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How to Reduce Inflation to Zero

Kevin Williamson’s Welcome to the Paradise of the Real was written over two years ago and I still refer it to readers.Sneaky Inflation is equal to that piece in bringing sound economic thought to bear on current issues with an engaging style.  Both pieces are in National Review.

An excerpt from Sneaky Inflation:

You see the same economics at work across all government activity. As Andrew Flowers reports at FiveThirtyEight, in 1998 about 60 percent of TANF (Temporary Assistance for Needy Families) spending went directly to poor people; today, that figure is only about 25 percent, with the rest of the money being diverted to other programs, many of which benefit important political constituencies rather than actual poor people. Medicaid isn’t a program for poor people, but a program for large, profitable, politically connected firms bidding on contracts worth hundreds of millions or billions of dollars.

The strange fact is that we are not seeing very much inflation at all except in those areas in which the government is trying to make things more affordable. We could probably get the inflation rate down to practically 0.00 percent — if only Washington would stop helping.

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Economics, Science and History

hko in Israel

Economics is a bit different from history by the use and study of certain underlying principles. It is  not a physical science but a  social science using scientific methods to analyze and understand. There are certain principles that are quite useful to explain and to in some sense predict inflation, unemployment, economic growth, trade deficits, unintended consequences, recessions, etc. But being social sciences these predictions are more meaningful in the long term than seeing changes by the month or quarter. These principles are useful to explain what happened even if it was not clear beforehand.  Keynesians predicted low interest rates would stimulate the economy, foes predicted inflation. Both were wrong. Monetarists did not foresee the drop in velocity.  Keynesians did not foresee that the accumulation of  higher fiscal friction costs would offset monetary stimulus. (Keynes, himself, was quite aware of this possibility and warned FDR accordingly.)  A lot of economists got pieces of the puzzle correct, but missed the picture.

But this experience like the Great Depression, and the Great Stagnation are great additions to the body of economic knowledge; like every plane crash makes flying safer.  Economics is still a very young “science”.

Economics began as a school of philosophy which was what Keynes earned his PhD in.  During this last collapse, we witnessed Wall Street surrendering its old philosophical understanding  of risk for a delusional mathematical certainty.  (PhD quants were becoming popular additions to trading organizations.)  The most notorious result was the record collapse of Long Term Capital -  a loud warning of what was to come that no body heard.)   Modern economics is guilty of the same.

Economic models are useful 90% of the time, but become quite useless in extreme circumstances, inflection points. Such points have also been the source of new discoveries in the physical sciences.

Woodrow Wilson was guilty of  seeing history as a predictive science, with an inevitability that defies… well, history.  Remnants of this flawed thinking remains whenever we hear of our political intellectuals speak of being on the right side of history.

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The True Cost of Low Rates

From Barron’s Stephanie Pomboy: A Grim Outlook for the Economy, Stocks by Leslie Norton

In the past rates that were too high were the trigger (for a financial crisis). Not this time. No. 1, we have basically bankrupted corporate and state and local pensions by having rates at these repressive levels. If you lay on top of that a decline in equity prices, there will be a scramble to plug holes in pensions. Obviously if a state or local government has to divert funds to plugging its pension, it won’t build more roads. The corporate sector has the luxury of kicking the can down the road, and because their spending has been on buybacks, not plants and equipment, the economy would suffer less. For S&P 1500 companies, the pension deficit is roughly $560 billion, but for state and local governments, it’s $1.2 trillion. According to the Center for Retirement Research, if you used a more conservative discount rate, the unfunded liability would go to $4 trillion.

No. 2, you’re pushing consumers to the brink as they try to save enough for retirement at zero rates. You’re already seeing a reluctant return to credit-card usage, a clear sign of distress—they are charging what they previously paid with cash. The credit-card delinquency rate is picking up.

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Stifling Inflation and Productivity

From The Reasons Behind the Obama Non-Recovery by Robert Barro in The Wall Street Journal

The main U.S. policy used to counter the Great Recession was increased government transfer payments. Federal social benefits to persons as a ratio to GDP went from 8.7% in 2007 to 11.7% in 2010, then fell to 10.9% in 2015. The main increases applied to Medicaid, Medicare, Social Security (including disability) and food stamps, whereas unemployment insurance first rose then fell. Unfortunately, increased transfer payments do not promote productivity growth.

The 2007-08 financial crisis was also followed by vast monetary expansion involving increases in the balance sheets of the Federal Reserve and other central banks. The Fed’s expansion featured a dramatic rise in excess reserves, used to fund increased holdings of Treasury bonds and mortgage-backed securities. Remarkably, the strong monetary growth came without inflation.

The absence of inflation is surprising but may have occurred because weak opportunities for private investment motivated banks and other institutions to hold the Fed’s added obligations despite the negative real interest rates paid. In this scenario, the key factor is the flight to quality stimulated by the heightened perceived risk in private investment.

HKO

High monetary growth without inflation happened because:

  1. High friction costs stifled investment. Included is the accumulation and addition of regulations and the uncertainty; every increase in regulation and taxation is followed by calls for more.
  2. The combination of low interest rates and higher friction costs meant that the prudent use of the cheap money was stock buy back rather than increases in productive investment. Misguided corporate incentives that pay for increased shareholder value rather than higher productivity or better return on assets (as opposed to equity) exacerbated this trend.
  3. Low velocity of money. Related to the above, individuals reduced debt and curtailed both consumption and investment.  The individuals still have some control.

 

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Common Economic Fallacies

Don Boudreaux at his excellent Cafe Hayek in his Quotation of the Day, finds an excerpt from Armen Alchian from a textbook, University Economics in 1972.

This excerpt points out several economic fallacies, many of which are still common today, and it points out that understanding competency in addressing our personal business and lives does not readily transfer into understanding the dynamics of economics on the greater society.

the excerpt

Although many of us solve our personal problems, we may still be grossly ignorant about how our actions and laws affect the rest of society.  Comprehension of these larger effects requires economic theory, even if virtually none is required to for individual decisions.  We can be sure, as we shall see later, that economic analysis is ignored when the following incorrect assertions are proposed: the rationale of the capitalistic system requires a “harmony of interests”; customers must take what producers offer them; minimum-wage laws help the unskilled; discrimination can be stopped; pollution of air and water unquestionably should be stopped; automation reduces available jobs; tariffs protect domestic wage earners from foreign labor; our otherwise unlimited productive capacity is curtailed by monopolistic capitalists who arbitrarily set prices high; unions protect workers from greedy employers; inflation hurts the wage earner and benefits the employer; private firms serve private interests while publicly owned agencies serve public interests; used-book markets must reduce the royalties of textbook authors; social conscience and civic sensitivity are or should be the guides to business corporate behavior; unemployment occurs because not enough jobs are available or because some people are shiftless and lazy; or American agriculture produces a surplus of wheat because it is so productive.  And that’s only a tiny sample!