Inflation targeting has been a supremely stupid and pernicious idea from the get go, anchored as it is in the misbegotten Great Depression theory of Milton Friedman and his fanatical disciple, Ben Bernanke.
Contrary to their contention, the Fed’s failure to crank-up its printing presses red hot between 1930 and 1933 did not cause that decade’s economic collapse. Instead, the 1930s deflation was the unavoidable payback for the massive worldwide wartime inflation of 1914-1919 and the financial asset inflation of the Roaring 20s that was layered on top by the Federal Reserve.
Needless to say, since monetarist and Keynesian economists alike—both being congregants of the Church of the State—got the 1930s wrong, they, perforce, have gotten it all wrong ever since.
Moreover, beyond the stingy Fed mistake, postwar economists embraced hook, line and sinker an even larger, more enveloping error. Namely, that the Great Depression was not a one-time aberration, but was symptomatic of a tendency toward severe cyclical instability and deflationary collapse that is allegedly inherent in capitalism itself—a dangerous defect that can only be cured by the deft ministrations of the central bank and the fiscal agencies of the state.
Of course, professional economists don’t need much coaxing to embrace the deflationary death wish notion. After all, if you want to exercise power at the Fed, the US Treasury and the White House economic advisory agencies and be feted for your heroism and brilliance, you need a persistent threat and solutions that only economists can comprehend and deliver.
In essence, that’s how we got to the idiocy of 2.00% inflation targeting and from there went to the inflation is “transitory” nonsense of the moment. If truth be told, Bernanke came up with the 2.00% target not based on any profound or compelling empirical proof that 2.00% inflation, as opposed to 0.00% or even -2.00% inflation, leads to demonstrably better growth of jobs, GDP, main street living standards and sustainable wealth. To the contrary, he essentially stuck his finger in the air and assessed that a 2% inflation cushion would be sufficient to enable central bankers to keep the bogeyman of deflation at bay.
That all inflation targeting amounts to–a half-assed mechanic for fighting a non-existent threat. To wit, there was essentially no inflation between 1870 and 1914, during which period real GDP grew by 3.8% per annum and real per capita income rose by the highest rate in history, before or since.
Q. E. D. No central bank. No deflationary threat. No nonsense that MOAAR inflation is good for the people.
Nevertheless, there is a decent chance that having backed itself into the “inflation is transitory” corner, the Fed may have finally hoisted itself on its own petard. That’s because the coming inflation is going to be nasty, but the Fed and other central bankers will this time get the blame.
After all, they have been outright institutional agents and advocates for the kind of elevated main street inflation that is the scourge of everyday workers, consumers and voters. And this time they won’t be able to blame it on OPEC, disappearance of the Peruvian anchovy schools or speculators in corn, hog and silver futures.
It goes without saying, therefore, that demonstration of the stupidity of the Fed’s pro-inflation stance will help add fuel to the coming anti-Fed fire. So here follows some analytical kerosene.
In the first place, inflation targeting assumes that the general price level can be accurately or consistently measured over time and that the Fed actually has tools to effect the closure of any gap between actual inflation and the sacred 2.00% policy target.
Alas, what the “transitory” debate is going to show is that neither of these presumptions are true. What gets measured by the government-produced inflation indices is merely an arbitrary, and, in fact, transitory reflection of the weightings for the infinite variety of prices in the real world economy. Moreover, these variant inflation vectors come from both domestic sources, which the Fed presumably can impact, and global sources, which in most cases it surely cannot.
Indeed, here is what has happened to the internals of the inflation indices that puts paid to the folly of seeking a 2% inflation cushion to ward off an nonexistent deflationary threat. In a word, the domestically-derived components have gone up a lot more than 2.00%, while the internationally-sourced components have been deflationary due to the export mercantilism practiced by “Shina” and other developing economies.
For want of doubt, here is the US international balance on goods and services trade since 1947. Self-evidently, the US ran modest surpluses prior to 1970, and then increasing and persistent negative balances thereafter.
Yes, there is no special virtue in trade surpluses if trade balances are the result of free market action transacted in reasonably sound money. Even then, surpluses are generally indicative of a highly competitive domestic wage/price/cost structure, while large, persisting deficits are suggestive of the opposite.
That’s why, of course, neither trade surpluses nor deficits tended to persist on a long-term basis under the gold standard. Deficits caused gold outflows and deflationary domestic price adjustments to stem the loss of monetary reserves, while surpluses resulted in the opposite. That is to say, trade imbalances were self-correcting under a sound money regime.
Self-evidently, that mechanism has not been operative since Nixon shit-canned the Breton Woods gold exchange standard in August 1971. Not surprisingly, therefore, the US trade accounts went deeply into the red, and, in turn, that has had a profound impact on the internals of the inflation indices.
In rough terms, the massive red ink shown below tracks the widening gap between US domestic costs and the production costs of the major exporters to the US economy led by China. The result was that an ever increasing share of durable goods and many nondurable manufactures were shifted from domestic sources to foreign factories.
As a consequence, the goods component of the inflation indices increasingly reflected foreign cost conditions and internal policies which the Fed could do little to impact, thereby turning the CPI into a domestic services orphan.
