November 15, 2007

Candidate Ron Paul understands inflation as the creation of money out of thin air.  While this view depicts a disturbing state of affairs and has a distinguished history, it is not in the least popular.  For one thing, it tends to incriminate the money creators.  

If inflation is defined as price increases, by coincidence the guilt falls on those who raise prices.  

So it is no surprise that inflation is widely defined as an increase in the level of prices.  How is this “price level” measured?  

The Department of Labor’s Bureau of Labor Statistics ( BLS ) produces a statistic called the Consumer Price Index ( CPI ) that’s supposed to give us a handle on prices and therefore inflation.  

BLS defines the CPI as “changes in the prices paid by urban consumers for a representative basket of goods and services.”  The BLS goes on to tell us that “The CPI is the most widely used measure of inflation and is sometimes viewed as an indicator of the effectiveness of government economic policy.”  

If we explore the BLS website to find the latest CPI statistic, we find this press release for September, 2007:  

The Consumer Price Index for All Urban Consumers ( CPI -U) increased 0.3 percent in September before seasonal adjustment . . .  The September level of 208.490 (1982-84=100) was 2.8 percent higher than in September 2006.  

It would therefore cost us $102.80 in September, 2007 to buy the same goods we bought for $100 in September, 2006.  Should we be worried?  Using the BLS inflation calculator and plugging in the first base year, 1982, we find it would cost us $216.05 now to buy what $100 would back then.  Is this what we’ve come to accept as sound monetary policy?  

According to historical data of the CPI from 1982 - 2006, the average annual increase was 3.1%, with a high of 5.8% (1982) and a low of 1.5% (2002).  These are not alarming figures to most people, yet they were enough to eliminate over half the dollar’s buying power.  

The CPI is a tool used by government to grade its own performance.  While it includes many ordinary consumption items such as coffee, gasoline, and haircuts, the CPI doesn’t include investments such as stocks, bonds, or real estate, which the BLS says “relate to savings and not to day-to-day consumption expenses.”  

However, dollars are being paid day-to-day for those assets, and some part of that money comes from bank credit expansion, not individual savings.  Whether those assets qualify as consumption expenses or not, by excluding them from the basket, the CPI understates the inflation rate.  As Thorsten Polleit explains:  

Rising asset prices that are not compensated for by declining prices of goods and services would simply imply inflation, an erosion of the purchasing power of money. In fact, asset price inflation is by no means less destructive for the value of money than "traditional" consumer price inflation.  

In truth, “Every person experiences his own ‘inflation rate,’” Murray Rothbard observed, “depending on what he customarily buys.”  And many people customarily buy assets.  

A Stable Price Level  

Back in the 1920s, influential economists and politicians  rhapsodized about the beauty of a stable price level and how it should be the goal of central bank policy.  If prices should threaten to fall, the Fed should simply print more money.  Given the tendency of prices to fall in a free market, this translates into job security for the printers at the Fed.  Creating money, to repeat, is not inflation, according to stable price theorists; only price increases are.  

If we examine price indexes of the 1920s, we find that prices didn’t fluctuate much either way.  For example, the Index of Wholesale Prices rose only slightly, going from 93.4 in June 1921 to 104.3 in November 1925, then falling to 95.2 by June 1929.  Consumer price indexes followed a similar pattern of slight rise followed by a slight decline.  

But these indexes exclude significant items.  Can we get a better picture of price movements for that period?  

As Rothbard notes in America’s Great Depression (p. 170), the Snyder Index of the General Price Level, which includes all types of prices (real estate, stocks, rents,  and wage rates, as well as wholesale prices) rose considerably during the period, from 158 in 1922 (1913 = 100) to 179 in 1929, a rise of 13 percent. Stability was therefore achieved only in consumer and wholesale prices, but these were and still are the fields considered especially important by most economic writers [emphasis added].  

But even a 13 percent increase in prices seems mild compared to the growth in the money supply, which went (p. 94) from $44.7 billion to $71.8 billion during the eight-year boom, an expansion of 60.6 percent.  Since total gold reserves only increased from $2.6 billion to $3.0 billion, or 15.4 percent, the bulk of the monetary increase was not, as some contend, due simply to an increase in gold deposits.  And since currency outside banks actually declined slightly during the 1920s, we are left with one conclusion: we have bank credit expansion to thank for the 63.4 percent rise in the supply of uncovered or counterfeit dollars.  

