Inflation in Recent Monetary History

0:00Let me sort of buy a quote from Henry Hazlitt that I think describes very well what inflation is and what it does. I'm quoting him. This is what monetary management really amounts to. In practice, it is merely a high sounding euphemism for continuous currency debasement. It consists of constant lying in order to support constant swindling. Instead of automatic currencies based on gold, people are forced to take managed currencies based on guile. Instead of precious metal, they hold paper promises whose value falls with every bureaucratic whim. And they are suavely assured that only hopelessly antiquated minds dream of returning to truth and honesty and solvency and gold.

0:48I would also add to Hazlitt, to what Hazlitt says is that really the choice is also between gold and dictatorship, as we've seen very recently, with secret meetings among central bank officials and officials of the administration to call a meeting at which they present a fait accompli to the bankers regarding taking ownership in their banks, in which they seat these bankers in alphabetical order, denigrating these bankers, treating them like school children, in which they had secretly agreed beforehand to call an end to the meeting as soon as any bankers objected to allow them to stew and worry for a day or two before they called another meeting, in which only one banker, CEO of Wells Fargo, God bless him, raised any sort of objection to this sort of treatment and asked why, in fact, does the government have to take a stake in the banks?

1:50After which he was taken aside and told that, well, he could sign voluntarily, but he had to keep in mind, or not sign, But you have to keep in mind that, in fact, all banks were regulated by the government. And if there should be problems with his bank, it would be carefully looked at. And whether or not he would get a cash infusion would be up to him and what he finally decided. So we're faced with that. We're faced with the White House. A few days later, after giving out this cash and telling banks, the White House then telling banks that now they had to lend it, even though there were no strings attached, they didn't attach any explicit strings because they were very, very fearful that the banks would not sign on to the whole deal.

2:42But once they did and began buying weaker competitors and also giving out bonuses with the money, We now had commands from the White House that they must lend, they must not hoard. In fact, one of the White House spokespersons had a temerity to suggest that banks have every incentive to lend, why aren't they, that's how they make money. Okay, so banks should lend. Well, entrepreneurs know how to make money, they don't have to be instructed in this by some punk from the White House. So, a dictatorship is well on the way, if we continue in the same direction. Let me go back to a lesson of talking about lying.

3:28Let me just mention something that Alan Greenspan had said. Now, he didn't say it in these words, but in the 1990s, in the midst of the huge stock run-up and the bubble in financial, in high-tech stocks, Greenspan's attitude was the following. He said or implied there is no bubble and if there was a bubble we wouldn't know about it because we don't have the tools to detect the bubble and if we knew there was a bubble we couldn't do anything about it. We don't have the tools to deal with a bubble and if we could do something about it we wouldn't because whatever we did would cause a recession in the economy. So this was an admission of the bankruptcy of modern Modern Macroeconomics, Modern Monetary Policy, and now we've seen it come home to roost, where from day to day these planners, policy makers, their court macroeconomists in academia do not know how to solve any of the problems that come up.

4:34They're just flying by the seat of their pants. They can't predict one day in advance what the effects of these policies are going to But to get back to Mises' lesson, Mises once pointed out, or pointed out a number of times actually, that inflation is an ideological as much as an economic phenomenon. Its ideological roots lie deep in the intellectual doctrines that hold sway among policymakers and the media and the public. This is true of a most recent inflation, which I would date roughly to the beginning of Greenspan's tenure as chairman of the Federal Reserve Board. and the Federal Reserve Board in the mid-1980s. So in my talk, I want to explore the ideological, doctrinal roots of our recent inflation that has led to the meltdown of the global financial system, or nearly so, and the various aspects and dimensions of the recent inflation and some fallacies and outright lies that have been spread about it.

5:32And finally, if I have time, I will also say a few words about the prospects for the future The possibility of hyperinflation, everyone's worried now about deflation, which is one of the problems, which has gotten us into this mess. The depreciation of the dollar in the last 25 years or so has gone hand in hand with the degeneration of economic thought, economic thinking on money and inflation. During what has come to be known as the Great Inflation of the 1970's, most economists and government policy makers abandoned the simplistic Keynesian doctrine that money did not matter when it came to explaining inflation and that monetary policy was ineffective. Inflation was reduced in the 1980's in the US and throughout the developed world as more and more central bankers began to heed the lesson taught by centuries of theory and history and terrain in the growth of their national money supplies.

