Why Is the Fed So Confused about Inflation?

fed confused inflation

By Michael Kendall   ManOnTheMargin.com   February 12, 2018

Inflation and deflation are a basic component of economics.  Yet, the Federal Reserve, which has monopoly control of the value of the dollar, admits that they “aren’t sure they understand how inflation works anymore.”  That a currency must be stable in value is axiomatic; still the Fed pursues a 2 percent inflation goal.  The Fed and major central banks have pulled out all the stops while blindly searching for the elusive, magical 2 percent inflation rate—as if achieving this ridiculous, manufactured economic Holy Grail will somehow right the global economic ship.

If the Federal Reserve cannot understand inflation, how can it be expected to maintain the value of the dollar?  It can’t.  That is why the dollar has lost 97 percent of its value since Nixon ended the Bretton Woods gold standard 46 years ago.  Inflation and deflation are as basic to economics as a compass is to navigation.  Attempting to navigate through the woods without understanding the directional indications of a compass would render one as lost as the Fed is in attempting to maintain the value of the dollar without understanding the basic indications of inflation.

How is it possible that the Federal Reserve with its legions of Ph.D. economists cannot grasp the simple concept of inflation?  George Gilder explains it with a Margaret Mead analogy.

I like to tell the story that Margaret Mead told, of these mariner tribes that once made their living building streamlined canoes to go out and catch fish in huge volumes, but over time just forgot how to make the canoes. They forgot the crucial factor in their prosperity. When Mead found them, they were sitting on the beaches gazing glumly out at the ocean. They were on a path to extinction with no idea that streamlined canoes were the solution to their problem.

Governments have forgotten what money is for and how it works.  In his last book, The Scandal of Money, Gilder examines the economic impact of money that is defined as wealth instead of as a measurement of wealth.  The Fed is sitting on the monetary shore, gazing glumly out at the economy with no idea that a stable dollar is the solution to their problem.

The definition of inflation, which is the same as deflation, is a decline in the monetary standard.  It is the concept of a monetary standard that baffles economists and academia.  Monetary policy requires a standard unit of measure, no different than all other basic units of measure.  Because its value remains stable, mankind has selected gold as the Numeraire, the monetary standard.  There is wobble in the value of gold.  There is no mathematical constant that defines its value.  However, over millennia gold’s value has proven reliably stable.  There remains nothing else in the monetary realm that competes with gold’s proven stability of value.  If there was it would replace gold as the monetary standard.  Any currency linked to a fixed weight of gold becomes as stable as gold in value.  Enacting this link, which is the definition of a gold standard, eliminates inflation and deflation.

Our floating fiat system has no defined monetary standard.  The price level is in flux, constantly adjusting to the changing value of the dollar.  This causes chaos in the exchange economy.  There is no defined standard upon which to base the terms of trade.  Maintaining the fiat system requires massive daily churning of foreign exchange rates, interest rates, and derivatives for no beneficial purpose.  Currency chaos directly subtracts from the productive economy.

On a gold standard, the price level adjusts to the new, stable monetary standard.  Once the adjustment is complete, the price level remains stable as long as currency managers properly maintain the gold standard.  A stable price level eliminates inflation and deflation.  Creditors and debtors are in balance with neither gaining an advantage over the other through a change in currency value.  Monetary policy is at its most efficient.  A rise or fall in the price of gold (POG) from the fixed price indicates the onset of inflation or deflation.  If this change becomes permanent, the price level will over time adjust to the changed monetary standard.  This is the definition of inflation and deflation: a decline in the monetary standard.

Observing inflation and deflation in our floating fiat system is understandable through the gold signal.  Despite our fiat system, there is an optimum POG that the price level has adjusted to.  This adjustment takes many years as prices and contracts work their way through the change.  The spot POG may deviate above, below or intersect with the optimum POG.  The spot POG is the inverse of the value of the dollar.  Because a fiat dollar is constantly changing in value the spot POG and optimum POG are also constantly changing in value.  How the spot price of gold correlates with the optimum price of gold indicates inflation or deflation.  This correlation signals inflationary or deflationary direction the same way a compass signals cardinal direction.

Understanding inflation and deflation correctly in relation to a monetary standard eliminates all the contrived definitions of inflation that never work as advertised and so confuse the Fed.  The Phillips Curve, NAIRU, demand-pull, cost-push, employment, wages, deficits, trade balances, and economic growth as determinants of inflation should be left on the ash heap of economic history.  The conventional dictum of “too much money chasing too few goods” has no meaning unless there is a standard of reference that defines money.  Inflation and deflation are solely a result of a central bank’s management of the supply of currency relative to demand, based on a monetary standard of reference.

The simple, monetary element gold confounds and insults economists and academicians.  How can a barbarous relic outperform in monetary stability the progressive knowledge and intellect of academic theorists in a quantum computational world?  With the breakup of BW, gold should have, as Milton Friedman averred, become a commodity no different than pork bellies.  Instead, it is central bankers–negative interest rate creators, secular stagnation apostles, two percent inflation rate diviners, and serial deflationists–who are more relatable, absent the damage they inflict, to pork bellies.

Any sentient human can recognize inflation by observing their Haagen-Dazs bar that is half its original size, their bag of Doritos that is mostly air, their $9 beer, and all the other rising prices–electricity, gas, housing, healthcare, college tuition, etc.–as the dollar continues to lose value.  Yet, somehow this is beyond the purview of central bankers.

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