Friday, February 6, 2009

"They Are Going to Have to Call on Bernanke"

George Melloan takes a look, in today's WSJ, at the current financial markets and the money that will be needed to fund the "stimulus" package, and he reaches one conclusion:
The Obama administration and Congress will call on Ben Bernanke at the Fed to demand that he create more dollars -- lots and lots of them.

What will happen as a result of this money printing madness? Melloan answers this question:

Well, the product of this sort of thing is called inflation. The Fed's outpouring of dollar liquidity after the September crash replaced the liquidity lost by the financial sector and has so far caused no significant uptick in consumer prices. But the worry lies in what will happen next.

Melloan gets the inflation part correct, but then believes this will automatically lead immediately to stagflation:
Inflation is the product of the demand for money as well as of the supply. And if the Fed finances federal deficits in a moribund economy, it can create more money than the economy can use. The result is "stagflation," a term coined to describe the 1970s experience. As the global economy slows and Congress relies more on the Fed to finance a huge deficit, there is a very real danger of a return of stagflation
In our book this is a fundamental misunderstanding of stagflation. Stagflation occurs when the Fed prints enough money to fuel inflation, but not enough to force the economy completely in the direction of a distorted consumption/savings ratio. Because the Fed printing ultimately leads to inflation, more and more new money needs to be printed to flood the economic structure in a fashion to distort it in favor of the capital goods sector. If you need 15% money printing to support the distorted structure, but the Fed is only printing 10%, that will result in inflation and recession, i.e., stagflation.

At the present time, the Fed's double digit money printing appears to be more than sufficient to support a distorted capital structure, which will mean inflation and a climbing economy and stock market.

The Nobel Prize winning economist, Friedrich Hayek, who coined the term stagflation, understood this. Inflation itself, when it is powerful enough, will fuel the stock market higher. He said as much in his interview in 1975 on Meet the Press. Equities were the best hedge against inflation, he said. The 1970's, however, did turn into a period of stagflation, as the Fed printed money, but not enough to support the distorted capital structure. Thus, you had recession and inflation. The current period, at least in the short-term, appears to be a period when the Fed printing will be sufficient to support the distorted capital structure and thus, the current period is likely to be a better fit for Hayek's advice, then when he initially gave it in 1975.


  1. Oh my gosh. So you're saying there would have been low unemployment in the 1970s if the Fed had just printed more money?

    Incidentally, can you give an actual quote from Friedrich Hayek in that interview, where he says that if the Fed printed more money, then the economy would do better? Since you misspelled his name I'm not confident you are accurately reporting his position. :P)

  2. 1.Yup, me and Hayek.It would have been tremendously destructive from an inflationary perspective,but it would have solved unemployment short-term. Check out Hayek's discussions of stagflation.

    2.It's roughly about two thirds of the way in his Meet the Press interview. He says equities are the place to be during an inflation.

    3.Sorry, I used spell check which apparently doesn't recognize German/Austrian (or is it Hayekian?) spellings. The Hayek way ignored again. Hey what do you want correct Austrian economics or correct spelling of German/Austrian given names? Corrected :)

  3. I just listened again to the second half of the Meet the Press recording.

    The Hayek comment is in the last quarter in response to a question from Irving R Levine, who asks Hayek what is the best think a person should do to protect his pocketbook. Hayek responds that it is to put the money in equities. Hayek adds that it is not a perfect solution but is the best at protecting most of a persons assets.

    Also, earlier, about two thirds in, he responds to a Lawrence Spivak question by stating that the consequence of the then high inflation in Great Britain is that ONCE IT IS STOPPED, high unemployment is likely.

    I have never seen Hayek anywhere say that inflation (unless you are at the final crack up boom stage) causes simultaneous unemployment (unless it is stagflation, where it is not enough inflation).