Origins of Financial Crises

The Wizard of Inflation
Price stability is one of two goals that make up the Fed’s mandate. Ben Bernanke, current Chairman of the Fed, said in his July 16, 2008 testimony before the Committee on Financial Services (U.S. House of Representatives) that “upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to a sharp pickup in inflation … ”

Interesting. Didn’t Bernanke say that rising prices lead to inflation?

Either Bernanke does not realize that rising prices are the result of inflation, or he does know and is purposely misleading the public. Both possibilities raise very real concerns.

The former would suggest that the most powerful economy in the world is run by a man who doesn’t understand basic economics. The latter entails an act of misdirection that would make even the great and powerful Wizard of Oz blush.

The Fed, disguised by fire, smoke and a giant head, says in a booming voice that the rising prices of several commodities are the cause of inflation. Who are we to dare to question the great and powerful Wizard of Oz?

The truth is, the Fed (of most any country), as the sole guardian of the money supply, is just the old man behind the curtain. His continued reign as the Wizard of Inflation is protected by the fact that the majority of people do just what he asks of them: “Pay no attention to the man behind the curtain.” How many people do you know that understand what the CPE is?

Ludwig von Mises, one of the first Austrian economists, explains: “[t]here is no longer any word available to signify the phenomenon that has been, up to now, called inflation… As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.”

Why do they do it?

Austrian economists agree that the state uses inflation as one of the three means by which it can fund its activities (the other two being taxing and borrowing).

Taxation is relatively straightforward. Military spending is often cited as the reason for resorting to inflation and borrowing. More recently we have seen all sorts of fiscal recklessness (bailouts, etc.) that provides another possible motive.

One method that central banks use to increase the money supply is to purchase government bonds on the open market. The bank can then create the money it uses to buy the securities and the government can create the securities that it sells to the bank (basically a complicated but common borrowing practice).

This type of arrangement is one way the U.S. government is able to service its more than $13 trillion in debt. Unfortunately, it also causes the money that everybody else holds to decrease in value (thus causing inflation).

Inflation is therefore a type of indirect tax (and a sneaky one at that). Given there is no foreseeable shortage of whims on which governments will be able to spend their taxpayers’ hard-earned money, it seems unlikely that this is a problem that will go away on its own.