10.01.2008 0

The High Price of Inflation

  • On: 10/10/2008 15:00:36
  • In: Monetary Policy
  • Of the many differences that divide Americans politically along party lines and ideologically, one thing that most Americans will agree on is that prices have been soaring. Gasoline prices keep reaching record highs. Electricity price hikes are being felt, too. Food has spiked as well.

    Inflation is the cruelest tax of all, and the resulting pain is felt by everyone. But while it is easy to understand how high prices hurt Americans struggling to pay their bills and keep their families fed, what many Americans may not realize is the cause of their reduction of purchasing power, namely, errant government policies.

    Inflation is a monetary issue and historically its causes have been due to wayward monetary policy. That means that the cure for it can only be via reversing those policies. After all, governments control the money supply.

    And a key principle in economics is that the more there is of something—the greater the supply—the less it will be worth. And so it is with the dollar.

    In the June 16th edition of Forbes magazine, publisher Steve Forbes makes the case that none other than the Federal Reserve is responsible for America’s price problems:

    “While denying it, the Federal Reserve is still in thrall to the Phillips curve. This posits that there is a tradeoff between economic growth and inflation: that to gin up an economy a central bank must print more money (which eventually leads to more inflation), and that to bring inflation down a central bank must tighten money (which slows down the economy). Experience has demonstrated time and again that the Phillips curve is b.s. Economies can achieve noninflationary prosperity. In both the 1980s and 1990s, for instance, the U.S. economy boomed even as inflation and interest rates declined.

    “Right now the Fed is befuddled. It has pumped out plenty of new money, yet the credit crisis lingers and the economy is sluggish. Chairman Ben Bernanke and Fed bureaucrats console themselves with the hope that things will get righted once the housing crisis is somehow solved.”

    In other words, the Fed has seen fit to use monetary policy to address the subprime mortgage crisis by lowering interest rates, thus making it cheaper to borrow money, which added more money into circulation. They were too clever by half: They manipulated the market to “solve” one problem. However, as Mr. Forbes notes, this has had an unintended—though predictable—consequence:

    “The proof of the Fed’s predominant role in the current disaster: When the credit crisis hit last August, the price of oil was $70 a barrel. Then the Fed began flooding the system with dollars. Today the price of oil is more than $130 a barrel, even though global demand has declined as economic activity has cooled off.”

    Obviously it based on that data that Mr. Forbes stated last month that at least half of the price of oil was due to the weak dollar. This Harvard study adds a lot of weight to that argument. One reason for the price spikes is because investors will often buy up commodities as a hedge against inflation. And the solution isn’t to go after the speculators, for they are only a symptom of the larger problem.

    As ALG News reported in “Exiting Inferno,” Congress Paul Ryan has a proposal that would restore the mandate of the Fed to simply focusing on price stability and checking inflation. The proposal would also get the central bank out of the business of trying to stimulate economic growth.

    In other words, the economy will take care of itself naturally. Inflation, on the other hand, will only be exacerbated if a country’s central bank is not on the ball. Mr. Forbes obviously agrees:

    “What Bernanke & Co. have yet to fathom, however, is that strengthening the dollar by removing the excess liquidity the Federal Reserve has created since 2004 will rapidly move the economy back on track. Business investment has stagnated because of the falling value of the dollar. Commodity speculation is reaching white-hot proportions, particularly with oil. If the dollar were stronger, equity markets would revive and corporate cash hoards would be reduced as companies began making capital investments again, as well as buying back their own equity and making acquisitions.”

    Mr. Forbes adds his own proposal to the mix by calling for a “modern gold standard”:

    “[T]he Administration and the Fed should adopt a strong-dollar policy and tell the markets what measurement they are going to use to guide monetary policy. The best measurement is the price of gold. But Bernanke mistakenly believes that the old gold standard somehow caused and deepened the Great Depression. Therefore, he is unlikely to adopt a modern gold standard, such as gearing monetary policy so that the dollar gold price remains in the $550-to-$600-an-ounce range.”

    Coupled with Mr. Ryan’s proposal, ALG News believes that Mr. Forbes is on the right track here. Unstable monetary policies have led to very serious economic downturns before. And today’s slowdown and price spikes could only be the beginning of a much more major economic crisis on the horizon.

    If both proposals—restoring the mandate of the Fed and moving to a modern gold standard—are enacted, individual Americans will begin to see real relief at the gas pump, at the grocery store, and when they receive their bills every month.

    That should be something we can all agree on.

    ALG Perspective: A strong dollar is not a partisan issue, and a strong dollar policy should be a transcendent matter that politicians on all sides of the political fence can rally around. The American people do not want to hear partisan bickering over the high costs of commodities. They want to know that the government understands the problem—which it inadvertently caused—and that it is taking corrective action to remedy it.

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