There is low price inflation because we are still in a deflationary credit contraction
He poses the scenario:
A question I have heard a lot from those with a Kuyperian bent is “since the Federal Reserve has so greatly increased the money supply, why hasn’t there been corresponding inflation because of it?”
I appreciate Andrew blogging about Austrian economics, a subject I care much about and love to discuss. But I would like to offer some slight differences on how to look at our present situation.
I think the claim that the Federal Reserve has greatly increased the money supply is an incorrect premise. The Federal Reserve has attempted to increase the money supply, but they cannot keep up with the wealth destruction that occurred in 2007 and the impending further wealth destruction. The reason they have not really increased the money supply is because cheap credit is a part of the money supply and affects prices.A massive contraction in credit is a contraction in the money supply . Bernanke’s new money is no match for the evaporated credit and destroyed wealth of the bust.
Role of Credit in Inflation
Failure to include credit in the definition of inflation and the analysis of economic activity causes many problems. Credit influences consumer prices, jobs creation, and asset prices. The mark-to-market value of credit influences the ability and willingness of banks to lend.
People tell me all the time, “all I care about is prices”. If they really mean it, they are fools. Without credit expansion there is little hiring. Without hiring and money to pay for things, consumers cannot pay back loans and asset prices in general, crash.
Trillions of dollars in debt-inflated (thus imaginary) wealth have been wiped out in housing and the stock market because of falling credit, loss of jobs, and inability to service debt. Many homes fell in price from $500,000 to $200,000 (or equivalent percentages).
This is far more important than the price of gasoline hitting $4 or the price of carrots rising 50% to $2 a bunch. Yet, inflationists constantly fret about prices, ignoring far more important credit conditions.
Price myopia has other problems. Both Greenspan and Bernanke ignored an explosion of credit that fueled housing. Thus, a focus on prices induced errors on the way up and on the way down.
If you think about how Bernanke has little control over where his new money flows, you can see he is in a trap. QE1 and QE2 and QE-infinity do cause some prices to rise. But what would happen if food prices and fuel prices shot up? Fewer people would be able to pay their mortgages. and fewer people would be able to spend money on other businesses. This would mean a further plummet in the housing market and even more of a crash in commercial real estate. One of the ways the CPI is inaccurate is that it doesn’t include certain expenses. If housing had been included in the CPI from 2001 to 2007, it would have been obvious we were already experiencing tremendous inflation. Likewise, after 2007, including housing in the CPI would have shown much more severe deflation. While booms are inflationary busts are deflationary. We are still in a bust despite all Bernanke’s efforts.
Mish has shown us, I think, the implications of Mises’ excellent insight on the business cycle, which Andrew points to. Andrew’s fourth point, to repeat, was this:
4. New money goes to capital goods and industries first.
One of Ludwig von Mises developments to Austrian Business Cycle Theory is that newly created inflationary money is lent out to pay for capital goods in certain industries, causing the prices of capital goods in those particular industries to artificially rise and send the signal to investors to invest in those industries where they normally would not have otherwise. An inflationary bubble begins to form in those industries that ultimately will result in a bust. While the new money will eventually find its way throughout the economy as a whole, it affects those goods first and worse than all others.
Exactly so. But now what happens when these prices rise in our current economic environment? The un- or underemployed consumers simply cannot afford them. Rather than a boom, these businesses experience loss of sales and bankruptcy.
Consider how Mish invokes Mises’ insight in a reply in 2010 to some predictors of inflation:
If Bernanke Wants 2% Inflation, Why Don’t We Have It?
Of course North and Murphy will point out that gasoline prices are soaring and they may claim food prices are soaring too, although I do not believe the latter and I do most of the shopping. Commodity prices certainly did soar.
Regardless, that point is it is irreverent because Bernanke does not want oil prices or food prices to rise, he really wants housing prices to rise, and prices of stuff in general to rise. Yet, in spite of $2 trillion in agency purchases to support home prices and home sales, prices are falling and home sales are at all time record lows.
Ignoring Constraint After Constraint
Murphy ignores constraint after constraint. First off, I do not think Bernanke can cause prices to rise at will, but IF he can, it clearly is not the prices he wants.
“The FED can print money but it can not dictate where the money goes, or indeed if it goes anywhere at all.”
Murphy and inflationistas need to read that sentence 100 times and understand the practical implications of it.
Rising commodity prices without a pass-through to consumer prices kills profit margins and especially destroys small businesses [boldface added]. That fact imposes a serious constraint on Bernanke.
If I understand Mish’s point, we might say we have gotten beyond the possibility of a boom/bust cycle because the “boom” is accompanied by more “bust” almost at the same times. How can any area really allow prices to rise if people don’t have jobs? Taxes have increased and are going to increase more as Obamacare and other burdens divert resources away from the power of the consumer. These are deflationary forces.
The Federal Reserve has no power to actually make the money circulate throughout the economy. That is why Bernanke is constantly opposed to spending cuts and constantly showing that he wants Congress to “stimulate.” As Mish wrote in that same piece:
Can Bernanke Force Prices Higher?
I say not really, at least without serious consequences. I am not the only one who believes that. Ben Bernanke now believes that.
For at least the fourth time since June, Federal Reserve Chairman Ben Bernanke publicly urged Congress to combat the lackluster recovery by increasing government spending, a recommendation that has gone unheeded by lawmakers.
In a speech at a conference of central bankers in Frankfurt, Bernanke once again said the Fed cannot save the economy on its own. The Fed’s recent move to add to its ballooning balance sheet by committing to buy up to $600 billion of government debt faces “limits” to its effectiveness, Bernanke said. The rest of the government, the chairman added, could aid the Fed’s efforts by hammering out a plan for stimulative spending.
So while Murphy and North think Bernanke can force prices higher, even Bernanke finally admits he needs help.
This by the way goes along with a statement that I have made numerous times over the years.
“The FED can print money but it can not dictate where the money goes.”
If the Fed could dictate where it went, unemployment would not be near 10%, and prices would be going up 2% annually (Bernanke’s inflation target).
The only way to achieve real general price inflation is to get a Congress intent on spending on more “stimulus.” Without massive spending to get the money flowing everywhere, there is no way to get the prices to climb.
Andrew mentioned another point:
3. The money simply has sat in ‘excess reserves’
One theory thrown out is that banks (both in the United States and abroad) have sat on the new money and have only recently begun to lend.
I think this is important but needs to be re-framed a bit. Banks aren’t just “sitting” on these reserves by some kind of accident in history or arbitrary decision. This again is related to the deflationary bust that is still drowning us. Who wants to borrow? Who wants to go deeply into debt? There is no opportunity for profits that would justify the risk of taking the loan. Likewise, the banks cannot afford to risk loaning out the money unless they are confident they will get a return. Where could such confidence come from?
Furthermore, these banks are probably insolvent and know they are insolvent. It wouldn’t surprise me if they would cling to every new dollar they can get. Thus, all Bernanke’s new money is being sucked up out of circulation. It distorts the economy by perpetuating zombie banks, but it doesn’t give rise to much or any inflation.
I attempted to explain/understand Mish’s stuff in my own words and concepts here:
But I really recommend Mish’s posts on this topic, including: