Stop Panicking Over Inflation

...likewise, consumers won't buy...

...Everyone quoted in the USA Today and New York Times stories following the announcement of the January inflation figures exhorted the Fed to raise rates still higher...

...Between 1800 and 1940, the U.S...

...As The Economist put it: "Sixteen months later, all members of that overcrowded club, the Hindsight Forecasters, agree that the rise in the discount rate tipped an overvalued stockmarket into the plunge of October 1987" After this new disaster, the Federal Reserve Board drew up a list of inflation indicators to reassure the public that it would not again raise interest rates unless the danger signals were real...

...Wages rise to keep up with prices...

...The S&Ls had shoveled loans out the door—convinced that asset values could only rise...

...It is the fear of the economy overheating that has led so many people to look to the Federal Reserve as a savior...

...The dollar was actually rising, the price of gold was falling, and the upward movement in commodity prices was almost entirely related to drought and drought-induced speculation from the summer's notorious heat-wave...

...In GrapesofWrath fashion, the farm-credit system collapsed, and the sight of a farmer auctioning off his tractor and his memories became commonplace...

...So they began to hoard silver, storing it in vaults around the world with the vision of rising Phoenix-like from the impending destruction of the dollar...

...Back in 1979, driven by an almost apocalyptic fear of inflation, the Hunts placed their faith in silver...

...The benefits of this productivity growth have taken the form of lower prices for manufactured products rather than higher wages and profits...

...A cynic might suggest that the interests of liberals have changed...

...Look at the banks...

...There are many villains in the S&L crisis, but one that is rarely fingered is the fear of inflation...

...Amazingly, the banks still expected high inflation...

...Inflation cooled, and like so many other prices, the cost of silver actually tumbled, falling from $34 an ounce in February 1980 to just $11 the next month...

...On April 12, his column in the Post was headlined "The Case For a Recession ") And Greenspan seems to be heeding the call...

...When the price rise hit in February, virtually every paper in the country ran a story saying that the Fed needed to step in...

...They even envisioned themselves issuing their own silver-backed bonds once inflation ravaged the world's currencies...

...In March, headlines in papers as different as The New York Times and The Washington Times sounded the alarm...

...During this period, which includes the Civil War and the rise in prices that almost always follows wars, the inflation rate fell...

...If we ever come to accept that it is a responsible, statesman-like act to ruin ventures and throw millions of people out of work with high interest rates, we will have become a hard-hearted people...

...According to the department's report, investment would be a major source of U.S...

...But there is no reason to worry so...

...economy grew tremendously...

...Taking shorter periods, statistics from Robert Barro's Macro Economics show an average annual growth rate in real GNP of 4.6 percent for the period 1840-1900—a hot performance...

...A second factor holding down inflation has been the surge in U.S...

...Obviously, that inflation never materialized and the Third World remains mired in debt...

...As a percentage of total budget outlays, net interest paid by the federal government rose to 14 percent in 1988 from 7.7 percent in 1978...

...Labor shortages sprout up...

...In retrospect, the banks should have built up their reserves in order to deal with the loans...

...A third force working against inflation is demographics...

...In 1987, interest payments on the debt totaled $139 billion, a sum almost identical to the budget deficit...

...This theory lasted a few days until the Commerce Department released its survey in September showing that real business spending on new plants and equipment was, in fact, surging—up 11.6 percent over the previous year...

...Enter the Federal Reserve...

...Time and time again, the American economy has proven it can meet demand...

...They were equally certain that the value of precious metals would soar...

...Economic growth per se does not cause inflation...

...The fact is that the Fed has not been gunning the engines the past two years, thus it's hard to imagine a monetary inflation...

...If the Fed pushes up interest rates, then the economy pulls over into the slow lane— business will be less inclined to borrow and expand...

...In 1964, it stood at 6.9 percent...

...What about the reports of price hikes of recent months...

