Inflation vs Demand

By: Thomas E. Brewton

Once again, inflation is not a result of rising demand by consumers or business enterprises. And the Fed’s interest rate tinkering does not cure inflation.

In an article titled “Tips for TIPS,” a Wall Street Journal reporter, who should know better, writes:

“For now, few people see inflation as a major threat. The world economy remains strong and the dollar has been sliding, making U.S. imports more costly. But tighter credit and a badly sagging housing sector are expected to hurt U.S. economic growth, and government data suggest that higher energy prices so far haven’t had a broad impact on inflation. Indeed, investors believe that the Federal Reserve, which has cut short-term interest rates twice to quell market turmoil, will do so again.”

Inflation is a general rise in the overall price level. And it results from only one thing: a deteriorating currency, that is, excessive money creation by banks, in particular, central banks.

The Federal Reserve has created an excessive money supply, and the recent cuts in the Fed’s interest rates are intended to make the money supply still more excessive. The Fed will implement those cuts by open market and direct purchases of securities from financial institutions, paying for them with bookkeeping entries to create previously non-existent money.

In contrast to overall inflation, increased demand raises prices for specific commodities.

Let’s take petroleum, for example. We have seen the price of oil, reflected in gasoline prices, rise and fall over recent years. But that is not general inflation. It is simply current and prospective demand exceeding current and prospective supply for that one commodity and its derivatives.

Absent ill-advised government intervention, when oil prices rise, some consumers and businesses will decide to curtail their use of oil and gasoline, feeling unwilling to incur the higher costs. The ratio of demand to supply will drop, and oil and gasoline prices will level off and eventually decline.

That’s why the Fed’s use of “core inflation” numbers to measure inflation is a sham. First, the Fed selects the price measurements to use in the core index. Second, movements up or down in specific commodity prices do not measure general inflation.

The other current Exhibit A price gyrations are home prices and private equity buyouts. The aberrant surge in prices paid by home buyers and private equity fund managers was fomented by the Fed’s creation of massively excess amounts of dollars. When businesses and consumers have money coming at them in a flood of credit availability, from banks and mortgage lenders, they will spend and pay more than the underlying values.

Reviewing our nation’s history will make it clear.

Except in wartimes, for more than 200 years, inflation was not a major factor in the United States. Until 1933, we were on one form or another of gold standard, which worked automatically to curb or expand the money supply in line with the economy’s changes in real production of goods and services.

Price levels were remarkably stable until our first socialist President, Franklin Roosevelt, deliberately debased the dollar in 1933 and restructured the Federal Reserve in 1934 to facilitate the Federal government’s massive deficit spending, funded by creation of money out of thin air by the Fed. This was the prescription of Keynesian economics, still the regnant dogma of the Democratic Party: for every hitch in the economy, more Federal spending.

The result has been unending inflation since 1933.

Today, regardless of higher or lower business activity and higher or lower consumer demand, inflation will continue to rise, probably at least by 2% per year, indefinitely. That inflation will be driven solely by the Fed’s continual pumping up the money supply.

No interest rate manipulation by the Fed can quell inflation. The Fed can only encourage or discourage business activity and consumer spending with interest rate manipulation.

In the worst circumstances, which the Keynesian economics of the Democratic Party gave us in the 1970s, the economy sinks into the swamp of stagflation. Unemployment rose sharply; business activity declined; Midwest industrial plants closed, becoming the “Rust Bowl.” Yet all the while prices rose, ultimately at annual rates exceeding 20%, with overall consumer and business demand flat on its back. Citizens’ lifetime savings lost more than 50% of their pre-stagflation purchasing power.

Clearly this fiasco was the result of excessive government spending for President Johnson’s Great Society and concomitant creation of phony money by the Fed.
Inflation finally was halted in the first Reagan administration, when the President encouraged the new Fed chairman Paul Volcker to do what had to be done: shrink the money supply.

In a PBS interview in more recent years, Mr. Volcker described it this way:
“Well, the Federal Reserve had been attempting to deal with the inflation for some time, but I think in the 1970s, in past hindsight, anyway, [it] got behind the curve. It’s always hard to raise interest rates.

“By the time I became chairman and there was more of a feeling of urgency, there was a willingness to accept more forceful measures to try to deal with the inflation. And we adopted an approach of doing it perhaps more directly, by saying, “We’ll take the emphasis off of interest rates and put the emphasis on the growth in the money supply, which is at the root cause of inflation” – too much money chasing too few goods …- “so we’ll attack the too-much-money part of the equation and we will stop the money supply from increasing as rapidly as it was.”

“And that led to a squeeze on the money markets and a squeeze on interest rates, and interest rates went up a lot. But we didn’t do it by saying, “We think the appropriate level of interest rates is X.” We said, “We think the appropriate level of the money supply or the appropriate rate of the money supply is X, and we’ll take whatever consequences that means for the interest rate because that will enable us to get inflation under control, and at that point interest rates will come down,” which, of course, eventually is what happened.”

Since then the Fed has reverted to the old, completely discredited Keynesian belief that government planners can fine-tune the economy in order to attain full employment, price stability, steady GDP growth, all while expanding the money supply essentially without limit to finance ever-growing welfare-state expenditures and Congress’s massive pork-barreling.

For more on this subject, read:

Federal Reserve’s NewSpeak

Ben Bernanke and the “Barbarous Relic”

How FDR Destroyed the Dollar

Democrats, the Fed, and Milton Friedman

Thomas E. Brewton is a staff writer for the New Media Alliance, Inc. The New Media Alliance is a non-profit (501c3) national coalition of writers, journalists and grass-roots media outlets.

His weblog is THE VIEW FROM 1776

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About The Author Thomas E. Brewton:
Thomas E. Brewton is a staff writer for the New Media Alliance, Inc. The New Media Alliance is a non-profit (501c3) national coalition of writers, journalists and grass-roots media outlets.

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