More Tricks, Fewer Treats

 That is what Almost Daily Grant's is predicting for Halloween this year. Candy prices are up by 13% compared to last year, the largest annual increase on record. Because of general inflation, households are expected to decrease their total spending on candy. As explained in its commentary:

Talk about a sugar high.  Citing data from the Labor Department, The Wall Street Journal relays that candy prices are up 13% from a year ago, the largest one-year increase on record, owing to galloping labor costs along with flour and sugar prices.

 

Consumers are responding to those surging costs with a modest downshift, as the National Retail Federation reckons that households will average $100 in Halloween-related spending this year. That’s down from last year’s $103 outlay. 

 

More tricks, fewer treats: it’s a type of hedonic adjustment.

Spending slightly less on candy when its price is higher, means fewer units are purchased, so the kiddies will have less to enjoy.

Good Inflation?

Dunstan Prial in his report, "Good Inflation, Bad Inflation: The Fed's Dilemma" talks about the spot between the inflationary rock and recessionary hard place the FED has put itself in. Prial rightly explains why Americans are concerned about price inflation. Prices for necessities are significantly higher now than they were only a year ago. According to the Bureau of Labor Statistics, prices of foodstuffs have risen by 17% since February.

Prices of  housing, electricity, airline travel, and gasoline also were noticeably higher.

Prial also rightly reports that the FED desires positive inflation of about 2%. That is, it desires that prices increase at that rate every year, which means it desires that the purchasing power of the dollar falls every year. 

Unfortunately, Prial also seems to embrace the false notion that inflation is a sign of economic growth.

[Inflation] means the economy is humming along nicely, creating jobs, lifting wages and increasing consumers’ ability to spend. All of which generates demand for goods and spurs economic growth.

I recently have noted that inflation does not cause economic expansion, nor is it a sign of economic expansion. If the economy really is more productive and we experience economic growth, the supply of goods would increase and overall prices would fall. If overall prices increase, that would be the result of an increased supply of or decreased demand for money, or some combination of both. We the FED has done its part by increasing the money supply by $4 trillion since January of 2009.

The bottom line is that there is no "good inflation." The only kind of inflation there is raises overall prices, shrinks the purchasing power of the dollar and leads to capital malinvestment that results in recession.

Improved Economic Growth Should Not Cause Increased Prices

Yet another misconception about the relationship between economic progress and overall prices is illustrated from this article from January by Bloomberg News' Jeanna Smialek and Victoria Stilwell claiming that "Improved U. S. Growth Lifts Inflation." The authors claim that the economy is gaining speed, as indicated by fewer jobless claims, increased manufacturing activity, and increases in spending on consumption, housing, and investment. In reality, however, we cannot point to economic growth as a cause of price inflation. If the economy is truly experiencing expansion, it is becoming more productive, so that we are producing more goods. If the supply of goods is increasing relative to demand, prices would be falling, not rising. If overall prices are rising, this is due to increase overall spending due to increases in the money supply.

Households Are Finding It Tougher Going

Because real income is down, while prices are up.  Real GDP reportedly shrunk during the first quarter for the first time in three years, while the food prices are rising at an annual rate of 22%! This is a consequence of Quantitative Easing Infinity. Monetary inflation via credit expansion fosters malinvestment which consumes capital and constrains economic progress. At the same time, it encourages increases in spending, which result in higher prices.

Yellen and Company Get Another Shot of Xanax

It has been nicely documented how leadership at the Fed past and present continue an irrational fear of deflation.  Well, they should be feeling even better than they were this time last month. The BLS reports that the CPI increased at an annual rate of 3.6%. That is the highest rate since last June. Most disturbing is that the pace of the increase is picking up as well. Indeed prices rose in April at a rate a third faster than the did the month before. Not to be left out, in April wholesale prices rose at their fastest pace in a year. Can you imagine how bad things would be if there was no deflation????

What You Need to Know about Capital in the 21st Century

The new book by Thomas Piketty, that is. Hunter Lewis and Peter Klein tell us what you need to know. What they note is similar to my initial thoughts upon hearing of the new book which is being trumpeted as the latest in a long trail of discarded hopes called "game changers" and "must reads" that will "change the way we think about economics forever." Let us please stop with the hyperbole.

