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Money And Inflation

Lawrence M. Parks is President of Systematic Asset Management Corporation, a registered investment adviser.

In his speech to the Economic Club of New ,York last year, Federal Reserve Chairman Alan Greenspan used the word “inflation” no less than 50 times. In the Chairman’s speeches and in Congressional testimony, he has said of inflation: It is going away. It is not coming back. It is not a problem. It is diminished. It is nonrecurring. It is subdued. There’s no re-emergence. We’ve learned our lesson.

So if inflation has ceased to be a problem, why does it occupy Mr. Greenspan’s thoughts so much? Perhaps inflation is more of an issue than he is letting on.

Why should inflation just be a measure of the prices of some arbitrary basket of items in the consumer goods market? Why exclude the price level of the capital and real estate markets? After all, money isn’t always spent on goods and services; some of it is invested in stocks and bonds and real estate. By any yardstick, stocks and bonds have gone way up in price in the last several years.

Further, the government has enacted laws and regulations that effectively persuade prudent people to put or keep money in the capital markets, thereby decreasing money that might otherwise be spent in the consumer goods market. For example, about $800 billion in IRA accounts by law must be invested only in stocks and bonds. Large amounts are also tied up in Keoghs, Pension Plans, 401(k)s and other quasi-savings plans that must be similarly invested.

Perhaps if people had free use of these monies, some might be used to improve homes, buy cars and other consumer items, which would certainly spike the price level of the consumer goods market and the nominal inflation rate. Clearly, there is vast deferred inflation. Some day people will spend that money, and that’s when nominal inflation will pop.

Similarly, because of inflation over the last two decades, if people sell appreciated property, capital gains taxes will many times result in a loss of capital. The result is that money is kept in the capital markets for tax purposes, and is kept out of the consumer goods market. Thus, people have been misled about the purchasing power of their savings which retain value provided they are never spent in the consumer goods market. Again, there is vast pent up purchasing power postponed by government and, as a result, a tidal wave of latent inflation.

The most widely reported measure of price increase is the Consumer Price Index (CPI). But the CPI is an untrustworthy measure of price inflation. First, the Consumer Price Index fails to account for products and services that have been inflated out of existence. For example, when I was a child, our family physician made house calls for $2. (What would a doctor’s house call cost today, assuming a doctor would make one?) There were ushers in movie theaters, and even middle-class folk employed domestic help. First-class postage was three cents, and the post office made four deliveries each day: two regulars and two specials.

For the most part, these and many other services no longer exist or have deteriorated greatly. Hence, if the measuring rod is not consistent, then CPI comparisons over time cannot be useful.

Another major failing of the CPI is that the government must fudge every time there is an improvement in a good or service. For products where innovation is frequent, such as consumer electronics, there is no meaningful way to compare price changes from year to year. Consider, also, the case of a more expensive automobile that is substantially smaller and lighter than its same make and model predecessor. Because the new automobile is “improved,” the government reduces the price increase for CPI purposes. How can this methodology be objective?

On top of that, the CPI “market basket” was last reformulated in 1982-1984 and, for budgetary reasons, is not due to be revised until 1996, if then. When I told one of the senior government economists about this article and that it was my contention that inflation was substantially understated, he said: “We would concur with that.”

Third, the CPI fails to report products and services whose prices are reduced by government subsidies. Continuing inflation many times causes certain goods and services to become so expensive that they either disappear or their manufacture is arbitraged to foreign countries. Where there are politically connected constituencies and where the production of products or services cannot be transferred out of the country, government many times subsidizes them, thereby reducing the price to consumers and keeping the CPI artificially lower than it would otherwise be.

For example, in some industries, government subsidizes research and development. Even after considerable machinations and subsidies from the state, New York’s Blue Cross/Blue Shield rates were recently increased 25 percent. Depending upon whom one listens to, a subway ride in New York City costs anywhere from $3.50 to $6.00, but the public is charged only $1.25. The rest is subsidized from taxes, whose increases are not in the CPI. Clearly, if the true cost of a subway ride was incorporated into the price, the CPI in New York City would be higher than it is.

Because of its historical link to gold, many foreigners still consider the dollar “as good as gold,” even though the link is irrevocably broken. As foreign governments, such as Russia, debase their own currencies, rather than switch into gold, foreigners many times switch into the next best thing (in their minds): United States dollars. According to Grant’s Interest Rate Observer, perhaps as much as 60 percent of the $363 billion in American currency is now circulating in foreign lands.

The drain of dollars from the United States to foreign lands is price deflationary in the United States. But if by accident some of these errant countries should get their monetary houses in order, then dollars will flow back to the United States. Again, there is substantial pent-up purchasing power that will someday be spent and, then, latent inflation will become obvious.

Prices Should Be Falling

As industrial processes and productivity improve, prices should decrease. In fact, the increasing productivity of the 1980s contributed to the lower rate of price inflation. Decreasing prices improve everybody’s living standard. That is the benefit of an advanced economy: higher production of better products available to more people at lower prices. If prices do not decrease because of inflation, then the benefits of productivity increases are not shared. By gerrymandering the CPI and pursuing “price stability,” the government obfuscates this fact.

During the past three years, by purchasing Treasury securities, the Federal Reserve has monetized government debt at a high rate, and the most basic measurement of money supply, M1, has increased 37 percent and currency has increased 27 percent. That this has not been reflected in price inflation is due only to the flawed definition of price inflation and the fact that vast amounts have diverted to foreign countries. Inflation is a worldwide phenomenon and has been understated all over the planet. Perhaps long-term interest rates haven’t dropped that much for good reason.

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