Inflation: It Just Doesn't Pay the Bills Anymore, and The Fed's Fate in Ron Paul's Paws
Jeffrey Rogers Hummel and Sheldon Richman at Forbes on the deflating powers of inflation to solve government's problems:
Historically governments inflated their currencies because they benefited in various ways. For example, they spent the new money, gaining the purchasing power lost by holders of the depreciating currency. This gain, called seigniorage, is an implicit tax on the people's cash balances.
Another way government can gain is in its role as a debtor. If inflation is unanticipated, interest rates will not have risen enough to compensate lenders for the decline in purchasing power. Net debtors gain, and net creditors lose. Government, of course, is the economy's biggest debtor. During the Great Inflation of the 1970s private investors holding long-term U.S. Treasury securities actually earned negative real returns despite receiving positive nominal interest. So from 1946 to 1982, while the government's nominal debt to the general public rose from $242 billion to $925 billion, in 1946 dollars it had actually fallen to $201 billion.
But these potential sources of inflation revenue have become attenuated in developed countries. Of the two, seigniorage has become the least lucrative in the post-World War II period. In a study of 90 countries between 1971 and 1990, Reid W. Click finds that almost no developed country could boast seigniorage amounting to more than 1% of GDP, despite the fact that the study incorporated the inflationary years of the 1970s. This no doubt contributed to inflation's worldwide decline after 1980.
What about the effect of inflation on government as a debtor, which generated about twice as much revenue for the U.S. government as did seigniorage during the unexpected inflation of the 1970s: about 4% of total expenditures or less than 1% of GDP? Investors are much savvier these days.
Globalization, with the corresponding relaxation of exchange controls in all major countries, allows them easily to flee to foreign currencies, with the result that changes in central-bank policy are almost immediately priced by exchange rates and interest rates. Add to this the ability to purchase inflation-indexed government securities, and it becomes highly unlikely investors will be caught off guard by anything less than sudden, catastrophic hyperinflation (defined as more than 50% per month)--and maybe even not then.
It has always struck me as especially clever of governments to ensure that one of the only relatively sure ways to preserve the value of your bucks was to lend them money, but there you go.
In other monetary policy related commentary, Joshua Green in Boston Globe says that the fate of Ron Paul's potential chairmanship of the House subcommittee that oversees the Fed is the bellwether of monetary policy's future:
Were he to assume the chairmanship, Paul would represent an altogether different type of critic: he really means what he says. But he's no lock for the job. His views on monetary policy, and his disinclination to defer to the GOP leadership, have twice before led his own party to ignore his seniority and deny him control of this subcommittee, in 2003 and 2005. One acid test of whether the Republican Party is serious about trying to aggressively influence monetary policy and thwart QE2 is if it finally lets Paul loose on the chairmanship.
Paul expects it will. "I'm assuming that I'll get it,'' he said. "I've had no indication at all that I won't.''
Representative Barney Frank, the outgoing chairman of the Financial Services Committee, agrees. "I think the GOP is afraid to deny him that chairmanship. The Tea Party would revolt."
If he does get it, Paul says that he will indeed go after the Fed, whose current strategy he considers to be "insanity.'' This would add the force of a major House subcommittee — with investigative and subpoena powers, and able to hold hearings — to the anti-Fed campaign, which would surely roil the markets and further interfere with the struggle to engineer a recovery.
Paul's stance toward the Fed is no different than it was in 2003 or in 2005. What has changed since then is that many other Republicans are now singing from the same hymnbook. That's significant because until very recently, the Republicans worshiped Federal Reserve chairman Alan Greenspan and dismissed Paul as someone whose economic views were so far outside the mainstream as to make him an embarrassment.
I wrote about the burgeoning anti-Fed movement and Ron Paul's role in it in this November 2009 Reason magazine feature.
