Inflation is beyond the tipping-point

2011-JUL-09

Forecasters face a dilemma: is the outlook inflation, or deflation? And given the recent signs of disappointing economic growth, are we worrying too much about inflation? Certainly, for the Keynesians, who are constantly on the look-out for signs of deflation, and who believe that governments must at all costs keep prices gently rising, the alarm bells are ringing.

At the heart of their economic philosophy is the tired old economic fallacy of under-consumption as the reason for recession, and government deficit spending and stimulation of consumption as the way to recovery. In their desire to promote consumption at all costs, they have destroyed savings, and encouraged consumers into unsustainable debt. And despite the stimulation of 10%+ budget deficits, the vapour trail of recovery is fast disappearing. The Keynesian solution has left us in a worse position than we were in at the time of the credit-crunch and the collapse of Bear Stearns and Lehman Brothers.

That point in our economic history marked the end of the era of ever-expanding credit, when banks competed to lend. The paralysis in the money-markets changed that, and ever since both the banks and highly-indebted borrowers have become risk-averse. It also marked the end of the post-war Keynesian experiment. The cycle of monetary go-stop has been repeated too often, and now fools no one.

The idea behind monetary stimulus is to get businesses investing in new production and creating jobs in the process. But any industrial investment requires long-term stability in the factors of production, which include labour costs, the cost of money, and raw material prices. The Keynesians have unfortunately achieved short-term instability in all of them by monetary manipulation.

If, instead of the systematic destruction of savings through taxation and inflation, savings had been encouraged, the US and UK would have a healthier balance between manufacturing and consumption, and their trade would be more balanced. This is the lesson we have failed to learn from observing the post-war economies of Germany and Japan, both of which were driven by a strong savings ethos.

Both the mark and the yen were exceptionally strong currencies against sterling and the dollar, which according to our Keynesian experts should have restored trade balances. At first sight, this static analysis appears logical, but it ignores the far greater benefit to German and Japanese industry of stability in the source (savings) and cost of money. It ignores the stability of labour and raw material costs that comes naturally with savings, and which do not suffer disruption from unstable money supply and bank credit.

The evidence from savings-driven and consumption-driven economic models clearly disproves the Keynesian fallacy of under-consumption, and its correction by monetary manipulation. But anyone with knowledge of economic history, and of the clear evidence that free markets cannot be bettered for allocating resources between consumption and savings, knows this. Relearning the lesson has destroyed our economies, and made us even more dependent on monetary inflation to buy off the consequences of debt-deflation.

We passed the tipping point when banks stopped becoming aggressive lenders. Now we will print money to save our skins.