It turns out that government intervention, especially in the form of monetary inflation is the primary cause of income inquality in more developed countries. When the Fed decides to inflate, the new government-initiated, bank-created money is given to some people--often Wall Street investors--while the rest of us must pay higher prices.

For additional insight, I recommend this brand new video by Mark Thornton on The Mises View:

 

We Can Sleep Well with Yellen at the Helm

The editor at Against Crony Capitalism show us this revealing graph of the history of consumer prices since 1775:

Boy I am so happy that Fed Chair Janet Yellen is on the look out protecting us from deflation. Clearly lower prices has been the bain of our economic existence. If you are like Violet in A Charlie Brown Christmas*, the previous was sarcasm.

* 
Don't you know sarcasm

Why We Cannot Hide Behind Core Inflation Anymore

Often, when government officials or central bankers wish to downplay price inflation numbers that appear to the masses as too hot to handle comfortably, they stress so-called "core inflation" which removes food and energy from the CPI because of their more volatile nature. Many think this is mere slight-of-hand rhetoric meant to confuse more than clarify. Most politicians and their intellectual enablers assert, however, that "core inflation" gives a better picture of overall price trends.

Well, regardless of the motive, we cannot hide behind core inflation anymore. As reported by Business Insider:

"Core" inflation — a measure that ignores food and energy prices — unexpectedly accelerated to 1.7% from a year earlier, up from 1.6% in February. Gains were driven by an acceleration in housing prices, which account for a little more than 41% of the whole index. The year-over-year change in the housing component rose to 2.8% from 2.5%, marking the fastest advance in housing prices since 2008.

Why We Should Not Rejoice About 2% Price Inflation

David Stockman has done excellent work showing the damage that seemingly mild-mannered price inflation at the rate of about 2% a year does to society. The purchasing power of the dollar shrinks significantly and we are generally worse off, especially those who must live on fixed incomes. Take a look at what the Fed has wrought over the past thirteen years, all the while trying to frighten the masses about the specter of deflation.

Why Yellen and Bernanke Should Be Sleeping Better

Consumer prices rose in March at an annual rate of 2.4%, according to the BLS. As a writer at Bloomberg News reveals, "The Fed’s goal of 2 percent inflation has proved elusive as the economic expansion was slow to gain momentum." The writer reminds us that the goal of the Fed is to perpetually shrink the purchasing power of the dollar. She also reveals the standard Keynesian mindset that economic progress means higher prices due to the economy being "overheated." In fact this could not be farther from economic reality. Economic expansion, by definition, means increases in output. As the supply of various goods increases relative to demand, their prices fall not increase, as more eager sellers bid down their selling prices. Economic expansion makes society better off, because consumers enjoy the opportunity to buy more goods at lower prices. All of us, thereby have the ability to achieve more of our ends. If prices are on the rise--and they are--this is due to the Fed's bankrolling monetary inflation, not due to any real recovery.

Would Supply Side Economics End the Obama Recession

Michael Busler, an Associate Professor at Richard Stockton College, thinks so. He argues that

The correct supply side action needed today is to reduce tax rates, especially for the wealthy, reduce capital gain tax rates, remove the stifling regulations and inject a sense of freedom and opportunity. This would increase output, grow the economy, reduce unemployment, eventually increase tax revenue, put downward pressure on inflation and finally end the “Obama Depression.”

While Busler's instincts seem good, I am not as optimistic as he.While removing interventionist regulation of business is a very sound idea, cutting taxes by themselves is no guarantee of economic expansion. This is because government spending must be funded somehow. If not by taxes then by borrowing from the non-bank public or the inflationary banking system. Either way, purchasing power is taken away from people in society and capital is consumed, either directly or indirectly via malinvestment. At the same time scarce economic resources are still consumed be government bureaucrats.

The primary problem is government spending. That is what drastically needs to be cut. Contrary to conventional Keynesian wisdom, reducing government does not reduce economic prosperity. It may reduce statistical GDP, but it does not impoverish society. To the contrary, if the government spends less, resources are freed from government consumption to be used in productive investment. Such investment is a key source of economic prosperity. To truly increase economic output, therefore, we should cut government spending which would allow tax cuts to truly induce economic expansion.

