The vice chairman of the FED, Donald Kohn, vowed recently at the Cato Institute to be vigilant in checking any drift toward deflation. Should we feel appreciative or dismayed? Truth be known, this vow is infected by the same sort of elitist thinking that justifies morally hazardous bailouts of highly leveraged financial institutions.
Interestingly, Kohn not only expressed doubts about the FED’s ability to use monetary policy to prevent asset bubbles, he also acknowledged that the FED may have been excessively confident in thinking that if laissez faire policy resulted in bubbles, it could manage the bubbles once they burst. While Kohn is an unbeliever about asset bubble prevention, he does seem religiously zealous about anticipating and managing any bubble inversions (deflation). He promises to “move aggressively” to prevent any development of the scourge of deflation. It seems odd, though: If the FED cannot anticipate the right prices for assets (as it claimed in regard to asset bubbles), why does Kohn think the FED should make pre-emptive strikes against an inverted deflation bubble? Is there more than meets the public eye?
There are two types of deflationary environments, one beneficial and the other malignant. Deflation is benign and even virtuous (beneficial) when worker productivity and business efficiency are growing in the context of prudent and sustainable resource management. In this “public interest” deflationary environment wages remain steady while the cost of living declines, thus providing natural (real) wage increases. Mild consumer price deflation is attractive and should be one of the primary goals of every democratic republic. This type of gentle deflation helps workers become grassroots capitalists, thus weakening the societal role of bankers.
People don’t need to put their money in a bank in mild deflationary climates because the value of money grows on its own (as a result of prudent monetary policy). People can hold money or loan it to family and friends to jumpstart local business endeavors. One does not need “commercial” return on investment or “bank interest.” Furthermore, consumerism is dampened since there is no need for hasty spending in the fear that the money will be worth less in years to come. Mild deflation in a society with sufficient capital generation to keep up with population growth and productive advances is a dream come true for Jeffersonians and the environmentally conscious. On the other hand, it is a plague upon the financial ambitions of Hamiltonians.
The idea of a “public interest deflationary environment” is generally ignored by bankers with all attention riveted on the dangerous type of asset deflation that occurs in a protracted recession in which capital is depleted as a result of a burst speculative bubble. If greedy financiers did not allow leveraged speculation, this type of hazard would rarely exist except on the heels of devastating war. Unfortunately, the world may face this risk because trillions of speculative dollars have been leveraged in the last twenty five years, and the role of derivatives in managing the leverage was misunderstood. Bailouts for financial institutions seem to be the FED’s way of dealing with this type of asset deflation. Debt grounded fiscal stimulus (i.e., government pork projects and entitlements) appears to be the way the FED wants the U.S. Congress to combat hints of consumer weakness (i.e., pullbacks that could lead to price deflation). While deflation can be a serious problem under certain circumstances, central bankers seem unwilling to speak honestly about deflation lest the public break free from its financial slave masters.
Inflation is the key to disproportionate wealth gains for bankers and the leisure class. Inflation is what makes leverage work on behalf of capital holders. (Inflation does not work for homeowners with children because home inflation just makes it harder for children to get started on their own.) One does not need to be more gifted than one’s fellow citizens to increase wealth when one has collateral and the opportunity to borrow at rates lower than the rate of inflation in capital assets. If asset inflation is running at a rate of 3% over the cost of investment capital (i.e., stock market performance until 2008), and if one can invest collateral in Treasury notes at the rate of consumer inflation (several points below the rate of asset inflation during the last twenty years), it merely takes 10:1 leverage to produce a return on underlying capital of 30% per year. Since capital compounds undisturbed by taxes until assets are sold, the real return is even higher. When profits are taken, a low capital gains tax rate insures that little of the wealth trickles back into the public domain.
During the last twenty five years the Wall Street crowd tucked away hundreds of billions into hedge funds and offshore accounts, aided directly by the FED’s commitment to economic growth as a means of providing full employment. Meanwhile, wage growth suppression for workers resulting from globalization helped hold down consumer prices, giving the FED the ability to increase the money supply available for inflating Wall Street assets while claiming that the inflation that mattered (i.e., the CPI) was under control. Wall Street leveraged itself 30:1, grabbing every billion it could to increase its ownership of world assets during this time of legalized counterfeiting for investment banks and hedge funds. The U.S. Congress turned a blind eye to the FED’s deference to Wall Street because the resultant economic growth increased government revenues, thereby making possible more government spending by which to keep voters feeling nourished.
Without two-tier inflation (modest inflation for consumer prices and higher inflation for assets) the banking system would play a lesser role in capitalism. Other types of financial institutions would come to have a greater role, especially those that help the general public participate in the stream of income generated by corporate enterprise. America is rich with real assets (buildings, infrastructure, capital equipment, etc.) but the working public does not own much of it. A banking system built on a two-tiered managed inflation dynamic is the core cause of this social immorality and economic injustice.
The United States will never see economic justice until we install a constitutionally guided monetary policy that handcuffs the ability of the FED to cater to financial elites. In sum, an environment of 2-4% consumer price inflation is the perfect environment for Wall Street to maximize the centralized banking system to its advantage. Wall Street is the ultimate private sector counterfeiting operation. Now it has joined forces with the Federal Reserve — the biggest governmentally sponsored fiat money operation in world history. Financial legitimacy is now a daydream. We’re left with brazen-faced plundering and political preferentialism. This is the world made by elites who believe God is dead or money is god.