Friday, April 4, 2014

Peter Schiff: The Audacious Attempt to Promote Price Inflation

Meet "Lowflation": Deflation's Scary Pal

By Peter Schiff

In recent years a good part of the monetary debate has become a simple war of words, with much of the conflict focused on
the definition for the word "inflation." Whereas economists up until the 1960's or 1970's mostly defined inflation as an expansion of the money supply, the vast majority now see it as simply rising prices. Since then the "experts" have gone further and devised variations on the word "inflation" (such as "deflation," "disinflation," and "stagflation"). And while past central banking policy usually focused on "inflation fighting," now bankers talk about "inflation ceilings" and more recently "inflation targets".  The latest front in this campaign came this week when Bloomberg News unveiled a brand new word: "lowflation" which it defines as a situation where prices are rising, but not fast enough to offer the economic benefits that are apparently delivered by higher inflation. Although the article was printed on April Fool's Day, sadly I do not believe it was meant as a joke.

Up until now, the inflation advocates have focused their arguments almost exclusively on the apparent dangers of "deflation," which they define as falling prices. Despite reams of evidence that show how an economy can thrive when prices fall, there is now a nearly universal belief that deflation is an economic poison that works its mischief by convincing consumers to delay purchases. For example, in a scenario of 1% deflation, a consumer who wants a $1,000 refrigerator will postpone her purchase if she expects it will cost only $990 in a year. Presumably she will just make do with her old fridge, or simply refrain from buying perishable items for a year to lock in that $10 savings. If she expects the cost of the refrigerator to decline another 1% in the following year, the purchase will be again put off. If deflation persists indefinitely they argue that she will put off the purchase indefinitely, perhaps living exclusively on dried foods while waiting for refrigerator prices to hit zero.

Economists extrapolate this to conclude that deflation will destroy aggregate demand and force the economy into recession. Despite the absurdity of this argument (people actually tend to buy more when prices fall), at least there is a phantom bogeyman for which to conjure phony terror. Low inflation (below 2%) is even harder to demonize. Few have argued that it has the same demand killing dynamics as deflation, but many say that it should be avoided simply because it is too close to deflation. Given their feeling that even a brief bout of minor deflation could lead to a catastrophic negative spiral, they argue for a prudent buffer of 2% inflation or more. But the writer of the Bloomberg piece, the London-based Simon Kennedy, quotes people in high positions in the financial establishment who offer new arguments as to why "lowflation" (as he calls it) is a "threat" in and of itself. And although the article was primarily concerned with Europe, you can be sure that these arguments will be applied soon to the situation in the United States.

The piece correctly notes that those struggling with high debt tend to welcome high rates of inflation. The math is simple. By diminishing the value of money, inflation benefits borrowers at the expense of lenders. By repaying with money of lesser value, the borrowers partially default, even when paying in full. The biggest borrowers in Europe (and the United States for that matter) are heavily indebted governments and the overly leveraged financial sector. Should it come as a surprise that they are the leading advocates for inflation? The writer admits that higher inflation will help these interests manage their debt burdens and in the case of the financial sector, profit from the increased lending that low interest rates and quantitative easing encourage.

On the other side of the ledger are the consumers, the savers, and the retirees. These groups want lower prices and higher rates of interest on their accumulated capital. Such a combination will lead to higher living standards for those who have worked and saved for many years in order to enjoy the fruits of their efforts. But these types of people are simply not on the "must call" list for our best and brightest economic journalists. As a result, we only get one side of the story.

The article also points out that higher inflation gives businesses more flexibility to retain workers in periods of weak growth. The argument is that if sales revenue falls, companies will not be able to lower wages, and will instead resort to layoffs to maintain their profitability. However, this is only true in cases involving labor union contracts or minimum wage workers. In all other cases, business could reduce wages in lieu of layoffs. Plus, if prices for consumer goods are also falling, real wages may not even decline as a result of the cuts.

In circumstances where wages cannot be legally reduced, as is the case for unionized or minimum wage workers, layoffs are often the employer's only option for keeping costs in line with revenue. However, inflation allows employers to do an end run around these obstacles. In an inflationary environment, rising prices compensate for falling sales. The added revenue allows employers to hold nominal wage costs steady, even when the raw amount of goods or services they sell declines. When inflation rages, higher skilled workers will often demand, and receive, pay raises. But low-skilled workers, who lack such leverage, are usually left holding the bag.

In other words, politicians can impose a high minimum wage to pander to voters, but then count on inflation to lower real labor costs, thereby limiting the unemployment that would otherwise result. So what the government openly gives with one hand, it secretly takes away with the other. Workers vote for politicians who promise higher wages, but those same politicians also create the inflation that negates the real value of the increase. But while government takes the credit for the former, it never assumes responsibility for the latter. The same analysis applies to labor unions. Based upon political protection offered by friendly officials, unions can secure unrealistic pay hikes for their members. But the same governments then work to reduce the real value of those increases to keep their employers in business.