Why Inequality?

Along with the premier of the latest cinematic iteration of The Great Gatsby, come a disturbing trend--superficial analysis of economic inequality. A good recent example is "Great Gatsby Economics" by E. J. Dionne. The author draws on the work of economist Alan Krueger who developed the "Great Gatsby Curve" to measure income mobility across generations. At once Dionne argues against the economic status quo as producing more economic inequality than in the three decades following World War II and calls for more egalitarian public policy. He means of course that we need more income redistribution and cites Krueger's claim that luck has a lot to do with who is profitable as a moral argument in favor of state redistribution of wealth.

Before suggestion solutions, however, perhaps we should establish causal relationships. Why is it that economic inequality has seemed to increase over the past ten years? What is it about the status quo that promotes inequality and a reduction in income mobility?

As I have written before, one of the primary reasons income inequality has expanded over the past decade is do to monetary inflation. Economists have known for decades that when the stock of money increases, spending will increase, driving up the overall prices of goods. The prices of goods, howver, do not go up proportionally for everyone all at once. When the banking system, prodded by the Federal Reserve, increases the money supply, it does so by expanding credit. Those who receive the new money first are able to buy durable consumer goods, capital goods, and financial assets before prices in general increase. These people who receive the money first benefit from wealth redistribution in their favor. They are able to accumulate more capital and financial assets. To add economic insult to malnivestment injury, after the financial meldtown of 2008, many of the principle beneficiaries of inflation who subsequently made bad investments were bailed out by taxpayers or the Federal Reserve, perpetuating the redistributution of wealth.

Any claims that we must reign in the free market because it breeds ever-widening income inequality utterly fails to recognize the myriad forms of government intervention into our economy and especially government manipulation of our monetary system. Such rhetoric attackes a straw man and, hence, leads us all astray. What we need to reign in is crony capitalism and the ideologies that support it.

Will Japan's Policy of Massive Inflation Lead to Prosperity?

Paul Krugman thinks Japan's inflation is good news. I beg to differ. My thoughts are more along the lines of David Howden. In his new essay "Japan's Easy Money Tsunami" Howden explains that the ultimate consequences of monetary inflation are always the same: decreased purchasing power of money and the business cycle:

However happy people have been about higher stock prices, eventually the economic effects will be harmful; indeed the recent stock price crashes foreshadow still more troubles to come.

He notes that Mises had the analysis correct way back in 1912.

Economic Method, Theory and Policy: Krugman Edition

In a recent attack on causal-realist economists [or the "Austrianish Horde" as he called it], Paul Krugman again reverts back to using a baby-sitting co-op as a model for the economy. His doing so provides an excellent example of what I tell my students the first day of my Foundations of Economics course. I explain that too often people wish to begin by answering policy questions without making sure their theory is correct. This is a disastrous mistake, because one's policy conclusions are directly related to one's understanding of economic theory. It is our economic theory that leads us to conclude that particular economic policies will result in particular economic consequences. For example, increasing the money supply by a billion dollars a day will result in its purchasing power being lower than it would be without the monetary inflation.

Krugman's recent blog post is a case in point. Krugman is well-known to be a Keynesian fiscal and monetary activist. He pushes this policy agenda in large part because of the way he conceives of the economy. He thinks we can model the economy as a baby-sitting cop-op that uses baby-sitting tickets to purchase sitter services. In doing so, Krugman uses what Rothbard called a "false mechanical analogy" of model building.  Rothbard criticizes the use of such model building because "the 'models' of economic and political theory are simply a few equations and concepts which, at very best, could only approximate a few of the numerous relations in the economy or society." As such, they often abstract so far from reality as to be irrelevant at best or destructive at worst.

Krugman's baby-sitting co-op model is an example of the latter. In this model the output is baby sitting and the "money" is the tickets. Krugman used this model way back in 1998 in the first edition of his Return of Depression Economics, by which he meant return of Keynesian economics.

