A while back I suggested that the the high price of gold may be a harbinger of rising inflation, and that even though some people suggest that gold prices are a fogeyish obsession of a few “gold bugs”, the price movement of this golden metal can still offer an early indicator of trouble.
I think I can say a mild “I told you so”. After having been off the radar for years, due to a variety of factors, inflation is rearing its head again. To an extent, of course, the cost of living has been rising in Britain a lot more than official statistics suggest because of the way in which Britain’s finance minister, Gordon Brown, has stripped out things like housing price movements and taxes to make the figures look better. (In all fairness to Brown, his Tory predecessors were no better in this respect). Anatole Kaletsky has a good article here warning that the mighty U.S. Federal Reserve is in danger of letting the inflation genie out of the bottle. A further rise in rates, he says, may be needed, possibly raising the risk of a recession. He may be right. The Fed’s key lending rate is 5.25 percent and has risen 17 times since its low-point around the time of 9/11.
It is a bit rich, though, for an unashamed neo-Keynesian like Kaletsky to bash the Fed for failing to be tough enough, and for not acting sooner, on rates. Kaletsky has not been shy of bashing the European Central Bank for its supposedly restrictive approach on interest rates. The problem of course is that no central bank chief, even if he or she has the wisdom of Solomon, can anticipate perfectly the right course for interest rates. If such a central bank makes an error, that mistake can be enormously costly in terms of jobs, livelihoods, even the loss of homes (I recall a now-departed commenter, called Euan Gray, dismiss such concerns with a sort of “let the experts sort it out” approach of his.)
The perils of central bankers getting the economic signals wrong explains why some classical liberal economists remain fond of F.A. Hayek’s argument for a return to a sort of commodity-backed, competitive currency system. Yes, such a system would have its problems and banks might go bust from time to time. But although such a banking system would have its crises, they would be relatively small compared to the risk of an entire economic region getting into trouble on account of a mistake by a central bank chief and his economists. The bigger and more powerful the central bank, the bigger the potential cockups. That remains for me a great attraction of Hayek’s idea: mistakes will get made, but those mistakes will be dispersed and people will have options to flee a delinquently-run currency.
ah, but will the US Fed follow the Austrian or the Monetarist method? When the economic numbers start to slip, will rates drop also? That is where all the bets are now being made, and alot of people are buying long bonds and inverting the yield curve on a bet that the Fed cuts sooner than later. Recall Bernanke’s praising of Friedman on the Monetarist solution to the Depression: should have cut rates and increased the money supply. The gold bugs are lining up for that bet also, because they believe with that policy comes price inflation like you have never seen before. An entertaining spectacle.
“How can the Fed commit itself to price stability and rapid growth? How can it halve US inflation from 4.5 to 2 per cent without allowing even a brief period of rising unemployment? Professor Bernanke offered no answers.”
Because economic growth does not cause inflation and there is no inherent trade-off between inflation and unemployment. This is standard Keynsian, demand-side, Phillips curve nonsense. Ironically this is the same thinking the Fed uses so it is a valid point in a way.
The real problem is that the Fed stayed too loose for too long and didn’t nip inflation in the bud back at the beginning of the rate hike cycle, and will have to go higher than they originally would have had to. If they had done a few half-point hikes at the beginning we would be in lot better shape now. But let’s not get carried away, this is hardly the 1970’s when inflation was 10%, Interest rates were 15% and unemployment was near 10%. Be serious, that sort of environment was the result of 15 years of loose money and a fundamental misunderstanding about what caused inflation and what didn’t.
Also the idea that a 5.5% Fed funds rate will drive what is an extremely robust economy into recession ignores the fact that the FF rate was higher than that for most of the robust economic growth of the 80’s and 90’s.
High interest rates are not a driver of recession they are indication of robust demand for capital.
“But although such a banking system would have its crises, they would be relatively small compared to the risk of an entire economic region getting into trouble on account of a mistake by a central bank chief and his economists. The bigger and more powerful the central bank, the bigger the potential cockups.”
I am reminded of an anecdote from Lucius Beebe’s superb 1966 book, “The Big Spenders” —
“Colonel [Ned] Green admired to have adequate funds available in the form of pocket money in case emergency should arise. Emergency arose on one of his frequent trips to Texas while he was breakfasting at the Adolphus Hotel in Dallas with Edward Harper, president of the Security National Bank. Just as the sausages were being served, a pallid and shaken emissary arrived to apprise the banker that there was a run on his institution and that additional funds were in urgent request.
Unwilling to see his guest inconvenienced, Green pulled out his wallet and counted out its contents, twenty $10,000 banknotes. This being insufficient for the emergency, Green sent a bellboy to his suite with instructions to fetch a battered valise which was on the bed. It turned out to be almost entirely filled with $10,000 bills from which the Colonel counted out another thirty and handed them to Harper without requesting a receipt. Half a million dollars proved sufficient to stop the run and the bank was saved. Green sent the valise back to his apartment with instructions to the bellboy to put it in the closet where it would be safe.”
(op. cit., p. 87)
This was sometime around 1915.
Observe: there was no government involved in any of it.
It is already too late to avoid trouble in the U.S. – the vast credit money bubble of the Greenspan years has seen to that. However, that is no reason to continue inflating the money supply (either “narrow” or “broad” now).
Hopefully any major bust can be delayed till after the mid terms (I say “hopefully” as I despise the Democrats even more than I despise the Republicans). But without “cutting interest rates” or any other move that would make the boom-bust even worse.
To judge by the money supply stats at the back of the “Economist” each week the Swiss seem to be inflating least at the moment and the British the most (so much for the wonderful “independent Bank of England” that Mr Brown set up).
By “inflating” I (of course) mean the increase in the money supply by the central bank and the private financial institutions that depend on it – I am not talking about any particular index of prices.