The World & Beyond

The writings of a global transient.

Month: July 2014

How the Fed Got Us to Accept Inflation

Paul Krugman and the Austrians go at it over inflation. He scores a run but loses the game.

 

Published on 21/7/14 Paul Krugman takes on the Austrians over inflation

 

Let’s look at the underlying issue. Mainstream economists define inflation as something along the lines of “a general increase in prices and fall in the purchasing power of money”. There are many different ways to measure this, but for our purposes we will stick to the most common measurement, the Consumer Price Index (CPI).

 

The consumer price index measures changes in the price of a market basket of consumer goods and services purchased by households.

 

Actually measuring the CPI is quite difficult. It sounds simple to take a market basket of goods in one year and then measure the price of those same goods the next year, but that does not really represent the true experiences that consumers felt during the course of the year. For example, consumer preferences change during the course of the year. At the end of the first year consumers might be purchasing a different basked of goods merely because there preferences have changed. Or, beef prices might have gone up during the year by 20%, but consumers might not have experienced such a hit because they switched to an alternative instead. Additionally, products get better over time. TV prices might have gone done 10% during the course of the year, but at the same time it’s not the same TV being purchase. This one is even better than the common model made the year before.

 

Of course the government attempts to deal with this, but the overarching point is that CPI is a difficult number to calculate and then to interpret what it really means to the average household.

 

On top of that, there are many who allege that the government fudges the numbers and that inflation is running far higher than the official government statistics. The publisher of www.shadowstats.com takes such a view and offers his alternative data as a subscription service.

 

The Austrian School of Economics sees things differently. The Austrian School of Economics defines inflation simply as an increase in the money supply. The logic behind this is simple: If you have X number of dollars chasing Y number of goods, then by definition if you increase X while keeping Y stable, each unit of X has less purchasing power.

 

This actually coincides nicely with the second part of the mainstream definition above: “.. fall in the purchasing power of money”. That an increase in the money supply leads to a fall in the purchasing power of money is simply a mathematical certainty.

 

So where exactly is the discrepancy between mainstream economists and Austrians? The discrepancy lies in what is being measured. Mainstream economists are simply measuring a basket of household goods. Austrians are measuring the overall purchasing power of the dollar in the economy. Why is there a difference? Because the nature of inflation has changed since the world has gone completely to fiat currencies.

 

Inflation has a long history. Since man first minted coin, those who control those coins have sought to de-value them in order to capture wealth for themselves.

 

The Roman Emperors routinely devalued the currency. In one famous incident the emperor devalued the Denari from 84 Denari per pound of silver to 96 Denari per pound of silver. The result of course was that the Emperor was able to simply spend more money at the expense of everyone else in Rome. (in other words, there was an increase in X despite Y staying the same). As a result there was a general price inflation.

 

It’s important to ask however how this extra money entered the system. It entered through purchases by the emperor of goods and services. In that manner the price of goods and services increased.

 

Had there been mainstream and Austrian economists observing at the time, there would have been little divergence between the increase in the money supply and the increase in general prices.

 

This relationship would stay true for close to 2,000 years. It all changed however in the 1980’s.

 

The 1970’s saw a general price inflation as the Nixon administration printed money in order to fund excessive government spending (Yes, I know that the government doesn’t technically print the money, but for purposes of this analysis it is the same thing). Money was created and it was channeled into goods and services. General prices rose. The people were angry. Part of the problem was also the idiotic belief by mainstream economists that inflation was good for employment (due to their belief in the misguided Phillips Curve). The print and spend polices continued into the Carter era and helped contribute to his defeat.

 

There was to be no more inflation after that. The people wouldn’t stand for it, and if the people won’t stand for it then the government won’t stand for it either less the next election turn out poorly.

 

Enter the Fed and Wall Street. The Greenspan discovered (whether accidentally or on purpose) that by making the rate at which banks accessed money artificially low, the banks would ultimately channel those dollars into asset purchases, and lending to people who purchased such assets. Furthermore, it was made clear that if those assets declined in value that the banks in general (if not a few specific ones) would be bailed out. This was the beginning of the boom and bust asset cycle that we still see today.