What I said about the model in my review of the book, still applies today:

Krugman’s main analytical model is a quintessential example of his strengths, such as they are, and weaknesses. While attempting to explain the workings of the economy in simple terms that the general population can readily understand, he hitches his analytical wagon to an article using a baby-sitting co-op in 1970s Georgetown as a model for the macroeconomy. As a result, Krugman makes fundamental errors regarding how the economy works. In an attempt to efficiently ration baby-sitting services among the members, the baby-sitting co-op issued coupons. Each member family paid a baby-sitting ticket whenever they used the co-op and received a ticket whenever they baby-sat for one of the other members of the co-op. Purposely leaving out the details, Krugman tells the reader that members of the co-op suddenly increased their demand to hold baby-sitting tickets. Consequently, there was not enough aggregate baby-sitting demand for the services of those members in the co-op who were looking to baby-sit in order to increase their ticket incomes. In other words, Krugman explains, the baby-sitting co-op went into a recession.

The attraction of this model is its seductive simplicity. Krugman is often quite good at taking issues and problems the general reader finds unmanageably complex and explaining them in ways simple to understand. While this is, of course, a virtue, it is only a virtue if his explanation accurately reflects reality. The chief responsibility of the economist is to get the analysis straight. For this, the
baby-sitting model will not do.

The fundamental error of this model is that it only has one good: baby-sitting. This leads the reader to think of economic output as if all goods produced in the economy are homogenous units making up one aggregate. The lesson of the model is that if a recession occurs, it must be that there is not enough demand for this homogenous output. In the baby-sitting model, the problem is that members
demanded to hold too many tickets. For the economy as a whole, as Krugman views it, “a recession is normally a matter of the public as a whole trying to accumulate cash” (p. 11). People decrease spending in order to increase their cash balances. The supply of goods not demanded sits idle, and unemployment results.

In reality, of course, the plethora of goods bought and sold in the world economy are heterogeneous. What causes a recession is not too little “aggregate demand” or “too much capacity” due to overinvestment. Recessions are a product of malinvestment, resulting from government intervention in credit markets. If the government increases the money supply through credit expansion by artificially lowering interest rates, an incentive is created for entrepreneurs to invest in too much production of some higher order goods and not enough production of other lower order goods. It is not that too much investment is occurring in every sector of the economy, rather, investment that is occurring is being directed toward producing the wrong things, from the point of view of the people who make up society.

A very telling characteristic of Krugman’s analysis is that he argues that recessions will persist until aggregate demand picks up due to monetary inflation. Again Krugman, alluding to both the baby-sitting co-op and the economy, states that the recession “can normally be cured simply by issuing more coupons” (p. 11). The immediate question that should come to mind is why the surplus was not eliminated by a fall in the price of baby-sitting. We do not know. Krugman does not even bring it up! The model assumes that the prices are fixed at a one-ticket-to-onenight-of-baby-sitting ratio. This lulls the reader, and it seems Krugman himself, into forgetting that prices will adjust downward to eliminate any surplus due to a drop in demand. It is curious, to say the least, that in a book with the word economics in the title, the author does not get around to discussing even the mere possibility of a price decrease in the face of a surplus until page 155, that is, until the reader has read 92 percent of the text.

How did Stocks Get So High?

That's the question asked by Business Week Magazine. The answer, I suggest, is money and by that I mean newly created money. The article notes that the S & P 500 average increased 25% over the past year. This seems surprising given the general economic stagnation during that time. In fact, over the previous 12 months ending in August, the True Money Supply, increased 8.4%. Such an increase in the money supply, made possible by credit expansion, reduces interest rates and increases asset prices including stock prices.

As Jesus Huerta de Soto explains in his Money, Bank Credit, and Economic Cycles:

In an economy which shows healthy, sustained growth, voluntary savings flow into the productive structure by two routes: either through the self-financing of companies, or through the stock market. Nevertheless the arrival of savings via the stock market is slow and gradual and does not involve stock market booms or euphoria (p. 461)..