6:28Unfortunately, by the end of the 1980s, there was backsliding into another pernicious doctrine, that the Fed neither had the means to control the money supply nor even the ability to measure it. In the US, Alan Greenspan was the most influential proponent of this view. The results were twofold. First, it allowed the Fed to obscure its key role in the inflation process, and second, it shifted the focus of monetary policy back to the manipulation of interest rates which had reigned under the Keynesian regime. This movement to downplay the central role that money plays in inflation and monetary policy has proceeded so far today that in a recent article in the highly respected review of the Federal Reserve Bank of St. Louis, They commented on this. In an article called The Effectiveness of Monetary Policy, Robert Raschi and Marcella Williams lamented, quote, money has largely disappeared from discussions on monetary policy.

7:31They go on to point out that in the 1970s, 11 of 22 central banks in industrial countries reported using a money and credit framework to formulate monetary policy. But by the 1990s, only two of these banks maintained this framework. They also reported a negative trend from 1970 to 2002 in the fraction of titles of articles in major economics journals that included the word money. Though the frequency of titles including the word inflation was relatively constant. So people kept writing about inflation, but less and less was money brought into the discussion. Finally, they cited a study that found the frequency of the word money in the annual reports of major central banks declined over the period 1996 to 2002.

8:20All of this has occurred at the same time that an increasing number of central banks have instituted so-called inflation targeting, a deliberate depreciation of the monetary unit at a fixed rate per year, usually between 2 to 3 percent, which we use the rule of 72, 3 percent, the price level will double, your purchasing power of your money will cut in half in 25 years or something. If it's more than that, obviously, then that period of time is shorter. A second ideological factor driving our recent inflation was the revival by central bank officials of deflation phobia, which I define as an unreasonable and hysterical fear of deflation. This was a calculated move by the Greenspan Fed that wanted to drive down interest rates to get the U.S. economy out of the recession of 2001.

9:14Thus, in November 2002, and this was really well planned out and took place step by step, in November of 2002, Fed Governor Ben Bernanke, who was not yet obviously the chair, A former Princeton University professor and prominent macroeconomic theorist delivered remarks to the prestigious National Economist Club in Washington D.C. entitled, Deflation, Making Sure It Doesn't Happen Here, just out of the blue, no one was talking about deflation, the public wasn't worried about deflation. There was a little bit of, there were a few hints that there was some deflation in Japan, but if you look at the record, The actual fall in prices in Japan, the fall in consumer price level, occurred one or two quarters out of ten years of their stagflation.

10:01And it was very, very minor, less than 1% per annum. Now, as a Fed governor, the topic, content and venue of Bernanke's remarks would have to have been cleared by Greenspan himself, if not actively suggested by him. And Anki began his speech by affirming his belief that the chance of significant deflation in the United States in the foreseeable future is extremely small, quote unquote. He further expressed confidence, quote, that the Fed would take whatever means necessary to prevent significant deflation in the United States, and moreover that the U.S. Central Bank, in cooperation with other parts of government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be mild and brief. okay so that was his statement and then in typical Fed speak which was really pioneered by Greenspan he added so having said that deflation in the United States is highly unlikely I would be imprudent to rule out the possibility altogether okay so start worrying okay that that's that's the message here when

11:07a central banker even hints at something like deflation okay the markets start to He then went on to identify the cause of deflation, standard Keynesian terms, as quote, in almost all cases a side effect of a collapse of aggregate demand, which we've been reading since the 1950s in our textbook. A drop in spending so severe that producers must cut their prices on an ongoing basis in order to find buyers. Bernanke devoted the rest of his remarks to detailing the measures available to the Fed to prevent deflation from occurring and to cure it if such preventative measures somehow failed. Not surprisingly, all of these preventive and remedial measures amounted to little more than conventional and unconventional guidelines and techniques for creating money.