...If demand is weak in the Third World, that's even less of a tug on our capacity...

...Bottlenecks snag production...

...Since bonds pay a fixed rate of interest, bondholders dread inflation...

...Unfortunately for them, but fortunately for the rest of us, the dollar didn't sink to the value of the proverbial continental...

...In late February, The Washington Post expressed doubt whether Greenspan "has done enough" by raising rates...

...It's worth looking at the way the Federal Reserve has panicked over inflation...

...Robert Samuelson of Newsweek has sounded the alarm for higher rates in three columns...

...Why have the views changed...

...Liberal Keynesians fear that growth will inevitably be followed by inflation...

...While it cannot decree what interest rates will be, it has several levers it can use to raise and lower them...

...They were convinced that inflation would roar unabated, making all paper money worthless...

...He's already indicated that he's inclined to tighten the reins—a move that could throw people out of work, crush more businesses, and revive all the horrible scenes of the early eighties, when the recession (hard as it may be to remember for those who have prospered) ruined many lives...

...It's supposed to be the inflation-buster...

...Maybe this time it's for real...

...One is the slow growth in money...

...Bank economists, egged on by weekly apocalyptic pronouncements by Reagan's budget director, David Stockman, assured their bosses that it would only be a matter of time before the prices of oil, copper, and raw materials in the Third World soared, making it possible for countries like Mexico to pay back the loans...

...The Fed's many apologists, ranging from Martin Feldstein to Fred Bergsten and Robert Reich, invented a new theory to justify the Fed's action: Demand was growing faster than capacity, and, since business was not investing, inflation was inevitable...

...Instead, the Fed went too far: interest rates shot up and contributed to the stock market crash that fall...

...Despite the immortal failure of the Hunts, hunPaul Craig Roberts holds the William E. Simon chair at the Center for Strategic & International Studies in Washington, D.C...

...Indeed, wages, while showing some rise recently, still seem to be under control...

...It seems that every day there are new calls for him and the Board of Governors to raise interest rates, even though the rates rose a full 3 percentage points last year...

...In August 1987, when interest rates rose slightly, the Fed became alarmed, seeing it as a sign that the economy was over-heating...

...Okay," you're thinking...

...It's worth considering that there are still many factors keeping inflation at bay...

...As consumption falls as a share of disposable income, there will be less demand and hence less pressure for prices to rise...

...The debt crisis precludes a near-term resumption of large-scale lending and has slowed the pace of internal development in most Third World countries...

...The point here is that the fear of inflation has consequences as real as inflation itself...

...Prices rise...

...Frightened out of its wits Whatever the reason for this shift in attitudes, killer inflation has been sighted more often than killer bees...

...And each new sighting proves equally absurd...

...As the boomers age, the personal savings rate should rise in the 1990s...

...According to the Fed, a falling dollar, a rising price of gold, and rising commodity prices would be its indicators of inflationary pressures, justifying higher interest rates to slow the economy...

...They leveraged themselves with debt, secure in the conviction that inflation, which allows a debtor to pay off his creditor in cheaper dollars, would make them winners...

...Today, of course, their enormous miscalculation could cost us more than $100 billion...

...In 1988, a Labor Department survey found that only 4 of every 10 labor contracts include an automatic cost-of-livingadjustment compared to 6 out of 10 in 1978...

...These days those fears have found their focus: Alan Greenspan, chairman of the Federal Reserve Bank...

...Before the 1981-82 recession, heavy lending to Third World countries was fueling demand for Western exports...

...But suppose these latest fears of inflation are exaggerated, just as they were for the farmer who borrowed himself into bankruptcy, or for Bunker Hunt...

...Besides, other countries, such as Japan, have faster rates of growth and less inflation...

...Rate Rise Expected from the Fed," The New York Times proclaimed, "Economists Can See Little Choice After Surge in Price Index ." Washington's conservative daily echoed those fears: "Interest rates must increase to beat inflation—economists...

