Friday, February 22, 2013

State-sanctioned inflation

In several recent articles I've warned about the real danger of accelerating inflation - even the potential risk for hyperinflation.  I recently pointed out that quantitative easing programs are likely to lead to massive increases in the inflation rate once all that artificially-generated liquidity goes into circulation, instead of being held back from the consumer market.  That day isn't far off.

In his latest 'Outside The Box' newsletter (link is to an Adobe Acrobat document in .PDF format), John Mauldin invites Scott Minerd of Guggenheim Funds to review the contribution of Keynesian economics to economic recession and depression.  One of Mr. Minerd's points is very relevant to our discussion of inflation.  I reproduce it below.

The most important question for investors concerns how public sector debt levels, which have risen exponentially over the past half-decade, will ultimately be discharged ... there are three options to reducing debt levels. The first is restructuring, also known as default. For obvious reasons this is painful and typically avoided except under the most dire circumstances. Governments can also pursue structural reform, which in today’s case would mean greater austerity. Implementation of this would stand in stark opposition to Keynes’s recommendation that the fiscal and monetary spigots be kept open during hard times. Although tightening is arguably the best long-term path, it appears unlikely that it will be the primary policy of choice in the near future. The third method, toward which I see global central bankers drifting, is to keep interest rates artificially low and permit increasing levels of inflation in the economy.

Pushing down the cost of borrowing and allowing the price level to rise is known as financial repression. The real value of debtors’ obligations is reduced by financially repressive policies. Keynes warned of the dangers of inflation in his early work, The Economic Consequences of the Peace, which presciently criticized the harshness of the Treaty of Versailles:

...By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens ... As inflation proceeds and the real value of the currency fluctuates wildly, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless.

Keynes reiterated his views in the mid-1940s when he visited the United States and saw programs that were touted as Keynesian although he viewed them as primarily inflationary.

Financial repression is nothing new. Between the 1940s and the early 1980s, the United States reduced its national debt from 140 percent of GDP to just 30 percent while continuing to run sizable deficits. The difference between then and now is the magnitude of the debt mountain on the Federal Reserve’s balance sheet that will need to be eroded. A subtle shift has begun in which policymakers are starting to think of inflation as a policy tool rather than the byproduct of their actions. Despite Keynes’ warnings, it appears that higher inflation will continue to be the monetary tool of choice for central bankers tasked with cleaning up sovereign balance sheets.

There's more at the link.  Bold, underlined print is my emphasis.

It's important to remember that politicians and policy-makers aren't interested in your well-being, but theirs.  If it makes more sense for them to foster inflation than to preserve your buying power, guess what they're going to do?  That's right . . . and you'll be left to face the consequences.  That's why politicians are still borrowing like there's no tomorrow in order to fund entitlement programs that we absolutely cannot afford to pay for.  That's also why they'll embrace inflation rather than fix the spending problem, because they can try to blame that on something external - 'inflation' - rather than their own fecklessness, knowing that many of the electorate who depend on those entitlement programs will go along with them rather than face the facts.

As Thomas Sowell memorably pointed out some years ago:

No one will really understand politics until they understand that politicians are not trying to solve our problems. They are trying to solve their own problems— of which getting elected and re-elected are number one and number two. Whatever is number three is far behind.




Graybeard said...

Yeah.. 10 years ago I thought they were going to inflate the problems away but then thought, "That would end up killing millions of people! Anyone whose life depends on their savings; retirees, people between jobs, they'll be destroyed. They'd never do that".

Oh how incredibly stupid I was in those days. They'd do that in a femtosecond. We mean exactly 0.0 to them.

trailbee said...

Thank you for posting two of my very best favorite writers. :) Whatever I learned in the last four years regarding politics and money comes from them. Smart guys.

Retired Mustang said...

I've been telling people for years that a major part of education must involve financial education. That includes everything from how to fill out a check register to the nature of money, credit and debt. It also includes an understanding of what wealth is and how it's accumulated.