11:55This was really a rehearsal or a setting out of the program that was going to occur in recent months. For example, Bernanke suggested that to prevent an unanticipated fall in aggregate demand from irritating a deflation, from initiating a deflation, the Fed needed to establish a buffer zone for the inflation rate, quote unquote. In other words, we have to have inflation, so we don't have deflation. Inflation protects us against deflation. We have to have a positive inflation within a certain buffer zone. This means that the Fed should deliberately aim at inflating prices in the U.S. from one to three percent per year, but this is not enough. The Fed should also remain continually on alert for any sign of weakness in financial institutions and markets and stand ready to flood the financial system with inflationary credit.

12:43That's exactly what they're doing now. This is back in 2002 when he's talking about this. In case of, for example, a stock market crash or even a shock to confidence caused by a terrorist attack. okay now we've had a real estate crash finally even with inflation rates safely within the buffer zone so-called buffer zone if the Fed observes a sudden deterioration of the fundamentals of the macroeconomy such as a fall in investment or consumption spending it must act quote more preemptively and more aggressively than usual unquote for stall deflation you know think about this this is the only agency or organization that can create inflation Why is it worried about deflation? This is the one thing the Fed can do. It can do it all different ways, as we're finding out.

13:32It's not an inflation fighter, it's the inflation creator, the inflation generator. So what they wanted was a program by which any recession or any big fall in asset prices that had occurred in the late nineties in the high-tech industries could be offset by simply uttering the word deflation and scaring people. In the unlikely event that these and more precautionary measures fail to stave off the dreaded fall in prices, and the Fed has already reduced the federal funds rate to zero, they're already talking about that, which we're getting close to now, Bernanke assures us that the Fed has an arsenal full of additional weapons at its disposal, capable of generating the desired positive inflation.

14:19These unconventional techniques for money creation include Reducing and capping yields on medium and long-term treasury debt by committing itself to making unlimited purchases of these securities at a fixed price consistent with targeted yields. Well, they're now trying to do this with commercial paper and other securities, obviously, mortgage-backed assets, so on. Following the same strategy in the market for foreign government debt, which the Fed has been legally empowered to purchase since 1980, in other words, buying foreign government debt. and the outstanding stock of which is several times the size of U.S. government debts. If they run out of buying U.S. treasuries, they can begin buying government debt. But now that they can buy domestic paper of all kinds, they haven't yet gotten to the foreign debt.

15:07The circumvent the restriction on Fed purchases of private securities extends zero interest loans to banks accepting commercial paper, corporate bonds and even mortgages, talking about this in 2001, we haven't had the run-up yet, as collateral, thus effectively driving down the yields on these debt instruments, financing a massive treasury cut, and they're talking about this now, dollar for dollar by monetizing resulting deficits to the full extent of the lost tax revenues, or monetizing direct treasury purchases of current goods and services or financial or private financial and physical assets. So in other words, some sort of stimulus plan which is being pushed today, which would be financed nominally by cutting our taxes, but really by simply printing money to make up for the lost revenue.

15:55As Bernanke points out, this last alternative is tantamount to showering the country with money via Milton Friedman's famous helicopter. And make no mistake about it, Bernanke is proposing, or was proposing, inflation pure and simple, and plenty of it, as the panacea for an economy be set by a falling price level. This is explicit in the following passage, he says, and this is pretty famous now, this passage, it's been quoted a number of times, I think I may have been one of the first people to, the first time I saw it was when I quoted it back in, after I read this, in 2003, and he says the following, The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.

16:41A little parable may prove useful. Today an ounce of gold sells for $300. Those were the days. More or less. Now, suppose that a modern alchemist, someone who can turn base metals like lead and so on into gold, which people were doing in the 1600s, solves his subject's oldest problem by finding a way to produce unlimited amounts of gold that essentially know cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemists had produced and marketed a single ounce of yellow metal.

17:33In other words, they're going to use the fear, the expectations of people, they're going to manipulate those expectations to bring about a fall in the price of gold to zero, even before they flood the market with gold. What has this got to do with monetary policy? I'm still quoting him here. Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called the printing press, or today its electronic equivalent, that allows it to produce as many U.S. dollars as it wishes, at essentially no cost. By increasing the number of dollars in circulation, or even incredibly threatening to do so, Excuse me. Let me just shut this off. It's Bernanke.