That is to say, the Fed heads have been hyperventilating about an inflation shortfall that they could not possibly remedy, and, as we will address in Part 4, was actually the result of their pro-inflation policies in the first place.
US Net Exports Of Goods and Services, 1947-2020
Here is one proof of the pudding. Between 1956 and 1970, when the US was running small trade surpluses, the durables component of the CPI increased roughly in lockstep with the overall CPI, thereby reflecting the heavily domestic sourced pricing of manufactured goods.
During the initial inflationary fiat dollar period from 1970 through 1995, this linkage continued,owing to the lack of sufficient sourcing capacity in low labor-cost venues. To wit, the durable goods component of the CPI rose by 4.9% per annum during that 25 year period, roughly in line with the 5.6% gain per year in the overall CPI.
But after the mid-1990s the whole story changed and drastically so. As shown in the trade balance chart above, 1995 was roughly the pivot point when Mr. Deng’s shiny new export factories began cranking out volume goods, causing the US trade deficit to explode from around $100 billion per year to upwards of $700 billion, which metric reached an all-time record of $803 billion during 2020.
Not surprisingly, with merchandise goods being increasingly sourced from China and other low-wage suppliers, the durable goods component of the CPI took a swan dive due south. During the last 25 years it has dropped by 17% or nearly -0.8% per annum.
Obviously, that was an anchor on the overall measured inflation rate, but it had nothing to do with the bogeyman of 1930 style economy-wide deflation. Nor was there a single bit of logic in the Fed’s attempting to counter this gift to the American consumer.
Now that China has emptied its rice paddies of surplus labor and is being forced into an increasingly autarkic form of internally focused, high-cost economic function, the anchor to windward in the US CPI is rapidly fading, with durable goods now rising at a 5.0% annual rate.
What this means, of course, is that the Fed’s “lowflation” pretext for money-pumping has been exposed as purely bogus. And what can be attacked with malice aforethought, therefore, is the utterly pointless and stupid pro-inflation policy and rhetoric around which the Fed has molded it communications to the American public for more than two decades running.
Overall CPI Versus Durables Index, 1956-2020
As it happens, variations of the above pattern are present in spades for a wide array of tradable goods which impact the CPI. Inside the nondurables component, for instance, the sub-index for apparel tells the same story.
Between 1947 and 1970, the apparel index rose by 1.32% per annum or at about two-thirds the rate of the overall CPI, which rose by 2.43% per annum.
Then, during the initial fiat dollar era between 1970 and 1995, the inflation gap widened considerably. The apparel sub-index rose by 2.82% per annum compared to a 5.62% per year rise in the overall CPI. That is to say, apparel was one of the first manufactured products to be out-sourced to low labor cost suppliers after 1970, causing apparel prices to rise at only half the rate of the overall CPI.
After 1995, of course, the gap blew wide open as damn near the entire apparel industry was shifted abroad. Accordingly, the apparel component has declined by 15% during the last 25 years or by more than -0.6% per annum, even as the overall CPI rose by 2.14% per year.
So why was the Fed pumping-money like no tomorrow in an effort to counter the windfall gift of affordable clothes being conferred on the American consumer?
In the months ahead, we think, they will have more than ample opportunity to explain their pro-inflation folly.
Overall CPI Versus Apparel Component, 1947-2020
Finally, here is the same data for footwear, yielding the same story. Here the lines actually crossed over in 1977, as the great outsourcing of domestic manufactures generated by the post-1970 fiat dollar begin to gather force.
That is to say, there was nothing inherently deflationary about footwear prices versus the top-line CPI during the relative sound dollar era.
Between 1947 and 1977, in fact, the footwear price index rose by 3.40% per annum versus 3.38% for the general CPI. But as production shifted off-shore, a growing gap opened up. Between 1977 and 1995, for instance, the footwear index rose by 2.88% per annum are by only 55% of the 5.26% per annum rise in the overall CPI.
Thereafter, footwear provided still another anchor to the windward on overall inflation. During the past 25 years, the footwear index has risen by only 0.29% per annum or by barely one-tenth of the 2.14% rise in the total CPI.
Overall CPI Versus Footwear Component, 1947-2020
For want of doubt, here is the same story for infants and toddlers apparel since the pivot point in 1995. During the last 25 years, prices for this component (red bars) have dropped by 10% compared to a 70% gain in the overall CPI (yellow bars).
But here’s the thing. This has been an enormous boon to working and poorer households because they are now producing the overwhelming share of America’s babies. So why in the world did the geniuses in the Eccles Building find this so objectionable that they had to step-up their rabid money-pumping, which mainly had the effect of inflating the asset prices of the 1% and 10% who own most of them?
Overall CPI versus Sub-Index for Infants’ and Toddlers’ Apparel, 1995-2020
In short, for two decades the Fed has been on a fools’ errand. And now that the prices of foreign sourced goods are rapidly risen, it will hopefully become apparent to the American people that they have been sold a bill of goods by the camarilla of unelected policy apparatchiks who have literally destroyed honest money and stable economic and financial function.