 

As the printing press was turned on in the 1980’s Austrians bemoaned loudly that inflation or even hyperinflation was coming. However looking at CPI it never really came (or at least not at the dire levels predicted). What happened instead was the asset bubbles which is turns out the people don’t have such a problem with as long as they participate in some manner.

 

So back to Krugman: Krugman correctly understands that there is simply a difference in the definition of inflation between mainstream and Austrian economists. He does however raise a good point saying “So when Austrians were predicting runaway inflation, they didn’t actually mean consumer prices”?

 

He has a good point. Many if not most Austrians failed to predict the way that the newly printed would be channeled into narrow asset classes. While Austrian economists understand this today, many casual followers still do not.

 

All the being said though, the Austrians are still correct in their measure of inflation. Each dollar today has seen a dramatic “fall in purchasing power”. Even if the fall and purchasing power for groceries is not that great, it certainly is for most assets, particularly financial assets which are not properly covered by the CPI

LC=BP

Im generally not a fan of motivational speakers, but Tony Robbins has some good stuff.  Depression is something that almost everyone deals with sometime in their life.  For some it is transitory, for others is is a crippling life long disease.

What is depression?  I dont know where I heard the following; it is probably someone famous and I am blanking on the name; but depression was once explained to me in the following manner:  Imagine you have been attacked by a wild animal.  You have been gutted and will die over the next ten minutes.  As you lay there dying you think about various regrets.  Specifically, things that you wish you had done in your life, things that you did do but didnt because they harmed your career, time you wish you had spent with you children but didnt.

A depressed person feels this way ALL THE TIME.

When this was told to me I was not depressed.  I have not been for many years, but when this was told to me it sure hit home because it certainly describes how I felt the times that I have been depressed.

Ive done some more studying on the subject and I basically agree with Tony Robbins formula.  We are unhappy when our Life Conditions (LC) Fall short of our Blueprint (BP).

That is, we have mapped out in our heads a Blueprint for our lives and when we fall behind that we get depressed.  This explains the stark unhappiness of many of my peers that I grew up with in Greenwich.  For most of them their parents were so successful that there was almost no chance of their life conditions meeting their blueprint (which was merely being the same as their parents).  Of course, not all of those I went to school with are depressed.  Those who are happy are the few that met their Blueprint and are very successful, but most of my old friends who are happy are  the people who changed their blueprint.  They are people who realized that happiness is a choice and that it does not come from material possessions, club memberships and the like.

When our life conditions do not meet our blueprint we essentially have 3 options:  Change our life conditions, change our blueprint, our blame ourselves and get depressed.

My belief is to go for the first two at the same time.  You can change your life conditions and change your blueprint at the same time.  Changing your life conditions is hard work, but everyone can do it.  At the same time, changing your blueprints is easy on the surface:  just lower your needs.  However, it requires years of de-programming.

I was fortunate to be introduced to a form of shock therapy when it came to my blueprint.  Having grown up with every possible advantage I still was not generally a very happy person.  Travel, however, changed everything.  Witnessing extreme poverty in Kenya and especially Sout Sudan had a great impact on me.   I also witnessed it all while living with only my laptop, kindle, and a suitcase full of clothes.

That is when it impacted me that everything I previously felt was important was in fact immaterial to my own well-being and happiness.

Changing your Life Conditions is also positively impacted by travel.  Most Americans are horribly entitled when it comes to work and effort.  Although I had a successful career, I thought it was actually difficult until I started traveling.  In Kenya, for example, I used to walk through Uhuru Park every day.  While walking through I would see scores of people in their best suit sleeping on the grass.  These were people who saved up enough money to take the bus into the city because they had a potential job interview or two.  They couldnt even afford to sit in a coffee shop to kill time in-between interviews.

