Wednesday, July 3, 2013

Is inflation a good thing?

“Is there really such a thing as too little inflation?”  That’s the question the economists at Kiplinger recently asked.  For retirees living on fixed incomes or for business owners with limited control over the prices they charge, the answer to that question is an emphatic “no!” since inflation hurts them.

Monetary policymakers, on the other hand, remain steadfast in their belief that a contained amount of inflation is actually good for the economy.  As Kiplinger points out, the Fed reasons that “Businesses won’t hire more because consumers aren’t buying enough.  Consumers would buy more today if they feared that prices would go up tomorrow.  Plus fatter paychecks for those who get cost-of-living hikes typically spur more spending (even though income in real terms, after inflation, doesn’t change).”  They point out further that for businesses that don’t make cost-of-living adjustments to wages, real labor costs would decline, prompting additional hiring and income growth. 

What the Fed’s QE3 stimulus program really amounts to is an attempt at creating inflation through artificial means.  The classical definition of inflation is an economic condition characterized by rising wages, rising prices and rising interest rates.  Inflation is a product of the 60-year long-term/long-wave economic cycle.  When the cycle is in its peak phase there is inflation.  This is due to a combination of demographic, structural and monetary variables.  The last time inflation was truly a problem for the U.S. economy was in the late ‘70s/early ‘80s. 

When the 60-year cycle is in its descending phase, especially in the final few years of the cycle, there tends to be deflation to some degree or another.  The 60-year cycle is due to bottom late next year, which explains why the Fed has been unsuccessful in creating inflation in the face of the “hard down” phase of the cycle.  Although the Fed has been unremitting in its attempt at fighting deflation, it has found that overcoming the natural forces of economic nature is an impossible task.  The best the central bank has been able to do in the face of the long-term cycle is to cushion the blow and keep deflation from overwhelming the economy.

It might be argued that inflation is not a good thing, at least not during the deflationary phase of the Kress cycle.  Artificially raising the consumer price level can actually be quite destructive when the economy’s natural tendency is toward lower prices.  It hurts even more when wages are stagnant or declining on an adjusted basis and interest rates are near record lows. 

In the final analysis, the Fed will end up doing more destruction than good with its policy of trying to create inflation.  It would do well to let nature take its course and allow the forces of the long-wave cycle to cleanse the system of the imbalances and impurities created during the last 30 or so years.  Unfortunately, this will never happen due to the interventionist nature of bureaucracy.  

Be warned that when the 60-year cycle finally bottoms, the Fed is apt to get a lot more inflation than it bargained for in the years that follow.

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