A Tale of Two Flations

October 31st, 2013
in Op Ed

Written by

Character actor Paul Ford played the part of blowhard "Mayor Shinn"  in the movie The Music Man. What a beautiful movie! Robert Preston; Shirley Jones; Meredith Willson's great songs. I don't recall whether it was in that movie, or in another role, that Mr. Ford triumphantly declared that "I'm against Inflation; I'm against Deflation; I'm for Flation." He didn't define what he meant by "Flation." The word does not appear in the dictionary. Presumably, it connotes a state of equilibrium of some kind.

The Music Man

Follow up:

Arthur Laffer, writing in The Wall Street Journal on June 11, 2009 (more than five years ago), was up-in-arms about the Federal Reserve's then-new program of "quantitative easing." He wrote that

"We can expect rapidly increasing prices and much, much higher interest rates over the next four or five years...by such a radical move, the Fed signaled a 180-degree shift I its focus from an anti-inflation position to an anti-deflation position...It's difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed's actions because, frankly, we haven't ever seen anything like this in the U.S."

Mr. Laffer was correct in saying that the Fed had "shifted its focus from an anti-inflation position to an anti-deflation position;" but during the last five years inflation has been minimal to nearly non-existent, and interest rates have remained low. Yes, gasoline prices have spiked, and the number of ounces of corn flakes in the cereal box has somehow shrunk, even though the price of the box may have remained the same; but overall, "core inflation" (as the Fed defines it) has remained very low, and interest rates have only recently begun to budge. Broadly speaking, I think it's fair to say that Mr. Laffer was wrong about deflation, and wrong about interest rates.

"Deflation" is defined (in Merriam-Webster) as "a contraction in the volume of available money or credit that results in a general decline in prices." Don't forget the "or credit" part.

The lead story in The New York Times last week discussed a supposedly new general feeling, inside and outside the Fed, that "more inflation" now would be a good thing. One wonders how that would be accomplished. The Fed has been trying to inflate the economy for more than five years, and all that it has managed to do in all that time is to have staved off deflation. It can be argued that it has "increased the volume of available money" (even though the public sees none of it), but the rate of destruction of credit by reason of bankruptcies and debt write-offs in several guises appears to have offset any "increase of the volume of available money," whereby the desired increase in the rate of inflation simply has not occurred.

The tenor of the contributors' input to the Times story is that the Fed has not done enough; that it must inflate more; that the "quantitative easing" program, to date, is just not getting the job done; that if the Fed will just ramp it up, the desired inflation will result.

No one is quoted as saying, flat-out, that "we have to do a whole lot more, if we're going to avoid deflation." No one is candid enough to say that. The Fed can't lower interest rates any lower than they are; they're almost zero now, at the Federal Funds and discount window level. (By the way - the Fed does not set interest rates at the market level; the market does). The Fed is "printing" (or is causing to be "printed") $85 billion per month "out of thin air." How much more can it do by way of "printing money" before it creates a furore in Congress, or jeopardizes its own shareholders, which are the banks?

The article is a gentle, bland introduction to the concept that the Fed is scared stiff of deflation, which is attended by a general contraction of the economy and by persistently falling prices - a trap which has ensnared Japan for at least ten years. No one is bold or brave enough to say it - that the Fed is terrified of the prospect of oncoming deflation, and that it doesn't know what to do. The import of the Times article is much more serious than its bland reporting style would lead one to believe. It's a door-opener. You really do need to read between the lines. Watch out when someone you know corrals you with a desire to "share something important" with you. Be wary. It's not going to be a gift; it's going to be a problem.

The final two paragraphs of the article are telling. I look upon Caterpillar as a "leading indicator," or "proxy," for the world economy in general and for the US economy in particular. See whether this bombshell at the end of the article brings you up short:

"In June, Caterpillar, the industrial equipment maker, persuaded several hundred workers at a Wisconsin factory to accept a six-year wage freeze. The company described the workers as overpaid, but it did not seek direct cuts."
"The slow pace of inflation, however, minimizes the benefits. Seeking further savings, Caterpillar has since laid off almost half of the workers."

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