More Money, Less Problems

If the case for increased monetary stimulus could be summed up in one picture, it would be the above chart. For the last several decades, nominal spending in the U.S. has increased at a fairly steady rate, and businesses and individuals acted in the expectation that this trend would continue. Contracts were written, debts undertaken, and business ventures began under the assumption that there would be roughly 2% inflation per year. The lower total spending means that there is not enough money flowing through the system to fulfill these contracts and pay back these debts, which the result that you get lots of defaults, unemployment, and less economic growth. Monetary stimulus, such as the Fed’s QEII program, is aimed at returning nominal spending to trend, leading to lower unemployment, fewer defaults, and higher economic growth.

Some conservatives and libertarians, however, have been warning not of deflation but of hyperinflation. Here, for example, is libertarian economist Bob Murphy:

I have been warning of severe price inflation for some time, and when people ask me “hyperinflation?” I respond, “What do you mean by ‘hyper’?” Recently someone coaxed a number of 25% annual inflation out of me, since I think Bernanke will do what needs to be done to bring it down to the maximum acceptable level, which I somewhat arbitrarily put at about 25%. (Of course the true increase in CPI will probably be more like 35%, but the official press releases–if you have a gun to my head and force me to pick a number–I’m picturing around 25%.)

Sarah Palin has blasted the Fed’s QEII program, as have a few Republican-leaning economists and commentators. Of course, many other conservatives do support the Fed program (see here, here, here and here). However, it is worth considering why people think that the threat right now is that inflation is or will be too high, and whether this worry has any real justification.

If you had to sum up the case for worrying about hyperinflation in one picture, it would be this:

The Fed has massively increased the monetary base in the wake of the current crisis. And increases in the monetary base do tend to be inflationary. It is only natural, therefore, that some people have concluded that there must be lots of inflation. This, however, is like noting that a house’s heater is on full blast and concluding that the house must be really hot. In reality the opposite is more likely to be the case: the reason the heater is on full blast is that the house is really cold.

Suppose that, in the fall of 2008, a mutant strain of cotton and linen-eating termite appeared and quickly gobbled up a third of the paper money in the United States. Demand for new dollars to replace this destroyed currency would rise dramatically, and unless the government printed large amounts of new money, the result would be massive deflation. Yet if you just looked at the rate at which Uncle Sam was printing greenbacks, you might easily conclude that the U.S. was due for massive inflation, not that it was acting to counteract massive deflation.

In actuality there was no dollar eating moth let loose on America in 2008. But something quite similar in effect did happen. Stocks crashed, home prices cratered, credit contracted. The a substantial portion of the net worth of many Americans disappeared into thin air. Without government action to counteract this, the result would have been a huge deflation akin to what happened in the 1930s. Its actions, therefore, were not inflationary so much as anti-deflationary.

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  1. I admit to Austrian sympathies, but I am sufficiently encumbered by my BA in Economics to acknowledge uncertainty. Notwithstanding my general agreement with Hayek (less so Rothbard), I have to say what is most unappealing about the Austrians is their unhealthy obsession with orthodoxy in a field that is ill-suited for it.

    Thanks for your post, BA. Interesting.

  2. This topic is appropriate for a Catholic weblog.

    QE2 is a “Hail Mary” pass. Nothing else has worked. We need Divine assistance.

    We will see if there results inflation or stagnation.

  3. What is missing in the discussion is whether or not all this fresh money has resulted in wealth creation. I contend that it hasn’t. The money has been created and shoved through the financial system and allowed banks to pretend they are solvent while fueling a massive – but illusory – rise in stocks. The price of gold and other commodities tells you what has really happened – because there is so much more money around, money has become worth far less while the amount of wealth backing the money has, at best, had only a tiny increase (and my bet is that we’ve had a net loss of wealth since 2007 – but we need not quibble over that).

    We’ve been on this track since the end of the First World War – a war which cost a huge amount of life and a vast amount of wealth. Post-WWI, the world could either suffer through a generation of privation while wealth and lives were rebuilt but, instead, the world opted for easy money. The United States got the “Roaring 20’s” as a result. But it had to be paid for – and in 1929, we started paying. But rather than pay the full price, we went for even easier money…and got some illusory growth in the mid-30’s. Just as we were about to start paying the price, again, along comes WWII, which cost even more lives and wealth than WWI.

