Monday, August 3, 2009

Inflation: An Intractable Political Phenomenon

I don't write enough about economics, because I'm convinced the seeds of an economic apocalypse have already been planted and there's nothing we can do to stop it. But then again, you might not be aware of it. So here's a good one from

    By Michael S Rozeff

    In 1963, Milton Friedman and Anna Schwartz wrote "Inflation is always and everywhere a monetary phenomenon." The thrust of this statement is that inflation is caused by unsound monetary arrangements – not by those who are raising prices or asking for higher wages, and not by oil speculators or by dealers in foreign exchange. This statement was made at a time when blame was being placed for inflation on groups in society.

    This statement focuses attention on the monetary role in inflation. It suggests that to have sound currency arrangements and avoid inflation as well as deflation, a society has to have sound monetary arrangements. This is true. Squelching businessmen who raise prices or instituting wage and price controls does not address the role of the central bank in inflation.

    The statement raises three deeper questions:

    • Why does a society not have sound media of exchange (monies) via its monetary system?
    • What arrangements will provide sound money?
What must the society change in order to get to sound money or monies?
    Friedman and Schwartz were not the first to focus on the monetary authority. Henry Hazlitt said the same at an earlier date, December 22, 1947: "The basic cause of inflation, always and everywhere, lies in the field of money and credit." Many observers and economists throughout history have noticed the link between inflation and money. They are correct. However, it is still necessary to dig deeper to understand the nature of the monetary authority and how it is behaving. In doing that, we encounter many and varied political forces that can produce many and varied results. A limited government with a limited power to issue money can produce a stable money. A government with little or no revenues that issues its own notes that it makes legal tender may produce inflation. A government that has an independent central bank mandated to produce stable prices might get stable prices, whereas a government that has a central bank mandated to subsidize socialist enterprises may get inflation. There are innumerable possible arrangements, each with its own set of incentives, and each producing different inflation results. And if we ask why we observe these different arrangements and incentives, we come back to politics.

    And, if I may digress briefly, we also encounter the fact that political authority and monetary authority interact with people in the society. There is an interplay of the expectations of people with actual events. What happens to prices depends on how people react to events that occur, what they expected to occur, and how their expectations change. If, for example, severe problems once again surfaced at several big banks in America, or if by chance members of the FED were to make certain kinds of remarks, or if the FED behaved one way instead of another, the people in America and outside might decide they wanted to hold more euros or more gold than dollars; or they might decide that problems had come to a head and it was time to hold more dollars. Hoarding of goods might begin, or abate.

    It is a fact that if Paul Krugman should happen to write an article that forecasts hyperinflation, he may trigger hyperinflation himself; this depending on unobservable expectations locked up in people’s minds and depending on innumerable other statements and events that may occur if he should make such a statement and their effects. But while the future holds many surprises, the behavior of people is predictable enough that we sometimes can foresee outcomes. Sometimes the political arrangements are such that things can move on and end in only a few predictable ways

Please read all of it.