Q&A: Inflation

Hello Eddy,
I’ve been reading your blog for a week or so now, and I just want to say hello and good luck. I followed a link to your blog from Bill Cara, whom I much admire.
As I near retirement, yes I’m a so called ‘baby boomer’, (boy do I hate that term), I regard Mr. Greenspan as an American hero. I recall the late 1970s, and early 1980s as a terribly difficult time in our country’s economy. At that time I was raising a young family and trying to get a new business off the ground. Securing a business loan was much more difficult than it is today, and paying 22% interest for a short term loan was the rule.
Those high inflationary days are long gone, and I will not miss them.
In fact I fear they’re return. It seems latley, Mr. Greenspan has become the target of unhappy Wall Street pundits and reporters, siting his tight fisted reign as the cause of the slow growth in today’s market. I don’t agree. Mr. Greenspan has returned this economy to normalcy. Now that he is about to retire, what can we expect? Will a new Fed chairman do as well? Will we again see uncontained and uncontrollable infaltion? Be careful what you wish for.
Good luck, again. I’ll be reading you often.

Thanks for your e-mail. I absolutely agree with you about inflation. I’m happy the days of inflation are long gone. Just thinking about the music and clothing is enough to scare me.
Inflation is nothing but bad news for an economy. The U.S. economy suffered years of uncontrolled inflation. One of the worst aspects of inflation is that it builds upon itself. A little inflation begets more which begets still more. By January 1980, inflation was beginning to spiral out of control. The price of gold spiked to over $800 an ounce.
I’ve always felt that there’s another criticism of inflation that economists miss. Inflation is cruel. It rewards debt and punishes people who save. People who live on fixed-income watch helplessly as a lifetime of savings is melted away. It’s a stealth tax on capital, and it’s never voted on. Inflation rewards people who speculate in gold and silver, while stocks and bonds fall far behind.
Look at what the Dow did over 17 years.
December 31, 1964 close: 874.13
December 31, 1981 close: 875.00
Twenty-five years ago, two Texas brothers tried to buy all the silver in the world. They would have gotten away with it too, if it weren’t for a bunch of meddling kids (i.e., the CFTC).
But stocks are claims on real assets. It’s part ownership in a corporation that grows and thrives; creates jobs and builds wealth. But 25 years ago, people were buying rocks.
Inflation also does damage to a society. In Weimar Germany, deutschmark were printed in notes of 50 trillion and 100 trillion. Inflation also hit France in the years before 1789. A debased currency breaks the bond been the government and the governed.
What creates inflation? That’s easy. It’s simply excessive M2 growth based on a three-month moving average against the implicit price deflator…eyes getting heavy…can’t stay awake.
I don’t worry about any of that, and I hope I can assuage your fears of inflation coming back. I always hear that inflation in on the “verge of coming back.” But it never does and I don’t think it will. The reason is that EVERYONE is worried about inflation.
Inflation is now broadly recognized as a Very Bad Thing. In the 1950’s and 1960’s, central bankers weren’t concerned about inflation. They were New Dealers. They lived and breathed the idea of preventing a repeat of the 1930’s. It never occurred to them that monetary policy could cause inflation. That was actually a very controversial idea. Even in the 1970’s many economists still thought that inflation was a necessary evil. It was merely the by product of affluence.
Now we know that it’s all the Fed’s fault. Even the most clueless American has probably heard the name Alan Greenspan. But how many Americans know his predecessors? You don’t often hear the name Marriner Eccles? William McChesney Martin? Back in the day, nobody knew who they were. No one parsed their speeches. Here’s an example: After the stock market crashed in 1929, the Federal Reserve actually raised interest rates. Dear lord! We now know that that’s the biggest, dumbest, wrongest thing you could possibly do. We’ve learned that mistake, and now we have a new conventional wisdom. That’s why I’m not worried about inflation.
Over the last 20 years, I’ve consistently heard that inflation is about to come back. But it never does. Oh sure, Hurricane Omicron Delta will wreck some oil rigs, and that will cause a price spike here and there. But general price inflation? Naw, ain’t gonna happen.
While you salute Alan Greenspan, don’t forget Paul Volcker too. During the 1981-82 recession, he had to have Secret Service protection. That was the Fed’s glory days. But nowadays, the Federal Reserve is overrated. It’s important, but it’s not all important. The best advantage we have is that the Fed realizes its own limits. This Bernanke fellow seems like a perfectly nice chap, and I have no reason to think he’ll do a bad job.
Today, if the Fed makes a misstep, there’s a gigantic international currency market ready to pounce. That’s the Big Story today, not inflation. The volume of currency transactions is nearly $2 trillion. Every day. The Fed is just another player in that game.
I hope you don’t mind if I put this in Baby Boomers term. If the economy is the Beatles, the Fed is the drummer. Sure, it’s nice to have a Ringo. But even without him, the band plays on.

Posted by on November 5th, 2005 at 1:57 pm


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