Inflation
There’s been a few major issues lately where inflation and central banks have been key elements: Zimbabwe’s collapse under Mugabe, the recent Australian Federal election, and the US sub-prime mortgage crisis. What I find fascinating is that it all seems to be treated as an absolute black art by almost everyone, in spite of economics supposedly being reasonably well understood these days.
It’s particularly weird, because at a fundamental level, inflation is absolutely trivial to deal with: if you don’t want inflation, stop printing more money; if you want to print more money, you’ll get inflation. Tin-pot dictators like Mugabe can’t manage that fairly simple recipe because it’s the only way they can ensure they have more money (and thus control) than their subjects — since they don’t create anything of value themselves no one gives them money by choce, and since they run their country into the ground, tax revenues don’t work well enough, leaving printing more money as the only way to replace whatever they’ve just wasted.
In Australia the situtation’s under better control: the Reserve Bank controls the money supply, and the bank’s major “pet project” is to have “low and stable inflation over the medium term”. Which it’s been doing pretty well — since 1991, consumer-price inflation has averaged 2.5% inflation, with a maximum of 6.1% — compare that to the period between 1978 and 1990, where the minimum inflation was 2.6%, the average was 8.3% and the maximum 12.5%. Go back earlier, and you get higher figures.
Yet despite that, there’s lots of fear and propaganda going on about how we’re somehow facing an inflation crisis, and, depening on your political leanings, that’s it’s either all the previous government’s fault and the new government will fix things; or how only the nous of the previous government kept it at bay, and the new government is going to make it even worse. But that’s all a load of nonsense because that’s just plain not what inflation is: it’s nothing more than a result of how much money’s floating around in the economy, and that’s under the control of the reserve bank. The government can move money from one person’s pocket to another, or transfer costs from some products to others, but that’s all it can do.
Inflation’s used as the boogeyman from the demand perspective too; like the story in the paper today Unions in rises push, wage talks spark inflation fears. The theory being that once Alice gets a higher salary, her boss Bob will charge his customer Carol more to pay for it, then Carol will demand higher wages, and thus everyone will end up getting the same salary increase and paying the same extra costs and it’ll all be for nought: thus, inflation. But it doesn’t actually work that way — whoever gets in first gets an advantage, because they get the higher salary before everyone else starts charging more; but more importantly, at some point there just isn’t any more money and you can’t give Zack the higher salary he needs. And that means you don’t end up with inflation, you just end up with some people getting higher salaries, and other people having to go without. Maybe that means the rich getting richer and the poor eating dog food, maybe it means the workers standing up for the rights while others don’t spend as much on SMS bills voting on reality tv shows. But either way, it’s just a normal part of life, not a massive inflationary crisis.
Though apparently that’s completely beyond most of the folks in the press or government; which I guess is why it’s a damn good thing we’ve got an independent reserve bank managing the currency, and seeming to do a decent job of it.
What’s been more confusing to me is the different behaviours between the US central bank and the Australian one — there’s been talk of a “global credit crunch”, which should mean that nobody’s willing to lend money, and thus that supply and demand would dictate that you should be able to raise your interest rates — if no one else is lending money, then borrowers have to come to you no matter what you charge. And that’s the way things are going in Australia, and more or less the point of reserve banks — to be the lender of last resort.
The US, on the other hand, has dropped its rates — from 5.25% up until September 2007, to 2.00% at the end of last month. That’s saying “please, sir, can you borrow some more?” at a time when, supposedly, too many people have borrowed too much, and almost no one’s willing to lend more money. The Fed however, is apparently happy to send good money after bad.
That in turn seems guaranteed to cause inflationary effects — of the sort where Alice gets more money without doing more work and until everyone else catches up, lives like a queen, until eventually everyone is back where they were, and the US dollar’s simply worth less than it used to be, or the Fed draws a line in the sand and stops pumping money into the economy, and Zack ends up paying the piper.
In a sense, that’s pretty much how “sub-prime” mortgages look: the Fed loans banks a lot of money at low rates, the banks have already given all the reliable borrowers as much as they can afford to repay so in order to make a profit have to give it to ever less-reliable borrowers, and that also means that if your borrower starts looking like defaulting there’s probably another bank that’ll refinance them. And everyone’s happy until suddenly Zack’s bank can’t find someone to refinance the loan again, and it all collapses.
I went to the library the other day and read most of Greenspan’s Bubbles, by William Feckenstein. It basically documents a few decades worth of incompetence from Alan Greenspan, and lays at his feet both the dot-com bubble and the sub-prime crisis, with the conclusion that the Fed has become too willing to bail out Wall Street when it screws up, rather than letting the market punish firms when they make bad judgements; without which you lose the selection pressure for good decisions, and you’re setting yourself up for quite a fall… And given the Fed still seems to be bailing out