Of course, what the Bloomberg writer was really arguing is that governments need inflation to bail themselves out of the policy mistakes they make to secure votes. But two wrongs never make a right. The correct policy would be to run balanced budgets rather than incur debts that can only be repaid with the help of inflation. On the labor front, the better policy would be to abolish the minimum wage and the special legal protections offered to labor unions, rather than papering over the adverse consequences of bad policies with inflation.

So be on the lookout for any more hand-wringing over the supposed dangers of lowflation. The noise will simply be an effort to convince you that what's bad for you is actually good. And although it's an audacious piece of propaganda to even attempt, the lack of critical awareness in the media gives it a fighting chance for success.

 Peter Schiff is CEO of Euro Pacific Capital and host of the nationally syndicated Peter Schiff ShowHis latest book, How an Economy Grows and Why It Crashes  - Collector's Editions was released in December.


  1. And the CPI, ostensibly created to track price levels, is manipulated beyond recognition. It's the only way to debase a currency to the extent the Fed has managed over the last century while simultaneously convincing people that the cost of living increases are moderate, when in fact, they are already into the high single digits annually. Compound interest over one's lifetime finishes the job.

    Why do people wonder why a single paycheck is no longer sufficient? Why are economists, journalists and policy-makers stumped at the hollowing out of the American middle class?

    Combine reckless monetary policy with out-of-control spending and you have a recipe for national bankruptcy and a currency crisis.

    But it takes more than drunken sailor spending and endless money-printing to bring about a nation's collapse. It takes a hopelessly ignorant populace to permit it all to transpire without knowing why it's happening.

    For that to occur, it requires a government-run "education" system to propagandize the rubes into believing that booms/busts, raging price increases, and economic chaos are the fault of the non-existent free market system.

    To recap:

    1. The government spends money it doesn't have to buy votes.
    2. The Fed prints the money to pay for it.
    3. The BLS lies about the statistics.
    4. The schools churn out generations of functional illiterates incapable of connecting the dots.
    5. When the situation becomes chaotic, divert the people with a war.

    All of this is so transparent, predictable, and completely avoidable. But it takes statesmanship, leadership, wisdom and courage to turn this around. Look at the collection of half-wits in Washington running things and plan accordingly.

    1. Excellent, Steve. Thank you.

    2. The CPI is not manipulated. There is no reason for the govt to manipulate the CPI. 99% of the voters don't even pay attention to the number and always think there is inflation since they typically only notice a price hike.

      High single digit inflation? So the economy is in recession? Nominal GDP grew 3.4% in 2013. You're suggesting the economy is contracting 3-5%/year. 2.1 million full time jobs were added to the private sector in 2013. The average work week stayed the same while productivity increased. All those numbers faked? What about the billion prices project? Is that fake as well?

      The Fed prints money? Not really. Money is printed by the commercial banks when they issue credit. Fed can influence that with the federal funds rate but currently with the federal funds rate set as low as possible, they are not having much luck. Excess reserves continue to accumulate. So if you use a credit card to make a donation to the Ron Paul foreign policy institute, you are part of the money printing process.

      Govt spends money it does not have? It isn't spending money it does not have. There is no reason for the federal govt to run a balanced budget since sovereign debt is only reduced relative to nominal GDP (debt as a % of GDP).

      Schools churning out functional illiterates? You mean people who believe the Earth is 6000 years old?

      Is Darwin's theory of evolution part of the education scam? Suspect you think so. How old is the Earth?

    3. Jerry is a professional troll. I suspect he's either huddled in his mother's basement or he "works" for Uncle Sam. Either way, he has no life and feels compelled to respond on sites like this.

      As to Jerry's points:

      Why did the government suddenly decide to change the way the CPI was calculated (and GDP, for that matter)? Was is a coincidence that they extracted from the metric the very things essential for our existence, food and energy? They claim they did it to remove the volatility. Does anyone buy this whopper (except Jerry, of course, who thinks government statistics are honestly reported and as pure as the driven snow)?

      Why do they engage in product substitutions and hedonics, Jerry? To people who aren't drinking Potomac Kool-aid, the answer is simple: to make the number smaller! It allows them to steal through financial repression and price inflation what they weren't willing to do through direct taxation, because then even the dolts among us would know who to blame.

      As for the Fed and its magic money machine, when the Treasury sells debt, and the Fed purchases said debt through the primary dealers, where does it get the currency to do so, Jerry? Does it have a stash of cash it earned through honest exchange sitting in a secret vault somewhere for this purpose? No it doesn't. It writes a check (or adds funds via computer) to "pay" for it. In Jerry's world, it's referred to as "monetary policy." In the real world, they call it counterfeiting.

      As for the schools, I don't have to resort to red herrings like creationism to understand that government run schools are hapless, hopeless, and criminally negligent in achieving their stated aims of transferring knowledge to children.

      How else does one explain the ability to "teach" them for 12 years, give them diplomas they can barely read, and send them on their way to a life of burger-flipping and toilet-scrubbing, because they are too ignorant to do anything else?

      But I'm sure Jerry will regurgitate more tired statist talking points in rebuttal. That's the one thing he excels at.

    4. "The CPI is not manipulated. There is no reason for the govt to manipulate the CPI."

