February 21, 2007

Yes Caroline, We Are in Trouble

Caroline Baum is making more progress toward clear-headed thinking with each passing week. In today's commentary at Bloomberg she gets to the heart of the "inflation ruse" perpetrated upon the American public, striking at the Achilles' Heel of contemporary monetary policy in the U.S. (i.e., that pesky "monetary phenomenon" warning by Milton Friedman).

She goes so far as to compare Ben Bernanke to Zimbabwe Central Bank Chief Gideon Gono, famous for $1,500 rolls of toilet paper and all sorts of other monetary oddities in an African nation where prices rise at a rate of 1,600 percent - per month!

[The Central Bank of Zimbabwe has a nice looking website, replete with a Monetary Policy Statement from just a few weeks ago - looks interesting.]

Fed's Inflation Analysis Ranks With Zimbabwe's
By Caroline Baum

Maybe it was the repetition, the iteration of the same monetary policy testimony on back-to-back days last week, that did it, that left the words grating on my consciousness.

Here was Federal Reserve Chairman Ben Bernanke, one of the outstanding monetary economists of his time, talking about inflation as if it were the result of some pesky exogenous forces.

"A waning of temporary factors that boosted inflation in recent years will probably help foster a continued edging down of core inflation,'' Bernanke said in testimony delivered to the Senate Banking Committee on Feb. 14 and the House Financial Services Committee the following day.

What's more, the contribution "from rents and shelter costs should also fall back,'' he said.

There's a big difference between an inflation measure, which Bernanke was talking about, and the inflation process. Policy makers -- Bernanke, Alan Greenspan before him, the Fed governors and bank presidents -- talk about the effect oil prices or imputed rental costs have on inflation gauges, such as the consumer price index. That's not the same as the inflation process, which is always and everywhere a monetary phenomenon.
Oil prices don't cause inflation. Nor do wages, even though you'd never know it from discussions on the subject. The Fed causes inflation all by itself, creating too much money relative to the supply of goods and services.

If the inflation-as-effect posture is just a shorthand way of communicating with Congress, that's one thing. If it's the Fed's analytical framework for inflation, then we're in trouble.

Caroline, it's no short hand - we are in trouble. Big trouble.

Central bankers are so far out of touch with the real world that not only do they believe "inflation" and the money supply are largely unrelated, they think that at two percent, "inflation" is overstated by up to one percent.

This is what Ben Bernanke termed "true inflation" in his previous visit to Capitol Hill.

The money and credit sloshing around the world is completely irrelevant. The central bankers of the world know better what inflation is and isn't and they'll tell the elected officials and the citizenry what to think about inflation.

Of course, this varies greatly from one country to another.

The Zimbabwe government recently outlawed inflation, arresting a number of senior executives in recent months for breaking the law: raising the price of flour and bread without the express approval of the Ministry of Industry and International Trade.

Venezuelan President Hugo Chavez adopted the same inflation- fighting tactic, threatening jail sentences and even nationaliztion if grocery store owners defy price controls.

The 1,331 word New York Times article on Zimbabwe's economy never mentions money. Rarely does the Fed refer to money -- in its public statements and apparently in its internal discussions. There are no mandated targets for the monetary aggregates, fewer aggregates (reporting on M3 was discontinued last year much to the chagrin of conspiracy theorists), no agreement on how to define money and no good way to measure it, we're told.

But excess money creation is the cause of inflation, and it would be better if the Fed could make the public understand that the rise in the price level is not a result of higher commodity prices, aggressive labor union demands for wage increases or greedy businessmen trying to milk the public.

It may not sell in Zimbabwe, where anyone trying to explain the roots of inflation might be arrested on the spot. But in the U.S., with inflation running at about 2.5 percent, the public can handle the truth.

Oh Caroline, you were doing so well there up until that last paragraph. What happened?

It's excess money that causes "inflation", but you actually believe it to be only 2.5 percent?

Oh Dear. You're as out of touch as the Fed Chairman.

[Note: Caroline Baum and I exchanged a number of very friendly emails after this was posted at the blog. She wrote a follow-up column later in the week titled From Pluto, U.S. Inflation Is Near 10%, quoting from the above.]