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Both the money supply and federal spending have increased at breathtaking rates over the past year, unprecedented in peacetime. The policy decisions made by the Federal Reserve Board and Congress virtually assure we will enter a period of 1970s-like stagflation. The recovery, when it comes, will combine slow economic growth, unusually long un- and underemployment, stagnating real incomes, rising interest rates and inflation. There is little that policymakers, having made colossal mistakes, can do to prevent such an outcome. However, there are steps that can be taken to shorten the period of stagflation and return to an era of robust economic growth, good jobs and stable asset and consumer prices. Indeed he has been catching - catching flak, that is, from critics on left and right and over both his foreign and domestic agendas. As he approaches the six-month mark of his presidency, his job has become less glamorous and more grueling. Allies in Congress are restive and for the first time, the whiff of failures and defeats is in the air. Thus the new tone from the White House press corps, which, like animals in the wild, preys on the weak. But don't be fooled by this dark patch. Obama's long-term prospects remain bright. - Washington Times

Dominant Social Theme: Inflation is coming!

Free-Market Analysis: This is a pretty good point of view in that it corresponds to reality. However, the Washington Times being what it is, and the author being who he is (a former legal consultant to Dick Cheney) it takes thousands of words to get to the point. And the point is not too complex. Stripped of all the learned language about M1, M2, M3, money flows, policy makers and spending analyses, the article is basically proposing that the federal government is spending too much money while not allowing the marketplace to unwind its debt.

While on the one hand the article is unnecessarily prolix, on the other it is uncertain about some basic terminology. Whether the author understands the classical definition of inflation is unclear in our opinion. Inflation, as free-market thinkers understand it, is an increase in the money supply. But stagflation, as interpreted by the mainstream media, has more in common with price inflation than an expansion of the money supply.

So let's approach this term from the point of view of price inflation. We've written this very thing in numerous articles, usually with a caveat that it is easier to anticipate price inflation than to predict it. One may understand the mechanism of inflation and deflation throughout the business cycle, but the timing is a tricky business. We remember 20 years ago when we first figured out what a free-market business cycle was, we were convinced that precious metal prices were about to go up right away.

Psychologically, our recognition of the business cycle generated a belief that the cycle would turn immediately. Instead it took another decade - until around 2000 - for the cycle to start to move. But once it started to move, we were immediately and intuitively aware of its direction. Having followed it so closely, we figure, because of government interference, this cycle has another 5-10 years to go.

Conclusion: The definition of stagflation, actually is a jobless recovery, which we just wrote about yesterday. But we can't see this economy generating substantial price inflation any time soon. Jobs are still degrading at a massive rate and housing prices are still falling as well. Eventually, given the amount of money that Western governments have printed, stagflation (price inflation with a stagnant economy) is a given. But the timing is not so clear cut. It may take a while to generate. There will be plenty of pain in the meantime.

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A recovery in confidence by households and businesses will be crucial to economic recovery, European Central Bank President Jean-Claude Trichet (pictured left) said, according to the transcript of a television interview. 'Households themselves can fight back,' he said, according to the transcript of the interview with Euronews television, released on Friday. 'When their confidence returns they can help fuel the recovery by consuming more, so companies will resume investment. The key is confidence,' he said. Trichet also said that the ECB had taken unprecedented steps in pumping billions of euros into the financial system and banks that had taken advantage should pass the benefit on. 'We are demanding the banks extend this credit across their client bases, and make a similar effort to the considerable one we are making,' he said. 'We are also asking them to restore their balance sheets to health, and take advantage of a range of options which different countries are offering to them. - Reuters

Dominant Social Theme: The key to whipping the downturn is to buy!

Free-Market Analysis: It is hard to believe that the president of the European Central Bank has resorted to this sort of suggestion. This is right out of the playbook of socialist economist John Maynard Keynes. Keynes, who was a central banker before he was anything else, had a fairly direct definition of an economic downturn. A downturn (recession/depression) was caused by a lack of economic activity. Thus, if the consumer could be made to spend more - consume more - then the lack of economic activity would be cured.

In order to make sure the consumer spent more, government had a role according to Keynes. Government could spend money on creating jobs, thus employing people and putting money in people's pockets. Government could also lend more money to banks to ensure that businesses would receive funds, thus in turn placing money in the pockets of people who would consume.

Today, with the experience of this latest downturn firmly at the forefront of our collective consciousness, we can see just how simplistic such an explanation is, and how convoluted is the solution that Keynes suggested. First of all, the idea that a downturn is caused by a lack of consumer demand is specious in the extreme. What actually happens is that central banks print too much, stimulate mal-investments which eventually lead the economy and the stock market off a cliff.

Second, the idea that government should utilize public works to combat the downturn and also print more money to flood the economy with liquidity is questionable, to say the least. Government is as bad at creating employment - especially lasting employment - as it is as anything else. Public works programs, as we are seeing now, often provide few jobs and even less in the way of practical, long term employment. The idea that central banks should flood the economy with liquidity sounds at least practical, but in reality it is not. During major financial crises, banks are scared to lend, even to each other. Providing them endless amounts of money doesn't get the money circulating in the economy. A deep tax cut would do the trick, but central banks have no incentive to suggest fiscal policy when their control is derived from the monetary mechanism.

On all levels, Keynes seems to strike out. His analysis of a downturn is simplistic and his solutions are unworkable. What is frightening, then, is that a man as powerful and financially astute as the head of the European Central Bank is reciting Keynesian analysis with seemingly total confidence. This is the best that Trichet can do? He quotes Keynes some 70 years after-the-fact as if Keynes is new again and his nostrums worthy of serious examination.

Conclusion: It is sad that Keynes is back in fashion. He was an entirely simplistic thinker who dressed up his mis-diagnoses in impenetrable mathematics and an equally impenetrable vocabulary. His ideas, misguided as they are, are being steadily implemented both in Europe and America - only because they provide the monetary elite with a justification for staying in control, not because they will do anything to alleviate the financial crisis in the short or long term. If Keynes' theories worked, gold and silver would likely subside in price. Instead, precious metals are high and likely going higher - as good a referendum on current governmental and banking policies as any.

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