      Bizarre as some of your comments are, Jerry, it's difficult for me to believe you're as utterly clueless as this one indicates. Let's see: Social Security cost of living increases, military retiree pay increases, veteran disability increases, multiyear Federal escalation contracts, recalculations by CMS to the RVU, limits to the year over year increase in the standard deduction, encouragement of a sustained fixed income rally. . .

      These are just some of the more glaringly obvious ways in which an artificial suppression of CPI benefits the federal government.

      If you can't understand something as basic as this, you would have to be considered one of those functional illiterates churned out by American schools to whom Steve refers.

    5. While the number of people listening and believing the CPI numbers on the evening network news have been dying off, there are still a great number of them, and that's why the number is manipulated. When they are all dead and all that's left is people who don't listen or don't believe then they'll phase it out.


  2. economists up until the 1960's or 1970's mostly defined inflation as an expansion of the money supply?

    Do not see claim supported by Milton Friedman's monetary history of the United States.

    You predicted hyperinflation. It did not show up. Get over it.

    1. Are you the village idiot somewhere? Does your mother know you're on the computer? Or are you some government bureaucrat with to much down time?

    2. Re: Jerry Wolfgang,
      -- economists up until the 1960's or 1970's mostly defined inflation as an expansion of the money supply? --

      Doesn't matter how economists defined back then. Inflation IS the rapid expansion of the money supply. That's the actual phenomenon, that is the mechanical reality. A general rising of prices is just the end effect, the result of inflation. Thinking inflation is simply higher prices is like saying that a burn means "getting blisters."

    3. Forget the semantics of the debate for a moment. Clearly there are two phenomena worth talking about: expansion of the money supply and a general rise in the prices of consumer goods. It's unfortunate that the term "inflation" has been applied to both because it only confuses the discussion. To distinguish, I try to use the terms "monetary inflation" and "price inflation"

      The real issue at hand is, what is the relationship between monetary inflation and price inflation? Fundamentally, it boils down to monetary inflation must, at some point, result in price inflation. It doesn't happen immediately because of mechanics of injecting new money into the economy and that banks and consumers have varying desires to hold cash in reserve. Further complicating our ability to observe the relationship between monetary and price inflations is that productivity improvements tend to lower the price of consumer goods. Since free market economies tend to have large increases in productivity over time, it's sometimes tough to see the affects of monetary inflation on price inflation.

    4. Mark, that was a very succinct and informative response. Thanks for putting into words what I have tried to but failed to do while discussing the inflation issue.

    5. Just a couple of points to add to your note Mark(which is good!):

      RW points out that much of the expanded money base is sitting in bank 'reserves', so by virtue of it being kept out of circulation it hasn't yet had a chance to increase prices in some areas.

      I agree with your note on inflation, which is expansion of the monetary base, different from price increases. The former leading to the latter usually once it's in circulation. But in the end, actual price increases are usually a RESULT of the money expansion(circulating) we have to be careful to continue to draw the distinction.

      Another major factor that I'm fascinated by is the topic of "money demand", which RW refers to at times in his "Daily Alert". (which is quite good, well worth the money)

      This is a major, but seemingly unpredictable factor that could have a major impact on price levels outside of the actual inflation of the base itself. It seems to me to be a purely psychological factor and as such not predictable:

      Hence reason for Mises's titled book "Human Action" and why RW is always careful to qualify any predictions/guesses when it comes to such things.

  3. Look at the reaction you guys have to someone rebuttal your comment. Now hes the "village idiot" and " does your mommy know your on the computer" comments loke that make you the idiot my friend. Your reactions to his comments make it seem your in high school your else. (State run of course). Peter Shiff is rich as 7uck. What he says is 1/2 maybe more of what he is actualy doing. He owns treasuries, he owns the US dollar, he own MBS debt someway or another the day before the crash. I dont get why people bash other people like that. If you were a real academic, you wouldn't bully him for his comment, you woukd embrace it..see sir, with your aditude, youll be the one dead in the streets for arguing with everyone. By reading the comment, it seema like people are drinking a little to much Peter Shiff cool-lade. Get iver your self.

    1. "Peter Shiff is rich as 7uck."

      You ridicule others for not being sufficiently academic in their replies, but then you resort to tired Marxist Polylogism in an attempt to discredit Peter Schiff's viewpoints. Him being wealthy doesn't refute his arguments. Also, make sure you don't make a litany of grammatical errors while preening about academic standards.

    2. If you want to talk academic standards:

      1) Look up the meaning of the word "troll". Someone who constantly engages in troll like behavior eventually loses the right to be taken seriously.

      2) Academic standards require you don't load your response full of spelling/grammatical errors.

      3) "Peter Shiff is rich as 7uck" is not an argument, but an insinuation that he cannot be correct because of how much money he has. It is a logical fallacy. An appeal to envy. Talk about academic standards.

      4) People who talk about academic standards need to stop posting as "anonymous" and give themselves a name, even a fake one, if necessary, so he can be properly addressed if he chooses to hang around or judge others.

      5) You claim people are drinking too much "Peter Schiff kool-aid". Wonderful argument, for someone who demands that people talk like "academics." Yes, Schiff is rich as 7uck; he must be evil, right?