    Once again, we should have had to pay for it – but by happy coincidence, we had blown our industrial competition to pieces (literally) while we lucked in to a population boom fueled by advances in health care, especially among children. Instead of having to pay for the war, we got a free ride. Until, that is, the rest of the world rebuilt itself – then it was time for us to pay the piper and finally go through what we should have gone through in the 1920’s. Instead of doing that, we went entirely off the gold standard and went for the easiest of easy money – piling up fiat money and debt like no tomorrow. Never retrenching and building anew our agricultural, mining and manufacturing industries, but using fiat money and debt to buy such things from foreign lands.

    And, so, here we are – in 2010 with the economy seemingly stabilised, but our debt absolutely crushing, China teetering on the brink of financial melt down, Europe trying desperately to stave off sovereign default and our own financial system kept afloat by “extend and pretend” policies. And the solution some offer? Print and borrow more money! That will get us inflation, and that’s a good thing!

    Nonsense. We might hold it together for a while – but the complete collapse of this fiat money, usury-based economy is inevitable. You can’t borrow, print and spend your way to wealth. Wealth come from hard work, savings and careful investment and by no other means. Period. Print away, if you like – bail out a couple more European nations, if it suits you…but it won’t work; it can’t work. It is doomed. The good news is that once the crash completely happens, we’ll be able to reform our nation and get some common sense built back in to our financial house.

  4. If you think there is no inflation, think again. The CPI excludes food and energy. It is heavily weighted to manufactured goods. Demand has fallen for those items due to unemployment and the stock market crash, and so prices have remained level. At the same time, however, food and energy have seen quite substantial price increases that are not measured in the CPI. My family shops wholesale, purchasing bulk commodities without individual packaging to save money. A case of bulk pork which cost $1.24/lb two years ago now costs $1.54/lb. A fifty pound bag of ADM All Montana flour cost a little over $8 two years ago, but now costs a little over $13. Sugar has gone from about $19 for a fifty pound bag has skyrocketed to $29. A case of #10 cans of fruit has gone from around $13-15 in 2008 now goes for $23-30.

    People can defer purchases of clothing, electronics, and other consumer goods, but not food and, to some extent, energy. Thus, prices of consumer goods remain flat due to demand, but food and energy increase due to monetary influences. Ultimately, the other markets will catch up to the realities of the huge increase in the money supply, but it will take time. Meanwhile, the government will continue to put out reports which deny the real effects of monetary policy.

  5. Not to be pedantic but the title of this post should be “More Money, FEWER Problems”. If you can count “how many” (problems, jobs, dogs, rocks, etc.) the proper term is “fewer”. If you quantify a noun with “how much” (money, water, sugar, cement, etc.) the proper term is “less.”

  6. The CPI excludes food and energy.

    No it doesn’t. The regular CPI numbers include food and energy prices.

  7. Not to be pedantic but the title of this post should be “More Money, FEWER Problems”

    If I thought more money would make some of the problems go away completely then fewer would be correct. But that’s not what I’m saying. Monetary stimulus won’t eliminate unemployment, for example, it will just lessen the unemployment problem. So less is proper.

  8. From Wikipedia:
    “‘The road to hell is paved with good intentions'” is a proverb or aphorism. It is thought to have originated with Saint Bernard of Clairvaux who wrote, ‘L’enfer est plein de bonnes volontés et désirs’ (hell is full of good wishes and desires).”

    No one is questioning the monetary geniuses’ motives. It’s just they can’t match the performance record of that the stopped analog clock, which is correct twice each 24 hours.

    They’re again heaving that metaphorical pigskin 60+ yards down field and hoping this time their guy comes down with the ball!

    I wonder what odds they’re getting in Vegas.

  9. Not to be pedantic but the title of this post should be “More Money, FEWER Problems”

    If I thought more money would make some of the problems go away completely then fewer would be correct. But that’s not what I’m saying. Monetary stimulus won’t eliminate unemployment, for example, it will just lessen the unemployment problem. So less is proper.

    Elaine is right, though, as to the proper grammar. If that is what you meant, then you should have said “more money, LESSENED problems”. This is the only aspect of your post that I am even marginally quaified to comment on.

