Offering frequent news and analysis from the majestic Evergreen State and beyond, The Cascadia Advocate is the Northwest Progressive Institute's unconventional perspective on world, national, and local politics.

Tuesday, June 06, 2006

A direct look at inflation

Even the Wall Street Journal says, "Get Used to It: Inflation Is Here to Stay." That part is right. The mumbo-jumbo that follows about "core inflation" could be flushed.

Let us take another direct look at the phenomenon of inflation.

Inflation is a general rise in prices. There are two kinds: demand-pull and cost-push.

Demand-pull inflation occurs when an overheated economy creates demand for goods that supply cannot handle. This occurs after wars, for example, when pent-up demand meets supply crimped by industries that have been destroyed or are not yet geared to consumer goods. The last time it occurred in the US was during the Johnson years, when the Vietnam War and the Great Society bid up the price of wages and products. But that was a mild case. After World War II, the whole world went shopping in America. Demand was over the top. That was a severe case.
Two attributes of demand-pull bear noting:

One, Wages can keep pace with rising prices, so it is those on fixed incomes who are hurt, not the working person. Eventually, and sooner rather than later (as in a year or two), production capacity will expand enough to moderate prices. This is particularly true now with global sources of supply. The "spiraling inflation" or "accelerating inflation" that preoccupies the Fed has never really happened with overheating. Currency collapse? Yes. Not from too much demand.

Two, There is a business boom associated with this type of inflation. That may seem to follow obviously from excess demand, but it is furthered by the fact that consistently upward prices mean that it is profitable to produce in the earlier, lower-cost times and sell into the later, higher-priced times. A corollary is that it may pay manipulators just to hold onto commodities and watch their price increase. This mandates a strong anti-monopoly regime, because a competitive market will defeat this strategy.

If demand-pull sounds familiar, it shouldn't. We haven't seen this in several decades.
Cost-push inflation is that associated with increases in producer costs which must be passed on as a matter of business solvency. This is what we see in energy price inflation, where the cost of production and transport goes up, so the price to the consumer goes up, the "surcharge" era. Health care costs are built into prices in a similar way. As are credit costs. Devaluation of currency adds more. This is the era of stagflation, such as we are entering again.
What!? Credit costs? Did I get that one by?

Yes. The cost of business operations is increased by the cost of capital.

But then doesn't the Fed increase interest rates to try to STOP inflation?

That they do. Does it work? No. In cost-push, it just increases costs. Of course, pretty soon there is a recession and people lose their jobs and demand IS so constricted that prices can't go up. But this is like amputation as a remedy for a hangnail.
Case History: In 1999 and 2000 Fed Chairman Alan "Maestro Magoo" Greenspan read "inflation" in his tea leaves. Unemployment was low, but it had been low for years without triggering an inflation. Ah ... but oil prices had begun to rise.
Greenspan hiked interest rates and learned quickly that it is easier to stop an economy with high interest rates than it is to restart one with low rates. In three years, Fed-controlled interest rates hit historical highs, then dropped to historical lows as the economy tanked. Those low interest rates are with us today, but precious little economic health.

We are seeing the same behavior in Ben Bernanke, Greenspan's replacement at the Fed. Energy cost-push inflation has begun to show itself, so he is raising interest rates. Long-term rates are beginning to follow.
What is the logic? If we are hoping to cut demand by raising rates, Why not just let energy prices do it themselves. Nothing bleeds effective demand better than siphoning it off into oil cartels and mega-corporations.

There is no logic. There IS a kind of funny sequence of reactions in the Market (capital M), however. When inflation begins to rise, stocks fall. Not because buyers are afraid business will begin producing more in anticipation of selling later into a higher-price, higher-wage environment.

No. It is entirely because they know from experience that the Fed will raise rates. And they know interest rate action will depress the economy. This is in spite of the fact that long-term rates have become separated from short-term rates. Too bad Fed action doesn't do anything to the inflation -- except add fuel to the fire.

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