Money Sage (archive)

Well folks, they are at it again. The inflation-phobes are rushing to the ramparts to defend the embattled central banks -- particularly the Federal Reserve and the European Central Bank (ECB) -- from the threatening depredations of the recession-fearers. (Or, as a late American president might have put it -- the "nervous nellie's". Come to think of it, a former Vice-President's verbal coinage might be even cuter: the FED and the ECB must not surrender to the "nattering nabobs of negativism").

This is but the latest chapter of an old, old story. It is the story of dear money versus cheap money, a story which has haunted the economic history of the United States at least since the Whiskey Rebellion of the 18th century.

Traditionally, the advocates of "hard money" and, since the abrogation of the gold standard, of dear money, have represented the interest of the creditor class. Lenders wish to be paid interest, and ultimately to have their loans repaid, in currency which possesses AT LEAST as much purchasing power as the the original loan amount. Indeed, the creditor class would prefer greatly to receive its interest and principal repayments in MORE VALUABLE MONEY than the real value of the original loan. The economic and monetary strategies which would accomplish this somewhat less than noble objective are of course: economic stagnation (or minimal growth, at most) and DEFLATION. Certainly, the more intelligent among the creditor class recognize that such a strategy, and such a result, while perhaps advantageous to their narrow interest as creditors could come at too high a cost -- depreciating the value of their investment in productive assets (business and stocks) and generating class self-awareness and anger among the lower orders, thereby threatening both the political and social hegemony of the creditor class (which is, of course, the same as the upper class, known in more common parlance as the rich).

Consequently, the more sagacious among the upper orders recognize that a more expansionary monetary policy, while mildly inflating prices and limiting, or even reducing slightly, the value of their interest payments and loan payoff, are more than offset by the more significant economic benefits to them as owners of businesses and equities. In addition, there is the more general, difficult to quantify but nonetheless very real, benefit of keeping the lower orders mesmerized by the possibility of ascent up the economic ladder. Finally, there is the need to insure a sufficient level of general prosperity and economic growth in order that debtors may have sufficient funds to service their debt and pay off the principal at maturity. This need becomes more pressing as the overall level of debt rises, increasing the possibility of cumulating default.

The more hidebound among the creditor class chooses not to acknowledge these factors, but to press instead for the realization of their immediate self-interest. They continue to seek an appreciating currency, a high level of interest rates and, if not an overtly deflationary economy, than at least one of limited growth. This self-interest is diguised behind a facade of conservatism. It is justified by recourse to the strictures of Calvinist morality. Finally, it is packaged for public consumption by the equation of stable prices with economic growth and social equity. In fact, what it studiously ignores is the reality that long term monetary depreciation at a modest rate, and the concomitant transfer of some wealth from creditors to entrepreneurs and to the social polity as a whole, have characterized American economic history, and have constituted one of the necessary preconditions for the remarkable growth of the American economy since the establishment of the republic.

In the current version of the age-old struggle between inflationists and deflationists, the hard money, "anti-inflation" crowd is now on the defensive. The reasons for this are as obvious as your next door neighbor's mortgage payment problems, which are now moving toward default, and then possibly foreclosure. In this situation, the inflation-phobes have recourse to one of the handiest tools in their bag of tricks: to proclaim that the central banks confront a "dilemma" as they consider the need to reduce interest rates further (i.e., to INCREASE LIQUIDITY = DRIVE DOWN THE PURCHASING POWER/VALUE OF THE currency in which interest payments and principal repayment to creditors are made). This "dilemma" is: the threat of rising inflation, which, as we have been told endlessly, is the source of all evil.

In truth, the inflation-phobes know as well as any economist that inflation is THE MOST LAGGING of all economic indicators. They know full well that the trajectory of inflation over the next 1-2 years is DOWN, as the contractionary and deflationary impact of the prior series of rate hikes works its way through the economy, its impact amplified by the deflationary crumbling of house prices and the downward pull generated by excessive household debt levels and a rising inability to service said debt. Moreover, all save the most wilfully obtuse are aware that the same situation exists in Euroland. With the Chinese and Indian and Korean central banks far along their tightening path, it does not take a Keynes to anticipate the forthcoming slowing of these economies, the consequent diminution in at least the growth in demand for commodities (including oil) and the forthcoming peaking (at least for this cycle) of commodity prices. Nevertheless, these folks will keep up their clamor as they always do.

We fully expect the FED to continue its rate-reducing. This is not a function per se of a diminution in the relative power of the inflation-phobes at the central bank, but rather is a consequence of much stronger forces: the intensification of political pressure in an election year, mounting FEAR at the FED itself over what their excessively tight monetary policy has wrought, and serious distress within the banking system and the credit market with potentially ominous economic implications. Both the FED and the Administration, we believe, will take sufficient measures to avert a serious economic crisis, sprurred on by self-interest and fear.