Consistent with Austrian trade cycle theory, much of this credit found its way into the market for titles to capital – stocks and real estate – where prices soared.  The Dow Jones Industrial Average (DJIA), for instance, rose from 63.9 in 1921 to 381.17 by late 1929, an increase of nearly 500 percent.   

When the Crash came, President Hoover intervened aggressively, keeping the market from correcting itself and causing undue suffering.  If the market had been left alone, it would have liquidated the unsound investments in relatively short order, as it had done in the past.  

Rothbard [p. 210]:  

[Treasury Secretary Andrew] Mellon wanted to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate,” and so “purge the rottenness” from the economy, lower the high cost of living, and spur hard work and efficient enterprise. Mellon cited the efficient working of this process in the depression of the 1870s. While phrased somewhat luridly, this was the sound and proper course for the administration to follow. But Mellon’s advice was overruled by Hoover . . .  

And by the time Hoover left office, the DJIA had plummeted to 41.22, with one in four workers out of a job.  

Tearing Down the Money Machine  

There are people who understand inflation and its calamities, who see the banking system as the sole source of inflation, who know that big government is impossible without a money machine stealing wealth surreptitiously from dollar holders.  But as far as I know, only one person is attempting to eradicate the institutional foundations of inflation and begin the process of establishing a system of honest money and banking.  

That person, of course, is Ron Paul, who has written two books on gold and its inseparable partnership with individual liberty: The Case for Gold, which he co-authored with Lewis Lehrman, and Gold, Peace, and Prosperity.  

While both books are great, the latter can be read and understood in one sitting.  And it’s written in a lively style that pulls no punches.  Here are some of the points Paul makes in Gold, Peace, and Prosperity:  

1.  The Federal Reserve System is an engine of inflation by design.  Bankers wanted a money machine, and they worked tirelessly until they got one.  At the time of the Fed’s creation, gold was still money, but the Fed required only a small fraction of gold backing for notes and deposits.

 

The central bank never set out to protect the integrity of our money. In fact, the Fed set out to destroy it by institutionalizing inflation. The gold coin standard was doomed and today's inflation made inevitable the day the Federal Reserve was created. (p. 47)

2.  Inflation is indispensable for state growth and meddling. The 1913 Federal Reserve Act made it possible to finance our catastrophic entrance into WW I. (pp. 24-25)  

3.  The Great Depression began as a consequence of the inflationary 1920s.  The depression was prolonged and deepened by massive government intervention on the part of both Republican and Democratic administrations.  (p. 25)  

4.  The claim that unions and businesses cause inflation by raising wages and prices is a myth:  

"[U]nions, like businesses, can only persuade government to inflate if the inflation mechanism is in place. A redeemable currency would make this impossible." (p. 35)  

5.  Inflation is taxation by deceit. Government deceives the people as to the tax burden, and who is bearing it.  The working and middle classes are gradually impoverished, while the poor are ground further down.  Wealth is transferred to the rich, from the hardworking and thrifty to the conniving and foxy. (p. 41)

6.  Nobel Laureate Paul Samuelson, author of the most popular economics textbook, said "The Federal Reserve System was formed . . . in the face of strong banker opposition."  In fact, the Fed was instituted at the behest of the American Bankers Association and the nation's biggest bankers, such as J. P. Morgan and Paul Warburg, to protect their industry against bank failures and to provide a more "elastic" currency. That is, to promote inflation that benefits bankers and big corporations. (p. 26)

7. A “modern” gold standard – one that’s separated from government – would bring about needed monetary reform.

"There is no law of economics stating that only gold can be used as money in a free society. But gold has served as the principal medium of exchange throughout history because its value does not depend on a government fulfilling its promises . . ." (p. 20)

Paul's book includes many relevant quotes to clarify his position and make the reading more interesting. Among those he cites are Jefferson , Jackson, Webster, Sennholz, Rothbard, Mises, Hayek, and especially the Keynes of 1919:

"There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and it does it in a manner which not one man in a million is able to diagnose."  (p. 51)

If you can believe anything about Ron Paul, you can believe his economic philosophy.  Inspired by Austrian economics and especially free market money, he entered politics in the 1970s to help bring about a major overhaul of government.  His congressional record supports his stated convictions.  In a sense, Ron Paul is a Trojan horse in government, working for it while trying to free us from its grip.

Those wishing a quick overview of his monetary views and an antidote to the “price increase” definition of inflation should enjoy Gold, Peace, and Prosperity.  With a foreword by Hazlitt and a preface by Rothbard, it comes highly recommended.