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Fighting Inflation

and the Significance of Goats

Copyright © 2000, 2004, 2005, 2007 by David E. Ross

Since I first wrote the following, another recession has come and is still struggling to end. Inflation that was temporarily held in check by budget surpluses under President Clinton led to reductions in interest rates unseen in two generations.

Now that inflation is reviving because of massive budget deficits under President Bush, the Federal Reserve Board (still led by Alan Greenspan) is again raising interest rates. Immediately, the cost of consumer credit — part of the cost of living — goes up within 24 hours of each FRB action while the interest paid to savers remains low. Yes, each increase in interest rates has an immediate inflationary impact without a corresponding increase in incomes.

In the meantime, credit card debt remains one of the most significant factors in personal bankruptcies. Rather than addressing the problems of excessive consumer debts, the President and his friends in Congress made it easier for the banks to collect on those debts when borrowers are forced into bankruptcy.

11 August 2004
Updated 12 October 2005

Greenspan has been replaced by Ben Bernanke. Using interest rates to fight inflation is still the policy of the Federal Reserve Board although that practice is now discredited by the collapse of the housing market and a world-wide credit squeeze. Today, the Federal Reserve Board cut short-term interest rates by 0.5% to prevent a recession and ease the pressure on financial markets. But they can see no tool other than raising interest rates for fighting inflation. Will they ever learn? Now, we might have both a recession and inflation — stagflation (inflation with stagnation) is what they called it in the 1970s — at the same time.

18 September 2007

Ask anyone who tried to support a family or operate a business in the United States in the late 1970s and early 1980s: Inflation can destroy hopes, plans, and even lives. No, our inflation at the beginning of the last quarter of the 20th century was not even of the same magnitude that ruined democracy in Germany after World War I or that periodically sickens Brazil. Yet, we saw the following:

Yes, the Federal Reserve Board (FRB) is quite correct in its focus on preventing inflation. However, the tool chosen by the FRB — raising interest rates in order to weaken the prosperity that some believe will fuel inflation — will actually make inflation worse and not better.

How do higher interest rates and a throttling back on prosperity promote inflation?

Of course, we must ask: "Is not welfare reform depending on full employment? Is not a budget surplus good for our national economy?"

The Needed Tool

The most important question is: "Cannot inflation be fought without creating inflationary increases in the costs of debt?" The answer happens to be "Yes"! During the 1950s, the FRB had statutory authority to regulate consumer credit. By regulation, the FRB mandated a minimum down-payment on consumer goods (including automobiles) and a maximum period for repaying consumer loans. Then as now, the concern was that a consumer shopping spree can fuel inflation.

If that statutory authority no longer exists, it must be reinstated without further delay, before rising interest rates push inflation further. However, the consumer economy is different today than it was in the 1950s. Then, most consumer debt was in the form of loans to buy specific durable goods (automobiles, washing machines, refrigerators, etc). Those were loans, each with a starting and ending date, each with the purchased item as collateral, and each with a fixed monthly payment. Today, most consumer debt is in the form of unsecured revolving credit card balances, with no ending date and with the monthly payment varying as payments are made and new purchases are charged.

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Working together, the federal regulatory agencies — FRB, Comptroller of the Currency, Office of Thrift Supervision, and FDIC — finally took a step in the right direction. Noting that minimum credit card payments now often fail to even cover the monthly accrued interest, they ordered that the minimum payments must cover not only all interest, fees, and service charges but also at least 1% of the current balance, effective 1 January 2006.

This is only a millimeter step. Although prompted more by a concern about consumer solvency than inflation, it still represents a pay-off period of more than eight years (not the three or four years I asserted when I first wrote this commentary in 2000), far too long when purchasing such short-term items as clothes, gasoline, CDs, and food. Consumer solvency will still be very much at risk.

12 October 2005

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Given the reality of today's "plastic consumer borrowing", the following controls on unsecured revolving consumer debt would provide an effective tool against inflation:

These controls would have these results:

For this to work most effectively, the practice of allowing consumers to access secured revolving loan accounts (e.g.: home equity loans) must also be curtailed. Instant extensions of secured credit via credit cards or checks should be prohibited. An advance from a home equity loan as a transfer of funds into a bank account should be subjected to a two-day hold to discourage its use for a purpose unrelated to the collateral.

Greenspan's Motives

The question remains: "What is wrong with prosperity?" While the answer should be "Nothing!", I remain concerned that Alan Greenspan and his friends do have an anti-prosperity motive. The problem is not with prosperity as such, it is with the growing spread of prosperity throughout the population.

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Greenspan has succeeded! The spread of prosperity was halted and is now limited to those favored by President Bush's tax cuts and no-bid government contracts. Poverty is growing. And it is quite clear that political power is further concentrating into the hands of those who benefit.

12 October 2005

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Yes, economic growth has not yet touched everyone. Pockets of poverty remain in every urban area and in many rural areas. However, a growing proportion of the population is beginning to see itself as prosperous. Greenspan fears that, as economic power spreads, so will a demand for a share of political power. After all, while each adult citizen has a vote, the publicity that promotes candidates and sways votes is purchased by those who have discretionary income, by those who do not have to spend every dollar earned on food and rent, by those who can contribute money and time to campaigns.

Perhaps, Greenspan fears that dispersed economic well-being can only cause dispersed political power. And dispersed political power cannot be controlled by "spin doctors", "photo ops", platitudes, demagoguery, or special interests. Only by ending economic growth can real power be kept centralized.

Yes, I do see an elitist agenda, an agenda to fight against inflation using a tool that will increase costs while reducing economic growth. To Greenspan and his colleagues, this bitter economic medicine is acceptable because it will prevent the undermining of the political power of special interests.

22 May 2000

Goat Entrails

The New York Stock Exchange paused. Investors held their breaths. The whole world watched and listened. Alan Greenspan was presenting his semi-annual report to a Senate committee.

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Greenspan admits it! My analysis was indeed correct. In an interview on CBS's 60 Minutes (16 Sep 07), Greenspan admitted that he was intentionally vague when testifying before Congress.

But Greenspan failed to tell us why. His dissembling was only slightly better than lying. Why did he feel this necessary? Instead, he could have merely said, "There are things best left unsaid."

Greenspan's successor, Bernanke, seems a bit more candid.

18 September 2007

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The sense of the report was familiar:

perhaps… on one hand… but on the other hand… maybe… it suggests…
As usual, it was equivocating, vague, and indefinite.

All the senators bought it. Not one serious question was asked. No one even seemed to notice the lack of concrete, definitive statements let alone question their absence from the report.

Economists from banks and universities rushed to tell us all what Greenspan said. Every investment advisor and analyst had an opinion. Reflecting a diversity of opinions about a vague report, the S&P 500 went up and then down.

Next week, Greenspan will pfumpf for a House of Representatives committee, and the charade will be repeated. Anyone who wants to find something in Greenspan's report about the future of interest rates, the stock market, or the economy would be better served reading goat entrails.

While Greenspan's report contains no real meaning, there is sense behind it. It is intentionally uncertain. Uncertainty is the enemy of prosperity, and prosperity scares Greenspan. If too many citizens share the affluence generated by prosperity, they will also want to share the political strength that affluence can buy. The political power of special interests would then cease. Greenspan fears such a diffusion and dispersion of power even more than he fears recession or even possibly inflation.

22 July 2000

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