Once an Inflationist, Always an Inflationist

June 16, 2009 – 9:53 am

by Rolfe Winkler, CFA

OA has noted P Krugman’s insistence that the Fed/Treasury use all the tools at their disposal to keep us from falling into another Depression.  We’ve yet to see any thorough discussion, however, of the consequences of such action.  He admits deficits are a “long-term” problem, that we need a plan to address them eventually.  In the meantime, policy-makers shouldn’t be afraid to spend and print to their hearts’ content.

Here are some excerpts from a ’98 column in which he made a similar argument.  Central banks should actively inflate, he argues, in order to arrest the incipient global recession spawned by the Asia Crisis:

Even if financial markets do continue to tumble, Alan Greenspan and his counterparts in other advanced countries have the tools they need to prevent paper losses from turning into a slump in real output. Mr. Greenspan turned a stock market crash into a real-economy non-event in 1987; he can do it again.

But will he? That’s where I start to worry. The real risk to the world economy comes not from bad fundamentals but from rigid ideologies—ideologies that might make policy makers fail to respond, or even move the wrong way, if a global slump starts to develop.

[Of course the rigid ideology responsible for our latest brush with economic disaster is, in fact, Krugman’s.  Back in 2002, like so many economists he was panicked about a fall in consumer spending.  So he favored using inflation to create a housing bubble in the first place.  Oops.]

One of those ideologies is the belief that a strong currency means a strong economy, that stable prices insure prosperity. Notice that my scenario had the Bank of Japan actually raising interest rates in a recession in order to defend the yen, and the Bundesbank refusing to cut rates because it doesn’t want to encourage laxity in its successors.

[The point of having a “strong, stable” currency isn’t to “insure prosperity,” it’s to get rid of artificial, Fed-induced booms and busts.  Already, Bernanke’s zero-interest rate policy is driving money managers to repeat the mistakes of the recent past.  Again they are chasing returns in risky securities because risk is underpriced.]

Both actions would be deeply foolish. Alas, given the strong-yen rhetoric of Japan and the stable-price rhetoric of Germany, both are also quite plausible. In his classic book ”Golden Fetters,” Barry Eichengreen, an economist at the University of California at Berkeley, showed that the spread of the Great Depression was, more than anything else, caused by the dogged determination of many nations to remain on the gold standard at all costs. Nobody is on the gold standard these days, but the urge to defend monetary purity, never mind the real economy, remains.

The other ideology might be summarized as ”blaming the victim.” Just listen to what one now hears about Asia: that it shouldn’t even attempt a quick recovery through monetary and fiscal expansion, because it will only delay the correction of deeper structural problems. This admonition sounds like an eerie echo of the famous advice that Herbert Hoover received from Andrew Mellon: ”Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate . . . purge the rottenness out of the system.”

It is easy to imagine that effective action against a slump might come too little, too late, because the initial stages of that slump are regarded not as danger signs but as just punishment for economic sins.

In the age of central banking, economists like PK have convinced us they have the power to fight off the business cycle.  Like a 19th century street mountebank hawking snake oil, they peddle a miracle elixir that can reverse the symptoms of any recession.  Its two magic ingredients—government spending and central bank money-printing—are available in different proportions, depending on the particular recessionary symptoms with which the “victim” is stricken.

The economists show us charts and regressions and other complicated arguments that no one unfamiliar with their argot can follow.  Deep down, we all know it’s bullshit.  We know at a gut level that more debt and more inflation won’t actually cure what ails us, that it will just mask the symptoms for a time.  Until, well, the next time we face economic difficulties.  At which point the economists will come back to sell us a new (better!) variety of snake oil.

We believe them because it’s easier to ignore the truth than to face it.

For instance, American families can’t afford two cars.  We don’t need the productive capacity to manufacture 16 million per year.  10 million will do just fine.  But this is unacceptable because there are too many “victims”—auto workers, dealers, parts makers, et al—created by the reduction in capacity.

[Smith and Corona somewhere are wondering why they weren’t bailed out when they fell “victim” to the PC]

Too easily forgotten is that the excess capacity was created by central bankers in the first place.  They encouraged the financial sector to operate with razor thin capital, to offer easy financing terms via the shadow banking system.  All of it protected by a charlatan’s potion, blessed by Krugman, called “The Greenspan Put.”

  1. 4 Responses to “Once an Inflationist, Always an Inflationist”

  2. Families can afford two cars – but only if they’re cheap enough. Very few families can really afford two SUV’s, but many families own two such. Very few families have more than three kids, so unless your kids are tremendously fat, they’ll fit in a Corolla (which gets almost 40 mpg and costs ~ $16k brand spankin’ new). Change your oil often & you should get close to 200,000 miles.

    By John on Jun 16, 2009

  3. A nit, nothing more. While I agree that a large reduction in car production is good and necessary (and unavoidable), I do not agree that GM (and maybe Chrysler) need to be whacked away along with their very skilled workers. Instead, what they should be machining up to do is diversify away from car manufacture and into passenger rail/light rail manufacture, wind and wave generators.

    There is no need to totally throw away all that skill and manufacturing strength, simply refocus it to more productive pursuits of the future.

    By Praedor Atrebates on Jun 16, 2009

  4. Most Americans can afford two cars, what they cannot afford is any more of this reckless government spending. We are in hock for a lot more than a couple of cars, we’ve been put on the hook for a couple of Bentley’s by Uncle Sam.

    By sangellone on Jun 16, 2009

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