by Gary North
Most of my readers were neither the captain of the football team nor queen of the prom. Yet millions of American teenagers today would like to have the opportunity of being either — or, in the case of athletically gifted girls, both.
Competition for the top spots in life begins early. The late, great humorist Jean Shepherd, who wrote the screenplay for "A Christmas Story" (1984), which was a composite of several of his short stories, had a theory that the reality of social hierarchy intrudes at a young age for boys: sandlot baseball. The order of who gets picked tells every boy about differences in performance. The outcome doesn't change over the years.
Literature is filled with stories of people who peaked too early, beginning with those archetypal early peakers, Adam and Eve. "It was all downhill after that" surely was applied first to them. Achilles and Hector were another pair of early performers who didn't have staying power.
I suppose the supreme model of the early peaker in our day is Elvis Presley, which is why the "Elvis is alive" legend persists, even among people who really don't believe it. As a very young man, Elvis had had it all, or so it seemed. Then he faded, rebounded, and then faded again. He is now a posthumous legend, with his very own commercially successful shrine.
In a PBS show that I had not seen until this week, "He Touched Me: The Gospel Music of Elvis Presley," one of the performers being interviewed said that Elvis' death was like President Kennedy's: people remember where they were when they heard about it. My pastor had this fact driven home to him last August, the 25th anniversary of Presley's death, when for some reason, he happened to ask a new member of the church if she could recall where she was when Elvis died. "Yes," she answered, "I can. I gave him his last bath, and then I tagged his toe." As a young woman, she had been on duty at the Memphis funeral home where his body had been taken.
How many teenage boys of my generation wanted to be Elvis? A lot of them. To be known as the king! All those screaming girls! This was the decade before groupies became a social phenomenon, proving to teenage boys and even older men what they had long suspected: electric guitars can be used as fishing polls.
But as time goes by, people grow up. They learn the truth of the tortoise and the hare. Fast-starters rarely win the marathon, and life is a marathon. When we are young, we are interested in the sprinters. That's where the action is. The fans at cross-country meets are few. I learned this early. My high school had the best cross-country program in the state — and, a year after I graduated, the nation — in part because the coach made the team train by running in the sand, pre-season. But hardly anyone on campus even knew there was a sport called cross-country. It was boring: again, rather like most of life.
From time to time, manias take place. People forget about boring, steady-Eddie investing. They get caught up in the greed that is fostered by a bubble. Then reality intrudes. Investors return to faith in long-term growth.
If the economy falls, as it did in the 1930's, faith in long-term growth is replaced by a loss of hope. Our generation doesn't remember this.
When the boom is on, the policy-makers don't warn us that the bubble will burst. When it does, they deny all responsibility for (1) having created the bubble; (2) not having announced a warning.
Warning: when investors have lost their collective shirts, policy-makers start a new marketing campaign that promises what investors want to hear. In this case, investors want to hear about guaranteed growth at lower rates.
The old line about compound interest being the eighth wonder of the world testifies to our awareness of the truth. Yet, given the spending habits of most Americans, this lesson has not been learned. People start out on the wrong side of the credit table. They borrow young to buy depreciating assets. They play catch-up for the rest of their lives. "What's in your wallet?" ask the characters in the Capital One credit card TV ads. The safest answer is this: "A debit card." Debit cards don't allow you to borrow, only spend what you have already deposited.
John Schaub became a multi-millionaire in real estate by following the advice of his course: making it big on little deals. It's the careful purchase of income-producing real estate, bought at 10+% discount from someone with a housing problem you can solve.
Success for the millionaire next door is by careful attention to detail, constant improvement in service, and a seemingly unteachable knack for seeing what consumers are willing to pay for. Success is the ability to stay in the game longer than your competitors.
The fast-starters imagine that success is easy. Then they lose their abilities. Or they lose the attention of their customers. In all three respects, "The Rolling Stones" are unique: their fans stayed fans, and most of the Stones stayed alive.
If you are not a rock star by age 40, you aren't going to be one. But there are other ways to become a success. Most people don't expect to become a success. Those few who do face great temptations.
What hammers most fast-starters is when Easy Street turns into a dead end. That's what happened to the NASDAQ in 2000. There may still being terminally naive investors who think that this event was not permanent. They don't pay any attention to demographics: an aging population that will have to sell its stocks to gain income. They don't look at the fact that Federal Reserve policy is today as expansionary as it was in the bubble era, 1995—2000. They don't understand that FED monetary policy will either inflate prices, thereby wiping out savers through currency depreciation, or else will keep interest rates low, thus wiping out savers through money-market returns below 1%.
When government tax-and-spend policies combine with central bank monetary policies to create a boom, the results undermine thrift, create a boom-bust cycle, and subsidize debt. The future of the economy is undermined. This is because the basis of long-term economic growth — accurate entrepreneurship and high rates of thrift — is undermined.
Expansionist monetary policy lures entrepreneurs and consumers into making mistakes. The habit of personal thrift is either broken by interest returns that do not pay anyone to save, or else is it converted into rampant speculation, as it was in 1995—2000, which always leads to massive losses in the recession phase.
In order to keep the economy from suffering the recession that is necessary to force down the prices of capital goods to meet expectations regarding consumers in the future, the central bank floods the economy with new money, in order to keep consumers buying and businessmen investing. At present expansion rates, the money supply will double every nine or ten years, i.e., money growth is in the 7% to 8% range per year.