In Albania, which is not much more developed than Kenya, on every street corner is a kid with a hose looking to wash your car, or a woman with cherries she picked herself that she is trying to sell, or if you are near a lake someone who caught some fish who is trying to sell them just to feed his family for the night.

Its a very humbling experience and has allowed me to work through situations where when I was younger I might have otherwise felt sorry for myself.  Whenever I feel tempted to complain to myself about a task I dont really want to do, I remember the people I have seen who will do anything for a days wage.  (The downside of this of course is whenever an unemployed friend in the US complains that there are no jobs I want to kick him/her in the ass.  There are jobs, you just dont want to do them).

Remember, happiness is a choice.  If you dont understand why you are unhappy it is because your Life Conditions are not meeting your Blue Print.  Work to change both.  Life is too short to spend it depressed.

Oh, Kenya

I love Kenya.  It was the first African nation that I landed in and I lived there on and off for 2 years.

The recent headlines from Kenya are startling.   (Gunmen in Kenya Kill Four in Mombassa)

“Terrorist” attacks are occurring against Kenya citizens by Al-Shabab, the Islamic forces in Somalia.  Why?  – Because Kenya has invaded Somalia on behalf of it’s British and American patrons.  The results in Kenya are not going to be good.  It is the nature of history and humanity that dominant powers – as strong as they are- can’t rule vast swaths of land without loyal local forces who do their bidding.  The British Empire is the best example of this.   The British ruled much of the modern world not with it’s tiny Army, but with it’s Navy backed by a keen diplomacy that fostered allies in regions the Empire wanted to control.

The question is:  How exactly does this work out for those who sell out their sovereignty Usually not very well.  The dominant countries survive no matter the outcome of their foreign wars.  The Americans in Vietnam built an alliance with the Hmong. Hmong_women_at_Coc_Ly_market,_Sapa,_Vietnam The Hmong – long the oppressed in the region – wanted to support their new and powerful ally.  The result was a mass exodus from Vietnam when the Americans had decided that they’d had enough.

History seems to suggest, however, that the worst thing that you can do is to be a minor ally of the British.  At the start of World War 1 Italy was allied with Germany and the Austro Hungarian Empire.  The alliance obligated the signers to the defense of each other if attacked.  Italy declined to enter the war on the theory that the Austro-Hungarian empire was the aggressor.

Britain entered the war thinking that 6 divisions was going to tip the balance.  As the war plodded on the Entente continually mislead itself on casualty figures and Entente leaders therefore felt that the Central Powers were always just on the breaking point if only one good offensive or one more front was opened up.

As a result the British and French did their best to entice Italy into the war on their side.  In the Treaty of London Italy was promised numerous territories after the war.

How did this work out for Italy?  For well over a year Italy attacked the Austro-Hungarian positions in the mountains with no gain.  Eventually The Austro Hungarian Empire and Germany routed Italy at the Battle of Caporetto. Eventually as the war neared an end Italy made some progress but the damage was done.  Italy suffered between 460,000-650,000 combat dead with over 900,00 wounded.  italy world war 1

After the war, Britain and France of course turned their backs on Italy, which  was a large part of Italy’s choice to side with the Axis in World War 2.

If this sounds bad then you don’t know much about Romania’s experience in World War 1.  Again thinking that surely the central powers needed just one more push.   The Entente convinced Romania to enter the war on the promise of the territorial gain of Transylvania.  Fighting took place from August 1916 until December 1917 at which point Romania suffered total defeat.  Transylvania was gained (only to be lost again, and then regained after another ruinous war)but at the price of 250,000 killed out of a population of less than 8 million.


What is the point of it all?  The point is that the great powers of any age hold a tremendous amount of sway over smaller powers, and churn them up and spit them out for their own purposes.WWI_Poster_Rumania

This is what is going on in Kenya.  In it’s never ending war on “terror” (which seems to be about as effective as the war on drugs) the United States and it’s allies are enlisting minor powers to do their bidding.  Kenya is ill-prepared for this conflict and has nothing to gain from it.

You can rest assured however that the Kenyan people will continue to suffer.

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