...economic growth in coming months...

...Since the recovery began in 1982, productivity has grown at a 4.5 percent annual rate—about twice the post-war average...

...Today liberals are part of the bond-holding class that fears, more than anything else, inflation...

...Exactly one year later, in August 1988, three hours before a Treasury financing, the Fed used its levers to raise interest rates, even though its own indicators did not support its action...

...Quench the flames But, first, a couple of basics...

...Maybe...

...Yet, in 1940 the wholesale price level was the same as in 1800...

...The board reasoned that a hike in the discount rate—the money it lends banks—would dispel the incipient inflation and allow interest rates to fall...

...Indeed, it's hard to believe that the economy is so overheated that there's just no way we can keep up...

...But the belief that reflation was just around the corner caused creditors and debtors to dig themselves in deeper, thus delaying for some years the recovery of the Third World from the Volcker recession of 1981-82...

...The unexpected collapse in the price of farmland, energy, and precious metals, together with the Fed's high interest policy, helped push the country's savings and loans into bankruptcy...

...This is crucial because production has been able to keep up with wages...

...Obviously, we need to be mindful of inflation, but a look at some of the scares of recent years will be enough to make one very skeptical of those who cry wolf...

...The baby boom generation hit the economy in the 1980s, a surge of young adults who have low saving rates...

...In the 1920s output rose and prices fell...

...Take the Hunt brothers of Texas, whose sloppy guesstimates about the rate of inflation cost them $4 billion...

...manufacturing productivity during the 1980s...

...For their part, conventional Republicans fear that the budget deficits will yield killer inflation...

...Look past the 1970s to the rest of our history...

...But look at the facts...

...To stem the destruction, direct government payments to farmers soared 1,300 percent from $1.3 billion in 1980 to $17 billion in 1987...

...The chairman finally relented, believing that the worst recession since the thirties had broken inflation and that continued high rates threatened the stability of the Third World and the large banks that are its creditors...

...According to the standard reasoning, as the economy grows, the demand of consumers outstrips the capacity of the economy to produce goods...

...The postCivil War period until 1900 was an era of rapid expansion in real output accompanied by price deflation...

...A slow economy quenches the flames of inflation...

...It's become conventional wisdom that higher interest is just the dose of castor oil the economy needs...

...And on it goes into the infamous "wage-price spiral" that was on everybody's lips a decade ago...

...The 1980s has been a period of low inflation, yet the fear of inflation has grown, leading savvy business-folk of moderate means, and those of great fortunes to _their demise...

...We must resist the idea of inevitable inflation or we will suffer a needless recession...

...dreds of thousands of investors continued to manage their money as if inflation were preordained...

...The expectation of renewed inflation caused them to delay for several years any realistic approach to their loans to Latin America and Africa...

...A fourth factor is weak world demand...

...Frightened out of its wits, the Fed quickly changed its tune and pumped out money to stop the wealth destruction that threatened the economy...

...It used to be that liberals understood this, but somewhere along the way liberal values underwent a transformation...

...Of course, high interest rates do cheer some, especially people with a lot of cash stashed in money market funds and, perhaps, foreigners who buy our Treasury bills...

...Farmers were KOed as the average value of farm land fell by half, from $1,053 per acre in 1979 to $564 in 1988 (in constant dollars...

...Today, it is $5.80...

...Back in 1982, as the Third World debt crisis peaked, foreign governments pleaded with Volcker to ease up on interest rates...

...If that were the case, then high interest rates would be more like poison than chemotherapy...

...Massive unemployment, bankruptcies, and the destruction of wealth ceased to be evils to avoid and became praiseworthy...

...And the experience of the rise of inflation in the seventies left many thinking that high interest rates are the only cure...

...A recession now, so the thinking goes, will prevent inflation later...

...It was astonishing to watch The Washington Post's Hobart Rowen and The New York Times editorial board defend Paul Volcker's record and demand his reappointment...