Ben Bernanke wants us to stop worrying about inflation. He downplays its significance at every opportunity, especially when he wants to inject more cash into the economy. Bernanke knows that his worst enemy is knowledge-knowledge on the part of the America people that all this fantasy money will at some point lead to inflation that will make the 1970’s look tame.
Let’s review quickly what inflation is. Many people think it is a phenomenon wherein prices get higher, but that is not quite accurate. It is more precise to say that money loses value. But isn’t it all relative? Why does it matter whether we say that products are more expensive or money is worth less?
It matters because there is a standard that historically has prove stable–gold. Century after century, gold’s ability to purchase goods has remained about the same. A really nice suit of clothes today costs about an ounce of gold, the same as a really nice toga did in Ancient Rome*.
Inflation occurs when too much money chases too few goods. There is a finite amount of usable value floating around an economy at any one time. This value is constituted by things we buy that do something for us–food, clothing, an extra Velvet Elvis, and so on. When these things circulate on the basis of a stable entity like gold, prices stay more or less the same over time.** The same would be true of paper currency if it were redeemable in gold because the government could not print more money than there existed gold to back it up.
Bernanke’s view of money is a bit different from mine. He thinks that economies are boosted by the injection of money, a remnant of the thinking of the economist John Maynard Keynes. Though I believe he would acknowledge that at some point printing money leads to inflation, he is more worried about a repeat of the Great Depression, which he attributes to the Federal Reserve’s failure to keep enough cash in circulation. His nickname, “Helicopter Ben” comes from his statement that he would drop money from helicopters if need be to prevent another crash like that.
In a sense, Ben is right. Let’s imagine a small town of about 100 people to make things easier to manage. If there were $100,000 in circulation, and I were to print $100,000 more dollars and distribute it among the inhabitants, everyone would feel richer. In fact, many would choose to spend this new-found wealth on a bigger house, a nicer car, and three or four Velvet Elvises (or should that be “Elvisi?”). The sellers of these goods would feel as if business had picked up and start making more goods accordingly. In fact, they would invest in business projects, believing that real demand had increased.
As the full $200,000 entered circulation, prices would eventually rise on everything. When things settled back down, businesses would find that they have sunk money into unprofitable projects because inflation forced consumers to trim back to their previous levels of consumption. The demand increase was never really there. Unfortunately, many of those investments will have been illiquid–building, machines, and other things that cannot be sold or converted to other uses easily. These factors of production may sit idle for years or even decades.
In Bernanke’s view, however, all that extra money has a real effect. It “jump-starts” the economy by increasing demand. Once businesses respond to the increased demand, they hire more people, which increases the sum of real products and services made, which in the end makes everyone better off. Politicians love this way of thinking because it gives them an excuse to spend money created out of thin air. They usually call it a “multiplier effect” to make us think they know what they are doing.
Thus, Q3 (a stealth round of increasing the money in circulation) is in the works. This time, the strategy appears to be using the proceeds from the money the Fed lent to government to buy more bonds (lend the government more money). In the end, the effect is the same as printing money outright.
Throughout history, attempts to pay for things with fake money have ended badly. Our own Continental Congress printed paper money to pay for the war (sound familiar?). It was worthless by the end of the conflict. Ditto for the Greenback during the Civil War. Will our dollar meet the same fate?
I think the answer is an emphatic “yes.” The Fed can really only print money or do things that have the same effect–putting more paper in circulation. Eventually, that policy must lead to inflation–big time. Any attempt by the Fed to take money out of circulation to prevent such inflation or to fight it after it occurs can disrupt things horribly. In other words, the mechanics are so screwed up that the Fed must either cause us great pain now or greater pain later. Which do you think they will choose? Me too. Like a child who would choose the risk of a deadly disease over the pain of a shot, the Fed will evade reality until it is too late.
*The run-up in gold prices in the last two or three years skews this a bit. Gold is now around $1500 an ounce. A nice suit of clothes can be had for less than that, at least for now. History suggests that with time, the price of a high-quality suit, shoes and a belt will be about $1500.
**Note that gold is no different from any other commodity in some ways. For example, if I were to find a 100,000-tonne gold nugget in my backyard, it would increase the total amount of gold on the planet significantly–significantly enough to “inflate” prices in terms of gold as it entered circulation.