Inflation and Supply-Side Economics
In the latest money supply report, the M3 measure of money supply surpassed the psychological barrier of $10 trillion. It is up 7.1% over the latest year (52 weeks) and at an annual rate of 11.2% over the latest 13 weeks.
Meanwhile, in a completely unrelated story, the consumer price index posted its biggest monthly (+1.2%) gain since 1980 and its biggest annual gain (+4.7%) since 1991.Of course, with a certain degree of deja vu we again saw how while the all-items index were higher then expected the markets still rallied because the "core index" was lower than expected.
Meanwhile, supply-side economics keep delivering us more economic wisdom. Larry Kudlow quotes approvingly Paul Hoffmeister, director of market strategy at the late Jude Wanniski's Polyconomics who now says that money supply increases (which he prefers to talk about as interest rate cuts) far from raising prices will actually lower them! You see, as it will "spur production", it will act to "soak up excess liquidity".
This must qualify as the wackiest economic theory since fellow supply-sider Tom Nugent's idea that budget deficits increase savings. In a confusion quite typical of supply-siders, he shortly thereafter however goes on to say that the Fed should lower the gold price by selling bonds. But selling bonds will uhm lower their price and thus raise interest rates, which of course would according to his theory inhibit production and thus increase prices. But I guess consistency is the hobgoblin of Misesian minds.
Comments (16)
Not only is the analysis of the supply-siders inconsistent, but also it is ultimately nonsense. The supply-siders can label themselves whatever the want, but fundamentally they are Keynesian inflationists and apologists for big government--high spending and high borrowing.
Thanks Stephan for posting and criticizing yet another round of inconsistencies and errors from the supply-siders.
Published: October 14, 2005 12:18 PM
Stephan,
I am not an economist and certainly no supply sider, but I wonder about the idea of the Fed controlling inflation by controlling the price of gold. If we must have a Fed, and it seems that there is little likelihood of relieving our economy of this institution, wouldn't this be a better method of controlling money supply than the current interest rate targeting?
Published: October 14, 2005 1:01 PM
It's a lot easier for them to inflate and deflate (make more or less money) than it is for them to price fix. Especially with the globalization of markets, and the emergence of hundreds of thousands of home traders, any price ceiling/floor would be destroyed if it conflicted with the market price. That's why they "target" what they want the rate to be at, thereby affecting the price of the dollar in terms of other currencies.
Published: October 14, 2005 3:25 PM
Well Joe, I guess that if the gold price rule were really followed consistently then it would be a slight improvement over the current unlimited discretionary power for the Fed Governors.
However, the gold price rule isn't even my second best choice after the abolition of central banking. My second best choice would be targeting of money supply growth (at a very low rate)as this would better mimic free market conditions.
The reason for that is that the gold price under its current condition when there is little monetary demand for it moves much more different and erratic then it would have done with a genuine gold standard and trying to target it would require quite erratic money supply movements. This is enhanced by the power central banks have to manipulate the gold market by gold sales.
It should also be said that the supply siders if they were to rise to power within the Fed would not apply this rule consistently. Following the supply-siders writingd throughout the years I know that they constantly change the gold price level they think the Fed should target according to what suits their purposes. This was also something that Murray Rothbard observed in his excellent critique of supply-side economics when Jude Wanniski first started to market it:
"Even more curious than the supply-sider attitude toward spending is their viewpoint on money. On the one hand, they say they are for hard money and an end to inflation by going back to the "gold standard." On the other hand, they have consistently attacked the Paul Volcker Federal Reserve, not for being too inflationist, but for imposing "too tight" money and thereby "crippling economic growth."
In short, these self-styled "conservative populists" begin to sound like old- fashioned populists in their devotion to inflation and cheap money. But how square that with their championing of the gold standard?
In the answer to this question lies the key to the heart of the seeming contradictions of the new supply-side economics. For the "gold standard" they want provides only the illusion of a gold standard without the substance. The banks would not have to redeem in gold coin, and the Fed would have the right to change the definition of the gold dollar at will, as a device to fine-tune the economy. In short, what the supply-siders want is not the old hard-money gold standard, but the phony "gold standard" of the Bretton Woods era, which collapsed under the bows of inflation and money management by the Fed.
The heart of supply-side doctrine is revealed in its best-selling philosophic manifesto, The Way the World Works by Jude Wanniski. Wanniski's view is that the people, the masses, are always right, and have always been right through history.
In economics, he claims, the masses want a massive welfare state, drastic income-tax cuts, and a balanced budget. How can these contradictory aims be achieved? By the legerdemain of the Laffer Curve. And in the monetary sphere, we might add, what the masses seem to want is inflation and cheap money along with a return to the gold standard. Hence, fueled by the axiom that the public is always right, the supply-siders propose to give the public what they want by giving them an inflationary, cheap-money Fed plus the illusion of stability through a phony gold standard."