On the other hand,when there has been monetary inflation in the form of credit expansion, it's another story:

Only when the banking sector initiates a policy of credit expansion unbacked by a prior increase in voluntary saving do stock market indexes show dramatic and sustained overall growth. In fact newly-created money in the form of bank loans reaches the stock market at once, starting a purely speculative upward trend in market prices which generally affects most securities to some extent. Prices may continue to mount as long as credit expansion is maintained at an accelerated rate. Credit expansion not only causes a sharp, artificial relative drop in interest rates, along with the upward movement in market prices which inevitably follows. It also allows securities with continuously rising prices to be used as collateral for new loan requests in a vicious circle which feeds on continual, speculative stock market booms, and which does not come to an end as long as credit expansion lasts. . . .Therefore (and this is perhaps one of the most important conclusions we can reach at this point) uninterrupted stock market growth never indicates favorable economic conditions. Quite the contrary: all such growth provides the most unmistakable sign of credit expansion unbacked by real savings, expansion which feeds an artificial boom that will invariably culminate in a severe stock market crisis (pp. 461-62).

Herbener on The Fed and QE3

My friend and department chair, Jeffrey Herbener is interviewed by Lee Wishing of Grove City College's Center for Vision and Values about Ben Bernanke's recent announcement that the Federal Reserve will buy $50 billions worth of bonds every month until the economy looks better. You can watch the interview by clicking here.

In this interview Herbener explains the likely economic consequences of such monetary expansion, including distortion of investment, capital malinvestment, hampering necessary economic adjustment, increasing stock market volatility, and increased price inflation.

Who Spends Wisest?

My latest op-ed has been published on Forbes.com. "Since Monetary Spending is Unequal, Who Spends Wisest?" explains one reason why government spending and monetary inflation are not roads to prosperity.  My main point is that, because of the existential fact of scarcity,

Not all monetary spending is equal. Economic prosperity requires wise entrepreneurship. If spending is funded by voluntary saving and invested according to profit and loss considerations, it tends to be productive and hence, add to our prosperity. If spending, however, is funded by coercion and apart from economic calculation, scarce goods are wasted, and the result is relative impoverishment, prolonged recession, and unemployment.

The Fed HAS Failed

When we fail to achieve our goals, it is human nature for us to try to make ourselves feel better by comparing ourselves to someone who has failed even worse. I thought of this when I saw yesterday's Chart of the Day at Business Insider. Fed apologist Joe Weisenthal uses the chart below to argue that it is the Bank of Japan that really has failed since 1995.

Weisenthal notes that the Bank of japan has had a much harder time hitting its inflation target of 1% than the Fed has of hitting its target of 2%. The Fed is relatively much more capable and credible. QED.

I would argue, however, that to measure an institution's effectiveness, one should not compare its performance to someone else, but rather should examine whether it has fulfilled its stated purpose. The Employment Act of 1946 stated that the official economic policy of the United States Government was "to promote maximum employment, production, and purchasing power." This general directive was explicitly applied to the Fed by the The Federal Reserve Reform Act of 1977 which identified price stability as a monetary policy goal. The following year, the Full Employment and Balanced Growth Act was approved and established full employment as a second goal of monetary policy.

Let's see how well the Fed has fulfilled its mandate. The chart below shows what has happened to the Consumer Price Index since the Fed's inception.

So how well has the Fed maintained price stability during its almost 100-year tenure? Not so well. The dollar has lost over 95% of its purchasing power since the advent of the FED. The increase in prices has been especially steep since leaving the last gasp of the international gold standard. The chart below shows what has happened to consumer prices since August of 1971 when Nixon closed the Gold window:

It is almost a continual climb upward. The performance for the period after August 1971 is very important, because once the international gold standard was abandoned, the only constraint on monetary policy was the Fed itself. It is one thing for the Fed to keep prices relatively stable when it knew that profligacy meant significant gold drain. Indeed even that threat proved too weak by the late 1960s, which prompted Nixon to abandon our obligations and cut the dollar free from gold. It is easy to see how successfully the Fed has stabilized prices since then.

The Fed clearly has failed in its mandate to maintain price stability. What about employment? It turns out that the unemployment rate has been wildly erratic since 1948, the farthest back unemployment data goes at FRED, the St. Louis Federal Reserve Data Base.