  10. Keynesian economic theory was discredited in the 1970s with stagflation. Why anybody follows it today is rather amazing. Printing fiat money (from nothing) and encouraging spending through borrowing (or extended unemployment benefits) is a recipe for disaster. Working, paying off debt(s), saving and investing is the wise path and the Austrian way. Common sense tells us this much.

  11. Keynesian economic theory was discredited in the 1970s with stagflation. Why anybody follows it today is rather amazing.

    The Keynesian economic theory of the 1970s was discredited by stagflation, and hardly anyone follows it today. When someone refers to himself as a Keynesian today he typically means something quite different from what someone who called himself a Keynesian in the 1960s-70s would have meant (details here).

    On the other hand, I would say that the Austrian economic theory of someone like Rothbard/Bob Murphy is discredited by recent events (as well as by the Great Depression, Japan’s lost decade, etc.)

  12. The presupposition that the economy can be centrally planned is a false.

    I would encourage folks to read the following excerpt by Dr. Murphy.

    He has written another entire book on the Great Depression which I encourage folks to read and make their own judgment.

  13. The presupposition that the economy can be centrally planned is a false.

    That would be salient in some other country. This country’s experience with central planning was limited to the first and second World Wars.

  14. The presupposition that the economy can be centrally planned is a false.

    I agree with this, but like Art I fail to see the relevance to the current discussion.

    If the Fed chooses not to engage in QE this is as much an instance of economic central planning as if it chooses to do so.

  15. Watch the below video of Jim Rogers to understand what happened regarding Japan’s lost decade. It was because of economic central planning that they have had a lost decade. We are following down the same road as Japan.

    Allow me to further explain my statement that the presupposition that the economy can be centrally planned is a false. Central banking is a form of central planning.

    In this country the Fed is a semi/quasi governmental organization. It can best be described as a hybrid organization, semi-private and semi-governmental. It’s leader (the Chairman) is appointed by the President and confirmed by Congress. It’s highly regulated by Congress. The Chairman regularly briefs and responds to questions from Congress on monetary policy. The Sec. of Treasury works with the Fed like a hand does with a glove. The Chairman responds to pressures from the President, Sec. of Treasury and the Congress. Some Chairman respond to these pressures more than others. The current Fed Chairman does respond to these pressures.

    To be sure some Presidential Administrations have centrally planned more than others, i.e. F.D.R, etc. To say though that central economic planning in this country was limited solely to the First and Second World Wars is a false and erroneous statement. Anytime the Fed acts to interfere with the economy it is participating in central economic planning. Anytime our government in their fiscal policy gives bail-outs to failing banks or corporations, it is centrally planning. The boom and bust cycles are largely created by government interference in the market. If left to its own, downturns would be less servere and our economy would recover much quicker. End the Fed and bail-outs.

  16. David,

    There is a difference between saying that we should get rid of the Fed and saying that the Fed should pursue one policy rather than another. Criticisms of the Fed’s QEII program are of the second type. They imply that the Fed should engage in one form of “central planning” rather than another. So even if the Fed ought to be abolished, that doesn’t tell you whether the QEII program is a good or bad idea.

    By analogy, government imposed price controls are a bad idea. But the fact that government imposed price controls are a bad idea doesn’t tell you whether a particular government imposed price is too low or too high. If the government had set the price of gas at $1.00 and then raised it to $1.50 it would make no sense to say that because you are opposed to price controls therefore the price should remain set at $1.00.

  17. BTW, I just watched some of the Jim Rogers interview. Most of what he says there is just factually wrong. He says, for example, that devaluing (what he calls “debasing the currency”) has never worked. That’s not true. Partial devaluation of the currency is generally the way countries get out of serious financial crises.

  18. David,

    “Central planning” refers to the erection of public agencies which allocate capital to specific projects in agriculture, extractive industry, construction, manufacturing, and tradable services in lieu of a reliance on the undirected processes of capital markets and private banking. ‘Twas done here only quite briefly during the World Wars.

    Central banking is not a form of ‘central planning’. The Federal Reserve is adjusting the interest rates it charges to and pays its clients and buying and selling securities to regulate the size of the monetary base. The minting and distribution of currency is an inherently public function, and an old one. Our last go ’round with a gold standard was economically ruinous, as was Argentina’s with the updated version thereof promoted by Hanke, et al.

  19. David,

    I think it would be more productive if you would try to engage other people’s comments, rather than just posting a bunch of links.

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