The Inflation & Deflation Mystery…

“Davidson” submits:

Inflation has always seemed a mystery to many. Milton Friedman said it is always too much money chasing too few goods. At all times, he said, inflation is a monetary phenomena. In the 1970s the thought was it was consumers over-spending and oil rising that was responsible. Some demanded that unionized factories produce more to drive prices down while President Ford issued his ‘WIN Button’ (Whip Inflation Now) October 1974. It took Paul Volcker’s rate rise in the Fed Funds to 20% June 1981 which forced the economy into recession to reverse runaway inflation psychology held by consumers. Consumers had embedded an inflation based mentality into their spending and which had come to dominate their financial decisions the past 10yrs that Volcker recognized as extremely dangerous.

The confusion about the causes of inflation remain. Today there are as many discussions about deflation as there are inflation. Each side recommends actions which they think appropriate. The Fed has exercised two QEs and one OpTwist while Congress authorized TARP all to prevent deflation which was feared would collapse the US financial system as assets fell below levels needed to collateralize existing debt. The fears of bank insolvency remains today. Deflation has always been a fear for the Fed since the Great Depression as it was something believed to be outside its ability to impact financial stability.

Market is a Human System

Brian Wesbury is one of only a handful of economists and investors who actually understood  the key point that most continue to miss today. The Great Depression and the Great Recession were the result primarily of ‘Mark-to-Market’ accounting rules(FAS157) applied mindlessly across bad and healthy assets during a period of investor panic. The rescues by government intervention could have been avoided had FAS157 been simply voided. TARP was not necessary!! Mark-to-Market panicked investors who could not tell good assets from bad assets. The markets turned higher the same day Ben Bernanke testified in front of Congress that Mark-to-Market rule FAS157 needed to be ignored. Two of Wesbury’s many commentaries are listed here:

1)    Sept 25, 2008 Mark to Market Mayhem

2)    Feb 24, 2009  Why Mark-To-Market Accounting Rules Must Die

‘We’ are the market. Markets are human systems which have evolved with the complexity of our financial system. Markets are based on rules with which all agree are fair. When we believe we improve ‘fairness’, we  modify the rules. Because we have changed the rules, the market of 2008 is not the market today. FAS157 is not the standard today. We learned, we adjusted, we moved forwards. We are constantly modifying old rules and adding entirely new ones to improve the market’s fairness to all participants. Even so, we do not understand markets well enough to have always imposed the best rules especially with much of the rule-making coming from individuals politically biased. We do our best. If one learns this, then one learns that the only way to look at our economy is with a ‘long-term-lens’. From this perspective, the source of inflation becomes apparent. Government Spending correlates with inflation-see chart below.