This is not a picture of stability. Instead the track record is one of repeated economic cycles which manifest significant unemployment.

Not withstanding the claims of Joe Weisenthal, the clear conclusion is that the Fed is  a failure. It clearly has not fulfilled its mandate. Sound monetary theory and business cycle theory teaches that the Federal Reserve has failed because it has caused price inflation, a massive shrinkage of the purchasing power of the dollar and the business cycle.

How the Fed Benefits Those Who Get the New Money First

Mark Spitznagel

Mark Spitznagel, founder and chief investment officer of the hedge fund Universa Investments L.P., knocks the ball out of the park in today's Wall Street Journal. With the precision of a Henry Hazlitt, Spitznagel explains exactly "How the Fed Favors the 1%."

The Federal Reserve benefits its favored class in the method it uses to push new money into the economy. The Fed does not increase everyone's cash balances simultaneously in the same proportion. It injects reserves into commercial banks and they then lend new money to borrowers. This injects money into the economy at specific places at specific times. As I said this morning in my conference presentation,

Increasing the money supply merely increases the amount of money being spent on the same quantity of goods, so overall prices increase and the purchasing power of the dollar falls. Those people who receive the new money first benefit while those people on fixed incomes are harmed. However, there is no general social benefit from inflation.

This point was made in the middle of the 18th century by Richard Cantillon and was also noted by the 20th Century's greatest economist, Ludwig von Mises.

The contribution of Mises is likewise recognized by Spitznagel. He writes,

In the 20th century, the economists of the Austrian school built upon this fact as their central monetary tenet. Ludwig von Mises and his students demonstrated how an increase in money supply is beneficial to those who get it first and is detrimental to those who get it last. Monetary inflation is a process, not a static effect. To think of it only in terms of aggregate price levels (which is all Fed Chairman Ben Bernanke seems capable of) is to ignore this pernicious process and the imbalance and economic dislocation that it creates.

Spitznagel cites Mises' students Rothbard and Hayek in explaining the pernicious effects of monetary inflation then hits the nail on the head has he explains the specific beneficiaries of our current inflationary monetary regime.

The Fed, having gone on an unprecedented credit expansion spree, has benefited the recipients who were first in line at the trough: banks (imagine borrowing for free and then buying up assets that you know the Fed is aggressively buying with you) and those favored entities and individuals deemed most creditworthy. Flush with capital, these recipients have proceeded to bid up the prices of assets and resources, while everyone else has watched their purchasing power decline.

This has to be one of the greatest commentaries to appear in the Wall Street Journal in a long time.

Howden: Will the Nickel Be the Next to Go in Canada?

The Canadian Royal Mint has announced it will stop producing the Canadian penny. David Howden, a Canadian economists who is presently Professor of Economics at University of St. Louis, Madrid Spain, asks, "Will the Nickel be Next?" He answers that it is entirely possible if the Bank of Canada does not stop inflating.

Howden explains why the penny is no longer worth minting:

Let’s not shoot the messenger here. It’s not that copper has gone up in value and as a result it is not fit for the task any longer. It’s that the value of 1¢ has gone down so much that it is no longer fit for copper. We can easily blame this all on some innocent bystander and sweep the problem under the carpet. But the fact of the matter remains: We pushed the poor penny as far as it would go and it finally broke. We kept issuing money until the poor penny was bound to be redundant. A rising copper price confirms this fact, but didn’t cause it.

When a central bank increases the money supply, people find they possess an excess supply of money. They mitigate this excess supply by spending the cash they do not want to hold. This increased spending drives up the demand for goods, which results in higher prices. Some of the goods for which the prices are higher are metals used to mint coins.

Canada's central bank has inflated the money supply so much over the years that the purchasing power of money has dropped to such an extent that the face value of the penny is worth less than the metal that is in every penny. This is already true, by the way for the old pre-1982 U.S. copper penny and the current U.S. nickel.

It does not have to be this way. Howden ends his essay with a rousing call to arms for his fellow Canadians:

The death of the penny may have been a long time coming, but let it not be in vain. Send a signal to the Bank of Canada that we don’t want to see the same fate befall other denominations. The penny is dead. Long live the nickel!