Since the financial crisis hit the country in September 2008, the White House, Congress, and Federal Reserve have responded with a combination of bailouts, federal spending, and an expansion of the money supply. Meanwhile, many free market thinkers have been warning of a wealth-sapping malady last seen in the U.S. more than a quarter century ago: It's a word that strikes fear in the hearts of survivors of the 1970s, elicits shrugs from the young voters who helped elect Barack Obama president, and (as we'll see) provokes fierce debate among even the most libertarian economists.
After decades of relative confidence that the price of milk would be more or less the same today as it was yesterday and last year, Americans are once again wondering whether to keep what money they have in mattresses, gold bars, or banks. Has the time come to stockpile canned goods and pick up a wheelbarrow for transporting currency, or should we be afraid of the opposite—a prolonged contraction that causes prices to crash?
In mid-July, inflation seers got their first juicy slice of supporting data when June wholesale prices jumped 1.8 percent, the sharpest rise in two years and twice the increase most analysts expected. Gold prices surged on the news to nearly $940 an ounce. Just before those figures were released, reason asked eight free market economists to assess the short-, medium-, and long-term prospects for inflation and to say what, if anything, can or should be done about it.—Katherine Mangu-Ward
Inflation Is Already Here; Next Come Rising Prices
Despite economists' efforts to obscure inflation in a tangle of jargon, it is an extremely simple phenomenon. Almost every dictionary defines inflation as an expansion of the money supply, not rising prices.Although more money may not immediately translate into rising prices, over time the correlation is extremely reliable.
Inflation has always been a means for governments to raise revenues without taxation. When gold was the only accepted currency, governments inflated through debasement of coins, surreptitiously blending base metals into gold. By melting down one real coin to make two alloyed coins, money could be "created" with little effort. Nice trick. But eventually consumers caught on that their coins were bogus. Their reaction was often violent.
Paper money largely solved this problem by allowing governments
to print money, or extend credit, at will. And thanks to the overly
complex Rube Goldberg explanations of inflation devised by
academics, such as "the wage-price spiral," "demand pull," and
"cost push," governments can
inflate without admitting culpability for rising prices. The Federal Reserve's monetary base statistics show that in the last year the money in circulation has increased far faster than at any other point in American history. Thus, by the dictionary definition, we have inflation. But prices
have been relatively stable because downward recessionary pressures are currently counterbalancing the upward pressures of the expanded money supply.
The new money has been largely parked in financial institutions. Thanks to government prodding and aggressive stimuli, it will soon be showered on the economy at large.When the tide rolls in, there will be more money chasing fewer goods. (Recessions reduce the supply of things.) The result: higher prices.
The government clings to the fantasy that it will be able to "mop up" this excess liquidity before the business end of inflation kicks in, effectively taking money back out of circulation. Good luck with that. Recent history clearly shows that the authorities have no political will to dispense tough medicine."Removing liquidity"would require either much higher interest rates or a severe curtailment of credit. But politicians believe that credit is the "lifeblood" of our economy. President Barack Obama himself has said so. If the Fed was unwilling to raise interest rates substantially in the middle years of this decade, when the economy seemed healthy, how can we expect it to do so now?
Peter Schiff (email@example.com) is president of Euro Pacific Capital and author of Crash Proof: How to Profit From the Coming Economic Collapse (Wiley).
Why Forecasts Are All Over the Map
Jeffrey Rogers Hummel
Under normal circumstances, a massive and sudden monetary explosion—like the one initiated by the Federal Reserve after September 18, 2008, which took us from a monetary base of $850 billion to $1.7 trillion in three months—would bring skyrocketing inflation. But these are not normal circumstances. A high demand for liquidity, mostly on the part of banks, has thus far prevented inflation from taking off. In fact, almost all of that increase was concentrated in bank reserves, which during that short period mushroomed by an incredible factor of 13.
On one hand, the Fed's expansion of the base encouraged banks to make loans, thereby increasing the amount of checkbook money: an inflationary step. On the other hand, it simultaneously paid banks to hold more reserves: a deflationary step.Is it any wonder that economists' forecasts have been all over the map? Ben Bernanke, in what must stand as the most egregious example of central planning hubris on the part of any Fed chairman since the institution's founding, seems convinced that fine adjustments to these two controls will allow him to manage the price level perfectly.
Buried within the bailout bill of October 3, 2008, that set up the Troubled Asset Relief Program (TARP) was a provision permitting the Fed to pay interest on bank reserves. This seemingly technical change not only gives banks an incentive to hold reserves rather than make loans; it also essentially converts reserves into more government debt. Fiat money traditionally pays no interest and therefore allows the government to purchase real resources without incurring any future tax liability. Economists refer to this revenue from creating money as seigniorage. Federal Reserve notes will continue to earn no interest. But now the seigniorage that government gains from creating bank reserves will be much reduced, if not entirely eliminated.
Outside of America's two hyperinflations (during the American Revolution and under the Confederacy during the Civil War), seigniorage peaked during World War II, to nearly a quarter of the war's cost,or about 12 percent of GDP. By the Great Inflation of the 1970s, financial innovations and market sophistication had managed to reduce seigniorage to only 2 percent of federal revenue, which translates into less than half a percent of GDP. Now with the Fed having to divert potential government revenue to pay interest on base money held by banks, seigniorage has virtually been eliminated as a source of future funding. And this constraint will become tighter as people replace the use of currency with bank debit cards and other forms of electronic fund transfers.