Tag: cpi

–Deficits: The Possible vs. the Certain

An alternative to popular faith

Human beings have difficulty distinguishing threat levels. Despite the absolute fact that airline travel is safer per mile than auto travel, some people drive, even long distances, because they fear the safer air travel more than the dangerous auto travel.

Then think of the people who won’t vaccinate their children against the H1N1 flue, because they fear any unknown, possible adverse effects of vaccination more than they fear the known, deadly effects of the flue.

I was reminded of this human failing when I read an article in which the author claimed the economic recovery was not “real,” because it relied on government funding rather than on private funding. The author seemed to feel government funding was, in some way, artificial – as though we were using saccharine, rather than sugar, to sweeten our coffee.

Of course, money is money, and federal money is indistinguishable in effect from private money. But I suspect the author had something more than artificiality in the back of his mind. He probably understands that the federal government has the unique and unlimited ability to create money from thin air, and repeatedly has proved it never can run out of money. So, what is his concern? He must fear two things: Federal deficit spending might cause inflation and our grandchildren might have to pay for deficits.

As for inflation: Despite current, massive deficit spending we do not now experience an unacceptable level of inflation, and are unlikely to soon. Moreover, in the thirty-five years since we went off the gold standard, large deficits never have caused inflation. Clearly, something is askew with the deficits-cause-inflation hypothesis.

Even if deficits did cause inflation, private spending is identical with public spending; both add money to the economy. So the author should fear the supposed inflationary effects of private and public spending, equally.

As for grandchildren, I am a grandchild of the adults who saw the gigantic deficits of WWII and of President Reagan. Yet, because tax rates have gone down, I never have paid one penny toward those monster deficits. Similarly, if tax rates continue to stay level or decline, as they should, my grandchildren will not pay a penny toward today’s deficits.

What has this to do with the human difficulty distinguishing threat levels? The debt hawks know with certainty, that many millions of people now suffer the devastating effects of unemployment and loss of homes and lifestyle. People are dying, financially, emotionally and yes, even physically.

These same debt hawks believe that at some unknown time in the future, their children, grandchildren or great grandchildren may have to pay some unknown amount toward today’s debt. Yet they fear unknown future damage more than the certainty of today’s. That is why you see people rail against deficits. In essence, they are so afraid they one day may run short of water, they will let a home burn to the ground rather than allowing the fire fighters to save it.

The shame is that many professional economists, who should know better, foster these misguided fears, leading to misguided actions.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com/

-Is inflation too much money chasing too few goods?


An alternative to popular faith

In the post “Do deficits cure inflation?” we saw that contrary to popular faith, deficit spending (i.e., too much money) has not caused inflation. We also saw that inflation can be cured by increasing the reward for owning money, i.e. by increasing interest rates.

Now we question another piece of popular faith: Is inflation caused by too much money chasing too few goods?

Begin with the notion of “too much money.” We already have seen that federal deficits are not related to inflation. What about another definition of money: M3? Please look at the following graph:

Clearly there is no immediate relationship between money supply and inflation. What about a subsequent relationship. Could “too much money” today, cause inflation later?

The graph indicates no such cause/effect relationship, with M3 peaks preceding inflation peaks by anywhere from 2 years to 10 years. It is difficult to imagine a graph revealing less relationship.

What about “too few goods”? If too few goods caused inflation, this would manifest itself with GDP moving opposite to CPI. Again, that does not seem to happen:

There seems to be no regular pattern, with GDP and CPI sometimes rising together and sometimes separately. In today’s international economy, it is difficult to substantiate the idea of a wide-spectrum commodity shortage when sufficient purchasing power exists.

Individual nations can experience shortages of individual commodities. Individual poor nations can experience shortages of a broad basket of commodities. But can a wealthy nation, with plenty of money to spend, suffer a shortage of a broad basket of commodities, thereby causing inflation? Has it recently happened?

Seems unlikely these days as products are made in multiple nations and shipped to multiple nations, with easy international shipping and instantaneous money convertibility. Your cotton shirt may have been grown in Egypt, woven in India, assembled in China, labeled in Italy and sold in the U.S. Clearly, a cotton shirt shortage would be rare, as any of these steps could occur in various countries, and that’s just one product. A nationwide “too-few-goods” situation, coincident with “too much money,” seems impossible.

There is however, one exception: Oil.

The graph below compares overall inflation with changes in energy prices, which are dominated by oil prices.

Oil is the one commodity that has worldwide usage, affects prices of most products and services, and can be in worldwide shortage. That is why, when oil prices rise or fall steeply, inflation rises and falls in concert.

The large oil price moves “pull” inflation in the same direction. When oil prices increased or decreased the most, inflation came along for the ride.

In summary, inflation is not caused by deficit spending or by “too much money chasing too few goods.” Inflation is caused by a combination of high oil prices and interest rates too low to counter-balance the oil prices.

The high oil prices can be caused by real shortages and/or by price manipulation.

Hyperinflation is a different beast, altogether. Every hyperinflation has been caused by shortages, most often shortages of food.

Zimbabwe, Weimar Republic, and Argentina had food shortages that created hyperinflations.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com