Friday, September 05, 2008

The Inflation Addiction

Now the chief effect of inflation which makes it at first generally welcome to business is precisely that prices of products turn out to be higher in general than foreseen. It is this which produces the general state of euphoria, a false sense of wellbeing, in which everybody seems to prosper. ..... It is this seemingly blessed state in which there are more jobs than applicants which Lord Beveridge defined as the state of full employment--never understanding that the shrinking value of his pension of which he so bitterly complained in old age was the inevitable consequence of his own recommendations having been followed.

But, and this brings me to my next point, "full employment" in his sense requires not only continued inflation but inflation at a growing rate. Because, as we have seen, it will have its immediate beneficial effect only so long as it, or at least its magnitude, is not foreseen. But once it has continued for some time, its further continuance comes to be expected. If prices have for some time been rising at five percent per annum, it comes to be expected that they will do the same in the future
. F. A. Hayek Can we still avoid Inflation?

During the past few years of generally rising prices there have been intermittent periods of price declines. Each of these periods has been hailed (by some) as the onset of a deflation or (by others) as a mere pause in a longer trend. Either outcome is certainly possible- the Central Banks can always deflate- but the political will to weather the storm caused thereby is rare.

Of late, as Gold holders like myself are keenly aware, commodity prices have not been rising. And, as has tended to occur, to greater or lesser degrees, during each such "deflationary" phase over the past few years, equity markets have tended to fall and unemployment has tended to rise.

Today's US Unemployment data seems a case on point.

In my view, the reason previous such phases have proven to be but a pause, instead of a new trend, and why I believe this phase will resolve similarly, is political- the will to endure the hardships of terminating the inflation has not manifested. Ron Paul's message did not appeal. Faith in a painless fix remains strong. Our addiction to inflation remains.

As Arthur Burns argued 30 years ago: But whatever the virtues or shortcomings of central banks may be, the fact remains that they alone will be able to cope only marginally with the inflation of our times. The persistent inflation that plagues the industrial democracies will not be vanquished-or even substantially curbed-until new currents of thought create a political environment in which the difficult adjustments required to end inflation can be undertaken.

Until that new current of thought gain credence, I'll stick to my inflationary outlook.