"In the early 1970s, when Richard Nixon appointed Arthur F. Burns, beloved economist and party hack — the Greenspan of his time — as chairman of the Fed’s board of governors, he said, u2018I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed.' The audience applauded, and Nixon turned to his old friend. u2018You see, Dr. Burns, that is a standing vote for lower interest rates and more money.' It was the only vote needed." Lew Rockwell in The Free Market, 1991.
And there is the crux. Higher oil prices per se are of no particular concern, they simply mark a valuation-led transfer of money to the oil producers and refiners at the expense of other sectors of the economy. In a world in which the money supply was inelastic, this would divert resources away from other goods and services, reducing prices realized in transactions there, perhaps leaving the overall price level (if such a thing can be has any meaning) unchanged. In time, capital would forsake those sectors now rendered less profitable, in favor of investments in the oil patch, or alternative energy technologies, and the price mechanism would have done its job of distributing resources according to consumers' most pressing needs. Though adjustments during this process could be upsetting to those directly effected, displaced Internet hopefuls could always leave Silicon Valley and get their hands dirty in Oklahoma.
However, if the central banks allow extra money to be created to offset the oil price rises, no such diversion need occur. What the central bank cannot do, of course, is command more oil to be pumped. Greenspan's prestidigitations can cause "money" to materialize out of thin air: wealth — i.e., the fruits of production — is a little less susceptible to his sorcery. The end result, then, will simply be to ensure that more money ends up chasing the same level of production, meaning generalized and debilitating price rises are likely to occur as economic actors seek to pass on costs and maintain their purchasing power.
We arrive at this third oil "shock" after a run through fiat-occasioned financial crises and "structural imbalances" for most of the 90's. All this while liquidity provision has been generous to a fault. Although the transmission mechanism has not worked through to higher measures in post-Bubble Japan, the ratio of M1 to GDP has risen 88% in a decade, The ECB has been expanding its balance sheet at a 10% rate for well over a year and the Fed has sat back while real broad money growth has, for two years, exceeded anything seen since Arthur Burns was helping to secure Nixon's re-election in 1972.
To date, subjective factors and other outlets have kept this from igniting 1970s-style price rises. In Japan, the generalized malaise has meant that BOJ pumping has either gone under domestic futons or has bled abroad to finance others' consumption.
America has instead been gripped with a typical paper "wealth" frenzy, with the dollar value of Nasdaq and NYSE transactions averaging 4 times GDP in the course of the last twelve months. Even if we allow for the fact that only around 3% of this febrile churning requires a payment after all the netting has been undertaken by the financial sector (as inferred from Depository Trust statistics), that still means over 15c in every dollar has been spent trading stocks, rather than being used in the real economy. This activity — and the related stock market hypertrophy of the last five years – has both directly absorbed and helped boost the subjective worth of these surplus dollars at home and abroad and has thus prevented them from doing visible harm to the traditional price indices, reinforcing the prevalent New Era fantasy that the business cycle (ie the credit cycle) has been abolished.
Now, however, that myth may be about to be dispelled. Petrol blockades in France and the UK have already begun to remind people that it might not be so different this time, after all Heating bills in the US are set to rise by anything up to 40% this winter, according to the DOE, while medical insurance costs are scheduled to rise by over a fifth. Once the evidence becomes too painful to be ignored, the shift in psychology — in those crucial subjective valuations — can be a sudden one.
Add to this mix a little unsubtle blackmail from the Oval Office, which has cowed the Republicans into accepting big rises in discretionary spending programs for fear of a Gingrich-style debacle with government shut-downs into the November elections. Given that Federal outlays were already a record $909 billion in the first half, and that the NYT has reported a 5% increase has already been conceded for FY2001, fiscal policy is hardly contractionary, surplus or no surplus. Big government is still busily milking the fiat money milch-cow for all its usual undemocratic reasons.
Finally, it should be noted, that while Fed staffers and their counterparts in Frankfurt and Threadneedle Street, in their laser beam and fiber-optic ivory towers, can be comforted by excising all manner of price rises to arrive at a "core" inflation number, your average citizen adds all these numbers straight back in. In a tight labor market, it might take some explaining to a truculent workforce why the CPI he has been taught to focus on is really only 2.4%, not 3.5% (or some other confection of suspect aggregate statistics), or why the loss of value of money should be borne by him, the employee, rather than an employer whose profit share of GDP these last three years GDP is at the extreme upper end of the last 40 years' range.
The next time Greenspan panders to the Beltway and gives us some technobabble about the New Economy and draws attention to whichever statistical fiction currently shows the least deterioration in price patterns, remember Arthur Burns was the man who invented "core" inflation.
As Steven Roach of Morgan Stanley Dean Witter has recently reminded us, Burns went on to take oil, food, mobile homes, used cars, purchased housing, jewellery, and children's toys out of the basket before he had finished. Miller's subsequent, brief, interregnum bears even less scrutiny. CPI ended up at 12.2% in 1974 and hit 14.6% in 1980 before Volcker finally bottled the genie back up by throwing the credit engine grindingly into reverse, stripping the gearwheels of malinvestment from Vera Cruz to Vermont, and from Paris to Peoria, in the worst recession since the war.
Ask yourself whether you think Greenspan and Duisenberg most closely resembles Burns or Volcker? Then ask yourself how well off we would be if we had neither of these monetary Magi with which to contend, but had honest money instead.
September 12, 2000
Sean Corrigan writes from London on the financial markets, and edits the daily Capital Letter and the Website Capital Insight.