Adjusted monetary base:
Money of zero maturity:
Today, consumers are buying, but businesses still resist investing. Businessmen are still not confident that this economic recovery, weak as it is, will be sustained.
THE NEW, IMPROVED SALES CAMPAIGN
Will the FED continue to inflate the money supply? In a speech that has been widely quoted in the narrow hard-money newsletter camp, Federal Reserve Board member Ben Bernanke made it clear that the FED sees deflation as being a remote possibility. He made it clear that the FED will do whatever is in its power to keep price deflation from taking place. But neither is price inflation a threat, he said. This is because central bankers and politicians are wise, and they have the tools to control prices without creating shortages.
Despite widespread "inflation pessimism," however, during the 1980s and 1990s most industrial-country central banks were able to cage, if not entirely tame, the inflation dragon. Although a number of factors converged to make this happy outcome possible, an essential element was the heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability.
In short, the free market now has the central planners that it has always needed to make it work properly, according to the textbook version of capitalism. These central planners control the money supply. Unlike socialist central planners, our central planners use the monetary carrot rather than socialism's stick for missed output quotas.
Then what of price deflation? Is it a threat? No. The policy-makers have taken care of that threat, too. Above all, commercial bankers are wise, and central bankers are both wise and powerful. They control the money supply.
So, is deflation a threat to the economic health of the United States? Not to leave you in suspense, I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small, for two principal reasons. The first is the resilience and structural stability of the U.S. economy itself. Over the years, the U.S. economy has shown a remarkable ability to absorb shocks of all kinds, to recover, and to continue to grow. Flexible and efficient markets for labor and capital, an entrepreneurial tradition, and a general willingness to tolerate and even embrace technological and economic change all contribute to this resiliency. A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape. Also helpful is that inflation has recently been not only low but quite stable, with one result being that inflation expectations seem well anchored. For example, according to the University of Michigan survey that underlies the index of consumer sentiment, the median expected rate of inflation during the next five to ten years among those interviewed was 2.9 percent in October 2002, as compared with 2.7 percent a year earlier and 3.0 percent two years earlier — a stable record indeed.
The second bulwark against deflation in the United States, and the one that will be the focus of my remarks today, is the Federal Reserve System itself. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.
So, here we have it. There won't be deflation. There won't be inflation. There will be only safe, secure, long-term economic growth without frightening price swings. In other words, what is being promised is what the planners think will sell.
The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand — a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending — namely, recession, rising unemployment, and financial stress.
Notice that he offers no explanation for this collapse in prices. It just comes out of nowhere. This is the Topsy theory of the business cycle. This theory is very popular among central bankers. They do not ask, as Ludwig von Mises asked 90 years ago, "What factor is so central to the economy that most entrepreneurs make the same mistake at the same time?" His answer: the monetary system. So, we should start looking for changes in the money supply — a system controlled by central bankers — to identify the cause of deflation. His conclusion: price deflation is caused by a recession, which in turn results from a prior inflation created by central bank monetary expansion. This is not a popular theory. It is merely accurate.
"WE HAVE NOT YET BEGUN TO INFLATE!"
Bernanke then moves to the issue that has persuaded a lot of hard-money editors to conclude that the FED is running out of options in the fight against price deflation: an interest rate of zero.
However, a deflationary recession may differ in one respect from "normal" recessions in which the inflation rate is at least modestly positive:
Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero. Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the "zero bound."
. . . To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.
Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value.
With the federal funds rate at 1.25%, are we facing a deflationary scenario, when money growth is insufficient to stimulate consumer demand? Deflationists think so. Bernanke discusses this possibility.
Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition" — that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank's inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy's response to policy actions. Hence I agree that the situation is one to be avoided if possible.
Does he think this will happen? No. He freely admits what we in the inflationist camp have been saying ever since the inflation vs. deflation debate broke out in hard-money circles back in 1974.
However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero.
The FED, he says, can buy long-term bonds, thereby lowering the price (interest rate).
Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association).
In short, the real estate boom will get all the money it needs to be sustained.
The FED can also make zero-interest loans to banks, he said. Will banks take free money? Count on it. Next, the FED can buy foreign nations' debt.
The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.
He did not even discuss the possibility of direct purchases by the FED of corporate equities.
He comes to the conclusion that I came to in 1962: the central bank will inflate, no matter what, when faced with widespread price deflation.
Sustained deflation can be highly destructive to a modern economy and should be strongly resisted. Fortunately, for the foreseeable future, the chances of a serious deflation in the United States appear remote indeed, in large part because of our economy's underlying strengths but also because of the determination of the Federal Reserve and other U.S. policymakers to act preemptively against deflationary pressures.
When it comes to fiat money, the old slogan applies:
"There's more where that came from."
We are not facing long-term deflation. We are facing a new round of price inflation as a result of existing monetary inflation, with more to come if necessary to avoid falling prices.
If there is one sector of the economy in which consumers are willing to take on new debt and buy more stuff, it is the housing market. If it collapses, a depression is likely. If the FED chooses to supply funds for Fannie Mae and Freddy Mac, the FED can keep this bubble going for a long time. It will become lender of last resort for the housing market.
December 5, 2002
Copyright © 2002 LewRockwell.com