Published: October 14, 2005 3:38 PM
I could add regarding Dennis observation of supply-siders as Keynesians that I have also long regarded them as a form of right-wing Keynesians, as opposed to traditional left-liberal Keynesians like Paul Krugman. They are in some aspects better than traditional Keynesians in their fairly consistent defence of tax cuts, deregulations and free trade. But on the issues of inflation and budget deficits they are usually even worse than Krugman and other left-wing Keynesians and as I noted in this post, they come up with really wacky theories to justify this.
Published: October 14, 2005 4:18 PM
"My second best choice would be targeting of money supply growth (at a very low rate)as this would better mimic free market conditions."
Would it be better to do this by credit expansion or government spending(cutting taxes accordingly)?
Published: October 14, 2005 4:32 PM
Stefan, I agree with your observation regarding the distinction between supply-siders and the more traditional Keynesians. In my experience, the supply-siders are at their most irrational and their theories and explanations the "wackiest" when they are trying to intellectually justify the policy measures of some politician or party that they support. Interesting how politics brings out the worst intellectually in individuals.
Published: October 14, 2005 7:52 PM
Richard A: What do you mean? Tax cuts have nothing to do with this issue and credit expansion is supposed to be limited.
Dennis: I would put the difference between left-Keynesians like Paul Krugman and supply-siders like Larry Kudlow this way. As Treasury Secretary, Kudlow would probably be better than Krugman. But as Fed Chairman Krugman would probably be a lesser evil than Kudlow. This despite the fact that Krugman is anything but sound on monetary issues.
Published: October 16, 2005 4:01 PM
Stephan,
Thanks for your reply to my comment. I had always wondered how the supply siders would account for potential central bank manipulation of the gold price and now I know --- they don't!
One question though. How do you decide what the proper growth of the money supply should be?
I guess this is why we should just go back to a true gold standard, huh?
Published: October 17, 2005 11:31 AM
"One question though. How do you decide what the proper growth of the money supply should be?
I guess this is why we should just go back to a true gold standard, huh?!
Well, yeah, only if we actually have a the proper gold standard can we be sure that there would be no monetary disruption of the economy. But I think that a growth rate of 1-2% would be almost equivalent, as 1-2% have been the average historical growth rate of the total gold stock in the world.
Published: October 17, 2005 2:58 PM
When asked if he still liked the idea of the gold standard and if he'd ever advocate going back to it, Greenspan answered to the effect that yes he still liked the gold standard idea and that fortunately, there was no need to go back to it as the FED was essentially duplicating the conditions of a gold standard with it's present behavior. Good answer! It was dishonest or delusional, but a good answer.
Therefore, I think a “close to� gold standard with no central banking even if disrupted by localized credit expansion of non-cartelized banks and the bank runs that would go with it, would be way more preferable to any purely paper money system with a theoretical/hypothetical limit on its inflationary tendencies.
It is just not consistent with human nature that central bankers would ever be disciplined enough to remain limited to a steady 1-2% annual increase in the supply of money. It's got to be commodity money, or the same trap will catch us every time.
Published: October 17, 2005 3:35 PM
“Supply side economics� works in the sense that tax cuts are apt to produce a substantial rise in government revenues after a little while.
I graphed economic growth and the proportion of GDP seized by the federal government since 1950. During periods when the proportion seized by the feds is unusually high, the economy stagnates. Average growth during high tax periods was 1.08%, average growth during normal times was 2.45%. Every high tax period was a long period of economic stagnation, malaise, or decline or else contained a long period of decline. Such events were rare during normal tax periods.
Published: December 25, 2005 12:20 PM
If you would have used gold as your currency, rather than US dollars, consumer prices would have effectively been cut in half over the past 5 years! Full article:
Consumer Prices Down 50% ... Priced in Gold
Published: August 6, 2006 9:11 PM
Great article and posts! A lot of good points being made. In defense of Laffer's curve, supply siders should keep in mind that it has an inflection point. Once you go below that point, you reduce income from taxes. Supply-siders act as though the Laffer curve were a straight line.
Supply-siders are dishonest at another point, too: tax cuts that cause deficits aren't really tax cuts; they're tax deferrals. Our kids and grandkids will have to pay the taxes that we aren't willing to.
Stephan is correct that targeting gold today would be senseless, because the real demand for gold comes from the jewelry market, although jewelry plays a role as money in Asia. Under a real gold monetary system, the greatest demand for gold would be as demand to hold money. When a demand for gold as money exists, then targeting gold prices would make sense.
Stephan, It seems that the Fed targeted money supply for a while in the 1980's. What happened? Were they dishonest, as usual, and not really doing what they said, or was there a problem with technique?
Published: August 7, 2006 8:49 AM
Stefan, Do you have any ideas on why the Fed abandoned its targeting of money supply in the early 1980's?
Published: August 9, 2006 11:12 AM
The gold standard has worked for years, but I always wondered what would happen if someone discovered millions of tons of gold tomorrow.
Published: August 31, 2007 5:09 PM