The Inflation Monster and Its Owner


When central bankers blast central banks for being reckless, you know the problem is serious. Indeed, it seems that everyone suddenly really cares about inflation. Everywhere you go, this is the talk, at the grocery, the gas station, among your neighbors. Price increases have been persistent in major sectors such as medicine and education for decades, but today the trend is conspicuously hitting the stuff that people buy every day. So the reminders are ubiquitous, and public anger is growing.

As the president of an institute that spends a vast amount of its resources on the issue of monetary policy and reform, I see this as both good and bad news. When no one else seems to care about these issues, we promote research and publish books that consider this topic from every angle. If you were going to reduce all these efforts to a single phrase, it would be: it’s the government’s doing. And the answer in a single phrase is: let the market, not government, manage the money.

But just as in the 1970s, and before people began to accept 3—5% annual price increases as part of the natural law, people today are still enormously confused about the cause. There is no obvious foreign demon to blame for our economic troubles. People generally suspect that something is wrong in Washington, but such is always the case. The most immediate culprit in people’s mind is actually the merchant, or perhaps a cartel of merchants.

Already, enterprises are posting signs to explain the higher prices in terms of their higher costs. Panera Bread is taking the offensive by explaining that the higher price of wheat is to blame. That is true enough, but it’s not the whole truth. Other retailers speak about the low dollar on international exchange — again true enough, but not the whole truth. Of course, the anger at oil executives is as predictable as it is unjustified.

In economics, finding the relationship between cause and effect isn’t as easy as tracing through a sequence of events. There is a time lag, of unpredictable length, between the monetary expansion of the Federal Reserve and the response in producer and consumer prices.

There is also the major problem that when the experts speak about these issues, they talk about the price level as if it were like the sea level, or something else that rises and falls like the volume on an iPod. The truth is that the price increases following a monetary expansion affect different prices in different ways, and, again, in an unpredictable manner.

Past bouts of expansion have created bubbles in the financial sector, plus other sectors such as housing, and state-dominated sectors like medicine and education. But a high dollar internationally, the growth of the international division of labor, as well as technological advance, kept the prices of consumer goods down, even falling. All these effects have been absorbed already, and the falling dollar relative to other international currencies has meant a higher price on imports. Lower productivity contributes as well, as does the general recessionary environment. So the downward price pressure on consumer goods is at an end.

Among the few who understand the role of money, there is the terrible problem that has grown up around the financial institutions created after deregulation. In short, hardly anyone knows what monetary instrument to measure to discover whether the Fed is creating a lot or a little new money. The only really reliable statistic is posted on the true money supply, which counts only immediately available money. It is here that we find the culprit: the great monetary expansion under Alan Greenspan that lasted from 2001 until 2005.

Despite all the complications, the fundamental cause is the Fed itself, which purports to be the great savior of the money system but in fact is its destroyer. By flooding the economy with ever more paper money, it reduces the value of our money — an insidious tax that the governing elites levy in ways that keep the people in the dark.

And here’s the heck of it. When the Fed expands the money supply, it can funnel money to the elites long before the people are forced to pay the price. As Rothbard explains, those who get the money first are permitted to use it before prices rise for everyone else. By the time the new money circulates through the economic system and hits everyman’s pocketbook, the elites who received the first round of injections have made off like bandits.

At times like these, there is a role for good economists to explain the true source of inflation to the public. In the 20th century, we were blessed by scholars like Rothbard, and public intellectuals like Henry Hazlitt who wrote for every possible venue to explain that “when the supply of money is increased, people have more money to offer for goods. If the supply of goods does not increase — or does not increase as much as the supply of money — then the prices of goods will go up. Each individual dollar becomes less valuable because there are more dollars. Therefore more of them will be offered against, say, a pair of shoes or a hundred bushels of wheat than before.”

The problems the Fed faces today are eerily similar to those of 1930 and following. The boom was caused by a loose money policy by the Fed, and the inevitable bust has come. But now everyone looks to the Fed to provide the answer. In the early 1930s, the Fed tried very hard to inflate the currency, but it could not manage to accomplish it through the credit markets alone. When bankers are reluctant to lend to shaky enterprises, and worried businessmen are reluctant to borrow, there is no other way to flood the markets. Today’s Fed has been exceedingly reckless in trying to forestall this program. It has engaged in direct bailouts of investment banks, and it is offering super-subsidized loans to banks by the tens of billions. This is Ben Bernanke’s little trick to use the banking sector more fully in his inflationary schemes.

If Bernanke loses, we all lose. But if Bernanke wins, we lose even more. More inflationary finance can only make the present situation worse.

Some people speculate that we are going to see not inflation but deflation due to the barriers faced by the Fed. My only comment on this is: we should be so lucky. The Great Depression would have been worse without its only saving grace: all goods were cheaper than before. The major mistake of Hoover and FDR was in thinking that low prices were somehow the cause of the depression rather than the effect.

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