18:26That was perfect. There we go, it's off. By increasing the number of U.S. dollars in circulation or even incredibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising prices in dollars of those goods and services. We conclude then that under a paper money system, a determined government can always generate higher spending and hence positive inflation. This passage is both true and chilling. Bernanke's analogy is based on correct economic analysis that the Fed indeed does have the power to bring about a collapse in the value of the dollar.

19:12What is so frightening is that the Fed governor, who later became Fed chairman, an allegedly moderate free market macroeconomist, Ernest, who was appointed by a Republican administration and has been rumored to be Greenspan's heir apparent, and in fact is now, has replaced him, dares to propose the use of such power as a remedy for a minor rise in the value of money. After all, the deflation of consumer prices in Japan, which Bernanke is so determined to avoid back then, has averaged less than 1% per year since it began in mid-1999. So it lasted for a few years, but it was less than 1% per year. And that was hardly Japan's main problem. Their main problem started in 1989 as a result of a bubble that they themselves had created, that is the Bank of Japan, by creating money.

20:03What I want to do now for just a few minutes that I have left is to show you, yeah, very quickly, some slides I brought showing that money should have never been left out of this equation, that they should have known that there was a bubble, that in fact there was a deliberate attempt to create a false prosperity in the US to avoid the problems with having a recession that went on into an election year. Let's look now. That's 1980. I've dated the inflation back to about 1985 when Greenspan took over. We see that the monetary base, which is completely controlled by the Federal Reserve, has increased tremendously from under $200 billion to near $1 trillion today.

21:01That is a constant, relentless increase. Now, taking two measures of the money supply that are official Fed measures, and I would measure it slightly different, MZM and M2, we see that it started at less than $2 trillion, and if you look at MZM, which I think is the better of the measures, went from maybe $1 trillion to over $8 trillion between 1980 and 2008. So it increased eight times. The increase is especially great after 2000.

21:48So the money supply, as we know, played a central role in all this. And no one talks about it. The media do not talk about it. The Fed funds rate, which they were focusing on, and which was really a misfocus, was what was being pushed down by the Fed. But in order to do so, they weren't just changing interest rates, they were infusing money, injecting money into the economy, to add to the reserves of banks that they could push the interest rates down by having more to lend out. The 30-year fixed mortgage rate followed suit as did all other interest rates. resulted, again, from this policy of injecting new money into the economy at a very rapid rate. The consumer price index, however, didn't increase as much as you would have expected because during the 1990s we had a tremendous amount of globalization as well as technological improvement in the high-tech industries in the U.S.

22:44So, as of the 1920s, the inflation was masked in terms of consumer prices, but not in terms of stock prices. We see in the 1990s, stock prices shooting up, then leveling off, then collapsing, when the first bubble was popped, the financial bubble, and then once again taking off and ending up at near 14,000. So asset prices bore the brunt of this inflation. You can see the bubble there. And it was broad-based. It wasn't just the Dow Jones, It was also the S&P, which is a much broader index of stocks.

23:29The U.S. exchange rate in terms of dollars per euro, you can see the depreciation there, meaning that we had to pay more dollars to get a euro going from around $1 sometime in 1999 per euro and rising all the way up to about $1.55 or something at its peak, okay? That's another indication of the tremendous depreciation and of the asset bubble that was being formed, one minute, okay? We see the home price index, now this is not a linear index, these are rates of increase in home prices, okay? So at the top here, home prices for the U.S. were increasing at 20% per year on a national level, and they were at 16% for a while.

24:20I mean, who could deny that there's a bubble there by looking at these data, and then the crash. So, home price is now falling at an annualized rate of about 16% per year. Now, one last graph here. The top graph, investment as a percent of nominal GDP, is very important. We often forget, we look at stock prices, we look at real estate prices, we forget that there's a real component or real complement to the boom in the financial markets and real estate markets. and that is the actual investment in goods and in producers goods okay and so you see that it always shoots up well what it showed was it always shoots up right before recessions and then and then it comes down during recessions so it went from something like 12% of GDP up to about 16% at the end of the 90s fell fell off back down below 14% and then by the 2006 or so rose again to around 16% of GDP, okay?

25:31So we had this real boom in investment, which of course they never really look at. So I'll end there. Thank you.