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Advocates
of government stimulus are running victory laps on recent developments that
appear to vindicate their strategy. In particular, Paul Krugman
compares the sluggish growth in Europe to the somewhat-less-sluggish growth
in the US to prove that stimulus was more effective than austerity. Other
economists are using government inflation measures to defend Fed Chairman
Bernanke's easy-money policy. The only problem is,
they're calling the race before the finish line is even in sight.
As usual,
Paul Krugman overlooks basic economics (which,
despite his Nobel Prize, is a science about which Mr. Krugman
really knows very little). The reason stimulus is so politically popular is
that it appears to work in the short-term. However, appearances can often be
deceiving, as they are right now in the US. Stimulus merely numbs the pain of
economic contraction, as the underlying trauma gets worse. Austerity might
slow an economy down, but at least the wounds are able to heal. America has
chosen the former and Europe the latter, albeit not quite as large a dose as
needed. The fact that in the short-run Europe is suffering more than the US
does not vindicate Washington's approach. On the contrary, this is exactly
what is to be expected.
What we're
seeing is like a race where each runner has a broken ankle. One has a coach
who tells him to pace himself and not worry so much about winning this one,
while the other coach gives his runner a shot of painkillers and tells him to
give it all he's got. Of course, early in the race, the doped-up runner is
going to be flying down the track like nothing's wrong, while the other
runner might be limping at half his normal speed. However, when the drugs
wear off, the sprinter is liable to collapse from pain, leaving the
better-coached runner to limp across the finish line.
The true
test is not the immediate effects of stimulus or austerity, but the long-term
results. For that reason, Krugman's conclusions are
meaningless. The apparent success of stimulus simply results from spending
more borrowed money on government programs and consumption. But don't we all
agree now that this is exactly what caused the financial crisis in the first
place?
As far as
inflation is concerned, a vindication of Federal Reserve Chairman Ben
Bernanke is equally premature. First of all, it's not that Quantitative
Easing will lead to inflation; it's that QE is inflation. Secondly,
there is a lag between QE and rising consumer prices, so the jury is still
out as to how high consumer prices will ultimately rise as a result of
current and past Fed policy mistakes.
But even
more fundamentally, it is absurd to look solely at government price measures,
which are built to understate inflation, and conclude that QE has not already
produced an elevated cost-of-living. For example, the 2.4% rise in the
Personal Consumption Expenditure (PCE) Index in 2011 is more of an indictment
of the accuracy of the index than a vindication of Bernanke. In fact, of all
the ways the government purports to measure inflation, the PCE is perhaps the
most meaningless, as it relies on built-in mechanisms like goods substitution
to hide a lower standard of living. As an example of how this works, imagine
you are used to eating farm-fresh butter but have to switch to cheaper but
also less-healthy margarine from a factory; the PCE would say you are no
worse off. That's exactly why the Fed chooses to use this uncommon metric.
Mark Gertler, an economics professor at New York University,
argues that even the Consumer Price Index, which rose at a more vigorous 3.2%
in 2011, proves Bernanke's critics wrong. According to Gertler,
the CPI has risen at an average annual rate of 2.4% thus far under Bernanke's
tenure, significantly less than the 3.1% average under Alan Greenspan, and
the 6.3% under Paul Volcker. However, Gertler
overlooks two key points. First, the methodology used to calculate the CPI
was much different during the Volcker era. If we still calculated the CPI the
way we did then, the numbers would be much higher for both Greenspan and
Bernanke. Second, given the huge economic contraction that has taken place
under Bernanke, consumer prices should have fallen –
significantly. The fact that they rose anyway indicates tremendous inflation.
Of course,
the Fed's ability to stimulate the economy with inflation only works as long
as bondholders remain ignorant of its plan. For now, the seemingly hopeful
news reports are giving the Fed cover to keep stimulating. As long as the
market remains convinced there is no inflation, the Fed can continue to
create it. However, once the effects are so pronounced that even the PCE can
no longer hide them, the Fed will be in a real bind.
Think of
our two runners again. Even after the race is over, the fellow who chose to
dope up likely injured himself even further. He
might have even ended his career. So, the early dash and the cheer of the
crowd in that one race was clearly not worth the
many years of misery he would incur in the future.
Regardless
of what the triumphant Keynesians would have you believe, my analysis
continues to be that the current combination of monetary and fiscal stimulus
is driving us toward disaster. Instead of a real recovery, the US will
experience an inflationary depression. Europe, on the other hand, will suffer
much less, precisely because it was not seduced by the short-term appeal of
stimulus.
Peter Schiff is CEO
of Euro Pacific Precious Metals, a gold and silver dealer selling reputable,
well-known bullion coins and bars at competitive prices. To learn more,
please visit www.europacmetals.com or call (888) GOLD-160.
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