The Fed regards inflation expectations as an independent variable, capable of producing inflation on their own. In other words, if we all expect higher prices tomorrow, we will buy more today and push prices up. Nonsense, say Austrian economists. People can't will prices higher. If the money supply doesn't increase, the public can't increase its expenditures regardless of anticipation of higher prices in the future. Only the central bank can create inflation, which it does when it accommodates our increased spending by passively providing the reserves (printing money) the banking system demands at any given overnight rate. The output gap sounds great in theory. An economy can only produce what it can produce, given a limited supply of land, labor and capital. If there is more demand for goods and services than producers can deliver, prices rise to allocate the supply. – Bloomberg/Caroline Baum
Dominant Social Theme: Central bankers will get it right as they have in the past … hey, wait a minute!
Free-Market Analysis: We just noticed Caroline Baum because of a current column, "Fat Lady Wanted as Guide to Fed Rate Setters" and her reference to Austrian free-market economics. It is an amazing column because it does succinctly what most, if not all, mainstream columns will not: It questions the fundamental ability of central banking to ascertain when to expand and contract the money supply.
Of course, as we regularly point out, central banks "fix" the supply of money, and price-fixing never works. The mechanism always, inevitably, results in a distortion of the market, the transferral of resources from one area of the economy to another and the generation of shortages, queues (or even an over-abundance of resources) in arbitrary sectors of the economy. The result, eventually, is dysfunction, especially when the process is repeated, as it is, over time. In the case of central banking, "dysfunction" can have titanic ramifications, leading to countrywide economic booms, busts and even, eventually, worldwide financial crises such as the one that occurred in 2008 when the dollar reserve system effectively shut down.
Despite the lunacy of the current system, few in the mainstream press ever dare comment on the fundamental anti-free-market nature of central banking. In this column, Baum seems to come as close to it as the mainstream press ever does. Mises.Org noticed her long ago. The libertarian website posted a review of her book "Just What I Said," back in 2006 by C.J. Maloney, who informs us: "Bloomberg columnist Caroline Baum has been writing about financial markets for over twenty years. … Unlike far too many of her contemporaries, Ms. Baum's writings on economic issues cause me to laugh only when she means me to. When last year Bloomberg Press gave us a collection of her columns, entitled Just What I Said, off to Ebay I went."
Maloney liked the book and Baum's skepticism about central banking, but with a major caveat: "Ms. Baum comes down in favor of the central bank ‘managing' the markets alleged propensity to inflate prices generally. In a 1999 column, she used Brazil's historic inflation rates (which tend to get a wee bit out of hand from time to time) to give example of a free market's inability to control inflation. She quotes an economist who wonders why ‘they never seem to get it right' – implying Brazil's occasional bouts with hyperinflation are a market failure in need of a central bank's guiding hand. But in Brazil, starting with SUMOC in 1945, interest rates have been set by a small coterie of Ph.D-addled Mathletes, not by the free market."
Maloney writes that Baum is in favor of central bankers managing inflation but wishes, nonetheless, to rein in the Fed, when it comes to the ability to set short term rates. In this, she sounds somewhat like a monetarist. It was Milton Friedman, famously, who believed that central banks ought to function within a kind of steady-state environment, without noticeably increasing or decreasing the money supply beyond (mysteriously) what the economy needed. Of course the devil is in the details. And no one – not even the great free-market economist Milton Friedman – can truly explain how a central banker can create a stable money supply via dictates, or coordinate it with the larger economy.
In her latest Bloomberg column, Caroline Baum addresses just this issue. She writes: "There's no canary in the coal mine to keel over, no fat lady to sing, no early warning system to signal imminent danger. Yet somehow the Federal Reserve will know when the time is right to exit from what it calls ‘the current exceptionally accommodative stance of policy' to something a little less exceptional? How, exactly? What will tell policy makers the era of easy money is over?"
Wow. For this statement to appear on Bloomberg is startling. Bloomberg is an entirely mainstream media company that provides information and securities prices to Wall Street itself. For a columnist at Bloomberg to question the price-fixing of central banking – and the Fed in particular – is quite surprising. That's why we noticed her column – and also because of the reference to Austrian economics. Mises noticed her too. Obviously she sticks out.
Baum even mentions econometrics. She informs us that, "The Fed has econometric models that predict growth and inflation (they're silent on asset bubbles). It relies on something called the output gap, or the difference between actual gross domestic product (hard to compute) and potential GDP (a moving target), to warn of inflation on the horizon … What it lacks is a track record that inspires confidence. For a group that refuses to acknowledge the key role monetary policy played in fueling the housing bubble (not to mention the Internet and tech-stock bubble before it), a group that advocates regulation, not preemption, as the cure, Fed officials want us to believe that this time they will get it right."
Of course, like other alternative, free-market-oriented news sites, we've written about this issue constantly, but again it is most surprising to see such statements enunciated in the mainstream press (and Bloomberg is as mainstream as it gets). The major flaw in central banking is the inability to predict the future. There are simply no good ways of knowing in advance how much money is too much, or whether the amount of money in the system is sufficient.
The crux question that Baum is expressing in her column is the issue of timing. "No one questions that the Fed has the tools it needs to raise interest rates and shrink its $2.5 trillion balance sheet. It's as easy to sell Treasuries as buy them if you're price insensitive. [But] how does the Fed know when it's time to take the first baby steps to normalize interest rates?"
This is exactly the issue, and it is one that makes us believe (as we've written previously) that Western economies lie currently in the eye of the storm. We figure that Bernanke et al. (the EU, China, Brazil, India, etc.) have dumped at least US$20 TRILLION into the market since 2008 with the intention of re-liquefying the failed dollar-reserve financial system worldwide. This sort of thing happened on a much smaller scale in the 1970s, especially in America, and the result was nearly hyperinflation. Paul Volcker rode to the rescue and raised rates to around 20 percent – virtually bringing the economy to a standstill – to slow the velocity of money and consumer demand.
Volcker's tough medicine worked at the time, though it sent the US and the world into a near depression. But the issues faced in the 1970s were nothing as compared to today. Baum writes, "With overall and core inflation below the central bank's 2 percent ceiling, time is one thing the Fed thinks it has plenty of … It's this kind of stuff that makes former first lady Nancy Reagan's reliance on astrology look sound."
The overhang of fiat money in the world's banks today is vast. It is in the magnitude of tens of trillions. It is absolutely impossible to track the fungibility of so much money. Eventually it will begin to circulate, if it has not already, and central banking attempts at "sterilization" will inevitably be too little and too late. The result: significant price inflation and – given the mind-bending sums of money at stake – possibly some form of hyperinflation. This analysis is not to be found in mainstream analyses of the current economic environment, though it is the single fundamental issue facing Western economies today (along with depressed employment demand).
Of course, when price inflation begins to rage, Ben Bernanke and other central bankers will once again express astonishment that the system has failed. They will make excuses and blame "extraneous" factors. They will assert that their models need tweaking and that in the future this sort dysfunction will be remedied. They will learn from their mistakes, they will explain. But given the magnitude of the sums involved and the pain that will be caused by the kind of price inflation that is inevitably headed our way, we wonder whether such explanations will be enough this time around.
Baum has put her finger on what is wrong, but the bigger story is whether central banking itself will survive the full expression of the current business cycle. We tend to think not. It may be that bad.