise in their standard of living and the rich would have experienced a collective decrease in their standard of living.
There are other major reasons why consumer prices have not risen in tandem with the money supply in the dramatic fashion of oil, gold, stocks and bonds. It would seem that the inflationary and Keynesian policies followed by the US, Europe, China, and Japan have resulted in an economic and financial environment where bankers are afraid to lend, entrepreneurs are afraid to invest, and where everyone is afraid of the currencies with which they are forced to endure.
In other words, the reason why price inflation predictions failed to materialize is that Keynesian policy prescriptions like bailouts, stimulus packages, and massive monetary inflation have failed to work and have indeed helped wreck the economy.
ADDENDUM: This is a complimentary article to the above.
Who Is the Fed Helping? Not the Little Guy
By Rich Danker
For more than five years the Federal Reserve has conducted an unprecedented monetary expansion. Over this stretch the Fed's balance sheet has tripled. Its key interest rate has been zero since December 2008, forcing down rates across the credit spectrum on everything from mortgages to municipal bonds. Various programs and objectives have been used to keep the ride going. What was conceived of as an emergency measure to provide liquidity to the banking system has morphed into a stimulus program that the Fed says is now supposed to heal the labor market. The real question is, who's benefited from this?
The answer is the economy's biggest borrowers. That starts with the government. Thanks to the Fed's bond-buying, Washington has been able to squeeze down interest payments as a percentage of the federal budget as it takes on record levels of debt. Last month Bloomberg reported that the Fed is absorbing about 90 percent of new issuance of Treasury and mortgage-backed debt. With the central bank as the ready buyer, Congress feels no market pressure to curtail its profligacy because paying for it has never been easier with the Fed's suppression of free-market interest rates. Why don't more "Tea Partiers" on Capitol Hill speak out against this?
Meanwhile, blue chip firms have seen their borrowing costs hit record lows. Bloomberg also reported that Disney sold three-year notes at a paltry 0.45% interest rate as part of a $3 billion offering that was its largest issuance ever. Overall, the market for top-tier corporate bonds is the frothiest in half a century. Investors who can't compete with the Fed for government debt are turning here for super-safe alternatives and bidding up prices. There is a similar story in municipal bonds which has hardly ruffled by rising unfunded pension liabilities and scattered local bankruptcies.
The downstream effect of the Fed's action doesn't end there. Three years ago, a tidal wave of unsecured debt associated with the pre-crisis leveraged buyout boom was coming due. Roughly $1 trillion of these loans had to be refinanced or face a painful work-out. If the capital markets couldn't refinance, widespread default would damage banks' loan portfolios and likely send notable American companies with inferior credit into bankruptcy. But the crisis was averted when the private sector enjoyed one of its best years for borrowing ever as the Fed solidified its commitment to easy money.
At what cost? The economy now exists in a murky place deprived of market input. The cost of credit has been leveled off. Big borrowers - whether governments or businesses - now raise money more on the basis of monetary policy than their individual credit profiles. Many large businesses probably still exist that would have gone extinct or reorganized under normal conditions. It's hard to see how that's ultimately good for their stakeholders. Are workers better off staying in chronically troubled industries? Would investors not have found better returns elsewhere? Certainly consumers won't find favor with brands living past their expiration date.
The Fed has constructed a safety net for government and big business. The upside is that hard calls implied by the financial crisis - to cut government spending, to reinvent an industry - don't have to be made because the status quo can continue fueled by easy credit. The downside is that we now live in an economy where it is increasingly difficult to distinguish between real economic growth and symptoms of another bubble. This is at the heart of what CEOs mean when they blame Washington for creating "uncertainty."
If that economic climate sounds familiar, it's because we lived through it during the Bush years. What was genuine and what was fake about the prosperity of that era? Not so easy to tell. The housing market we know was largely credit-built, but what about 65 straight months of job growth? What about the bull market in stocks that peaked in 2007? No doubt some of the jobs created then exist now as legacies of the bubble. The point is not that we live in a new century plagued by capitalism run amok - it always has - but that we are in a financial environment partially created by the Fed and only partially possessed by the market. It is increasingly difficult to tell where the central bank's influence ends and the market's begins.
The Fed's distortion of the economy makes it particularly tough for smaller businesses and entrepreneurial ventures to get financing. Lenders are either reluctant to offer credit at artificially low interest rates or are wary of new bubbles. Judging risk is hard when economic signals like interest rates and labor movements are compromised. Five years in, the Fed's help has mainly gone to big business and big government at the expense of economic growth. Will it take the implosion of still more bubbles for the Fed to consider these consequences?
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