The inflation road

So what does the re-election of Barack Obama mean in the broader scheme of things? I was impressed by a short, economic-historical analysis Matthew Stevenson did for Reuters focusing on the fatal flaw of the progressive agenda: its economic foundation (or lack thereof).

Stevenson alludes to the long-standing struggle between those committed to a stable currency and inflationists, a struggle which has been at the heart of many presidential contests.

In this instance, clearly '[t]he victors were the forces of cheap money. William Jennings Bryan would be proud - as would bimetallists and Weimar Republicans.'

'Inflation won because it is the panacea for all that ails the body politic: a short-term cure-all that promises economic growth, the possibility of paying off national and international debts, new-found prosperity for the middle classes and liquidity for the impoverished, who otherwise would be voting in the streets with rocks and burning tires.

'... Cheap money defers many liabilities. Real wages for industrial workers have declined since the 1970s. True unemployment – including those too discouraged to look further and others working part-time for unlivable wages – is closer to 22 percent than the official figure of 7.9 percent. The national debt, $16.3 trillion, exceeds the gross national product. With unfunded entitlement programs, such as Medicare and Social Security, the government is eventually on the hook for a further $46 trillion, which it would rather not pay with pieces of eight.

'The hard-money men have not been able to win many elections since the 19th century, arguing as they do for reductions in the monetary supply; an asset-backed currency (preferably with gold) and policies that lead to deflation...

'The magic of inflation, before it turns everything to dust, is that it papers over a number of financial problems. The United States government is now able to run monumental trade and budget deficits, fight multiple foreign wars, vote tax cuts, extend unfunded pension and healthcare benefits to citizens over age 65 and spend money with Medici-like munificence on myriad federal programs by printing money or borrowing in national and international capital markets.

'Were the dollar unacceptable as a reserve currency in investor portfolios here and abroad, these financial sleights of hand would have ended long ago. Imagine the consequences if the Chinese demanded gold, diamonds or barrels of oil as collateral for their U.S. dollar bond investments. Already, the dollar is badly depreciated against many currencies ...'

Stevenson suggests that the official inflation figures grossly understate actual inflation and cites 'four-year college tuition at $200,000, one-bedroom New York appartments for $1 million, gasoline at $3.46 a gallon and carts of groceries that routinely cost at least $250.'

Inflation 'allows the political classes to maintain the illusion of power and authority. Without the ability to print and circulate paper money to balance the books ... U.S. presidents would be riding Greyhound on their appointed rounds, not the magic carpet of Air Force One.'

Furthermore, inflation allows politicians to create 'a veneer of fairness' but 'it is a direct tax on the savings of American citizens, especially those of the middle classes who lack hedges against its effects ...'

'[T]he economic carnival will end when the dollar is no longer acceptable as a reserve currency, first in international markets and later domestically.'

The only reason the Chinese hold debts denominated in dollars, Stevenson notes, 'is because it helps them maintain the artificially low exchange rate of the renmimbi.'

'Whether or not the United States goes over the fiscal cliff, it will remain unified as a nation of debtors for whom the goal is always to repay their loans with debased currency.'

Matthew Stevenson has a nice turn of phrase and a good sense of history. I agree with the general thrust of what he says even if a few of his assertions are problematic. There is no doubt in my mind that the massive U.S. national debt is eventually going to bring the country down, but exactly how and when is just not predictable. (To his credit, Stevenson leaves the timetable open.)

Had Romney prevailed, I would have watched and waited and wondered whether, after all and against the odds, America could come back.

But it's gone now, headed for inevitable, irrevocable decline. It was probably too late to start to turn things around anyway. But that we will never know for sure.

'Stimulus' spending

I continue to be amazed at the extent to which economists are driven by ideology. How else can you explain the diametrically-opposed views of conservative and Keynesian economists on the effects of government borrowing and spending? One side or the other are kidding themselves; and it's not easy for us non-economists to join - or even understand - the debate.

Clearly, values are involved here, but the question of whether specific policies work is an objective one.

Writing in The Wall Street Journal, Arthur B. Laffer makes a case (based on figures from the IMF) that stimulus spending has actually been counterproductive, "more like a valium for lethargic economies than a stimulant."

Of the 34 OECD countries, those that 'stimulated' the most from 2007 to 2009 saw the least growth in subsequent GDP rates.

"Sorry, Keynesians. There was no discernible two or three dollar multiplier effect from every dollar the government spent and borrowed. In reality, every dollar of public-sector spending on stimulus simply wiped out a dollar of private investment and output, resulting in an overall decline in GDP. This is an even more astonishing result because government spending is counted in official GDP numbers."

It might be objected that an economic downturn will trigger increases in public spending, and so the appearance of a negative relationship between stimulus spending and economic growth. But Laffer focuses on changes in the rate of GDP growth to help isolate the effects of more spending.

"The evidence is extremely damaging to the case made by Obama and others that there is economic value to spending more money on infrastructure, education, unemployment insurance, food stamps, windmills and bailouts. Obama keeps saying that if only Congress would pass his second stimulus plan, unemployment would finally start to fall. That's an expensive leap of faith with no evidence to confirm it."

When will inflation strike?

Adam Creighton sounds a warning in a recent piece on the policies of the Federal Reserve, the Bank of England and the European Central Bank. Money creation would normally lead to inflation, but inflation has not yet kicked in.

'Actual inflation appears dormant for now, and big lenders appear content to buy bonds at very low interest rates. But bond holders were very wrong about future inflation in the 1970s, and as [Milton] Friedman wrote, "monetary policy action takes a longer time to affect the price level than to affect the monetary totals."

'The amount of money has risen by almost 40 per cent in the US since early 2008, while consumer prices have risen only 6 per cent. More money chasing the same amount of goods and services should ultimately prompt inflation.'

Creighton argues that money creation programs have taken the pressure off politicians to implement necessary changes; and cheap money has protected highly leveraged private banks and dulled incentives to clean up balance sheets.

What makes this particularly disturbing is that it is occurring in a context of extremely high levels of government debt.

And yet liberals routinely fail to be disturbed by the situation. They are generally critical of bank bailouts, of course, but they see government borrowing for fine and noble causes (such as welfare programs, hospitals, schools and infrastructure) as a fine and noble thing, no matter the budgetary position.