|
|
People are
slowly becoming aware that we have an inflation problem, an
inflation problem which seems to stretch around the world.
Perhaps it is time to think about how to resolve it. But a few coy remarks by
some Federal Reserve representatives aren't going to be effective. If that
were all it took, then nobody would ever have an inflation problem.
You would just say, "We are concerned about inflation" –
echoing Ben Bernanke and Hank Paulson already this summer, and it would
disappear – Poof! – like a cartoon genie.
Sorry: not quite so easy. Inflation is in fact childishly simple to
understand. But economists like to remain confused.
When a currency loses value, markets gradually adjust to reflect this new
development. When the Dollar's value falls in half, things that cost $10
eventually cost $20, more or less. It's no more complicated than that. The
Dollar's decline, since it comes in the form of official government money, is
best measured against something that's not official government currency
– and so gold, for centuries considered a stable measure of value,
offers a rigid yardstick.
The Dollar is now worth about 1/900th of an ounce of gold, compared to about
1/350th on average during the 1980s and 1990s. You can do the maths yourself and figure out what this means for Dollar
prices in the shops going forward. Conversely, if a currency remains stable
– pegged to Gold, for example – then there can be no inflation of
the money supply, whether an economy collapses (as in the early 1930s) or
expands (as in the 1960s).
One of the reasons why inflation went on so long in the 1970s is that people
imagined that stopping the inflation would be very painful. I call it the
Volcker Myth: that "we need a recession so horrible that it breaks the
back of inflation." The power of this inflation myth was so intense, in
effect, that people tried their hardest to make it come true, and the 1982
recession was the result.
This inflation myth continues today with the idea that there is a
"tradeoff" between inflation and growth. Baloney. Inflation is bad
for economies, and a stable currency is good. You can't devalue yourself to
prosperity. Nor can you recession yourself to a sound currency.
Ronald Reagan took a different view. If inflation is bad for an economy
– this had been fairly well proven by 1980 – then certainly
stopping inflation must be good, right? Reagan's plan was to put the Dollar
back on the gold standard in 1981, and also to cut taxes dramatically. The
combination of sound money and a hefty tax cut would create lower interest
rates and an economic boom.
If sound money and lower taxes are good for an economy – and they most
certainly are – then the result should be a better economy, not a worse
one.
This idea has been proven out many times since 1980, particularly in the
former Soviet sphere. Over the past eight years or so, one country after
another has stabilized their currencies and implemented amazing "flat
tax" programs. Russia led the way with its 13% income tax in 2000. The
result has been a tremendous economic advancement, with falling interest
rates and expanding finance. Many of these countries are experiencing their biggest
economic boom since before World War I.
Unfortunately, Reagan's plan was a little too sunny for the American
imagination circa 1980. For the election that year, Reagan recorded
television commercials promising a gold standard, but they were never
broadcast. Instead, the Fed undertook the "Monetarist experiment"
in which short-term interest rates went as high as 18%. Instead of cutting
taxes right away, the tax-cut plan was delayed until 1983, watered down, and
phased in over years. Tax cuts might have got in the way of the plan to have
"a recession so horrible that it breaks the back of inflation."
Economists these days are madly, insanely, pathologically fascinated by
interest-rate manipulation. They believe that, with a sufficiently high
short-term interest rate target, inflation can be resolved. This rarely
works. To solve the worsening inflation, in September 1973 Fed Chairman
Arthur Burns went to an average Fed funds rate of 10.78%. It was a flop
– the Dollar kept falling in value until late 1974. It was a flop in
the long term as well, with inflation worsening until the early 1980s.
Often, these high interest rate targets effectively cripple the economy, the
currency falls even more, and inflation gets worse. Many Asian government
found this out the hard way in 1997 and 1998, until they learned to ignore
the IMF's bad advice.
Low interest rates don't work either of course. But the Monetarist experiment
stopped the 1970s devaluation trend only by producing such chaos and mayhem
that it too was abandoned in 1982, after only three years.
The solution to inflation isn't a recession. The solution is not high
interest rates. Reagan had the right idea: peg the currency to Gold, and
slash taxes to rev up the economy. The Russian 13% flat tax plan would do
just fine. With this combo, the US economy could have the best economic boom
since the last time the US enjoyed a gold standard and a big tax cut, which
was 1964-1966.
Or perhaps the Russian or Chinese governments will discover the high road to
economic success – a gold standard and low taxes – leaving the US
to destroy itself with cheap-money solutions.
Eventually, central bankers are likely to respond to worsening inflation with
rate hikes. The rate hikes will likely cause economic stress, but fail to
solve the inflation problem. At this point, the central bankers will blame
everything under the sun for the mysterious "stagflation", except
themselves. It will become apparent that the central bankers are much better
at producing excuses than solutions. Then the central bankers will be
replaced.
That is the point where the Reagan of the future will be able to step to the
forefront. Cut taxes. Peg the currency to Gold. Enjoy the results.
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United
States, Japan,
and the Middle East. About the Book: Gold:
The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is
available at bookstores nationwide, from all major online booksellers, and
direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada, call
800-567-4797.
|
|
