Practitioners of Malpractice

Practitioners of Malpractice
by Mark Anderson, Columnist

December 10, 2002

"Dollars and Sense"

On November 21, Federal Reserve Governor Ben S. Bernanke made a few remarks that I feel morally obliged to address. Mr. Bernanke unveiled the arsenal of weapons the Fed can enlist to "cure deflation" - i.e., lowering nominal interest rates to zero, purchasing mortgages, U.S. government securities, foreign securities, and corporate securities. I believe he discussed just about every method other than killing cows and burning oil fields - please, don't get any ideas.

Too often, me and my fellow economic practitioners fail to trace the pathology of the problem. By consuming ourselves with the "markers" of a recession - i.e., the revelations from statistics, graphs, charts and equations - we look for ways to adjust these markers, as though the present is hermetically sealed off from all previous human action. If we think this through logically, we should have no problem concluding that something must have caused these conditions.

First, I must begin by defining inflation for Mr. Bernanke. Contrary to the Keynesian/Monetarist definition of inflation, it is not a general rise in prices. That definition is the contorted inverse of Irving Fisher's quantity theory of money. The general rise in prices is the usual result of inflation, which is an expansion of the inconvertible money supply. That statement, however, cannot go without punctuation. The demand for dollars, supply of goods and services, demand for goods and services, and time preferences, all affect prices.

Is it possible that Ludwig von Mises - the most ignored genius of his day - was right about the business cycle? Looking at the monetary aggregates alone, we can see that we have had inflation all throughout the nineties. According to the Austrian Business Cycle Theory (ABCT), credit expansion precipitates an unsustainable boom, and is, therefore, the very cause of recession. Inflation distorts the time preferences of firms and people, as they mistake this injection of new currency for real savings. Although this new currency does suffice to masquerade as savings at first, it actually amounts to a redistribution savings. This causes firms and people to malinvest, and even over-invest in capital goods. Should it be a surprise that prices may then fall?

Those who are last in the money line - as they exchange their goods and services for a diluted dollar - may end up over-estimating profits, which they realize once it comes to restock their inventories. Or, with methods in place to account for a depreciating dollar, such as LIFO accounting, maybe they even under-estimate their profits.

Attempting to curtail demand for the dollar, in order to stimulate aggregate demand for goods and services, is akin to drowning our patient to increase their intake of fluids. I would like to emphasize the fact that demand for the dollar is inextricably linked to our capacity to consume. Where, then, does the Fed get this idea that there is some sort of conflict between our propensity to consume and demand for the dollar? Furthermore, what would be so injurious about a troublesome, rapid, liquidation of assets? All we have to do is incinerate everything afterwards, and this would help us "cure" deflation by raising prices. This would accomplish roughly the same thing as inflating the money supply, since higher prices means we won't be able to buy as much.

With the altitudinal descent of interest rates, having been manipulated by twelve cuts in 2001, and another Federal Funds Rate cut this year, what does this ineffective shock therapy tell us? Perhaps this "excessive" demand for the dollar is fiction. This would mean, then, that it is time to put the "ink and paper" away. It is certainly no time for the Federal Open Market Committee (FOMC) to be employing inflationary schemes in this seemingly state of tabula rasa.

Milton Friedman's "Angel Gabriel" story does a fine job at illustrating the illusory gains of inflation, but inflation never happens proportionately. If it did, inflating the money supply would be a nugatory and absurd process. This means that inflationary life support will - possibly - stimulate a fragment of the near death assemblage temporarily, but it is going to flat line other fragments of the economy at an accelerated rate, by crowding out meaningful capital formation in the very process of consuming capital. In an era of cost-cutting, does the Fed really believe higher prices will heal the sick, and resurrect the dead?

Lest we forget that we went off the gold standard in 1933, which had little nexus with anything other than giving the Fed more flexibility to inflate. Obviously, those efforts failed miserably. The Great Depression was extended, rather than defeated, by those policies. Every policy of the Fed seems to exact punishment on saving and reward consumption - an antagonism that must be dealt with. The Fed's policies, intended to manipulate our habits in favor of borrowing and consumption, combined with the largest federal government budget ever, will inevitably erode capital and leave us with nothing to consume. Resorting to inflation now is like trying to cure a hangover with alcohol. Why don't the architects of Fed policy understand this? ***

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Photo of the author courtesy of staff files