Monetary inflation: A lesson from the 70s

Bill Bonner - Wed 13 Feb, 2008

We wondered what lesson he was talking about. As near as we can remember, the lesson of the ‘70s was that monetary inflation doesn’t always work. At some point, adding more money and credit becomes counterproductive...

The latest dispatches from the front lines give an edge to inflation. Yesterday, the Dow rose 133 points – putting it more than 500 points above its January low.

Commodities backed off, with the CRB down slightly…and gold off more than $15.

This was very good news to Ben Bernanke and his merry band of market manipulators. Mr. Bernanke famously remarked four years ago that the world was a better place because of “improved monetary policy.”

Monetary policymakers “will not forget the lessons of the 1970s,” he assured investors.

We wondered what lesson he was talking about. As near as we can remember, the lesson of the ‘70s was that monetary inflation doesn’t always work. At some point, adding more money and credit becomes counterproductive… Or, to describe it in the language of classical economics…the marginal utility of greater and greater inputs of cash and credit falls into negative territory. Then, instead of producing the desired growth and prosperity, more inflation produces stagflation – rising prices without growth.

When that happens, the only way to deal with it is to bring in someone like “Tall Paul” Volcker, who stops waiting for the Humpty Dumpty economy to fall; he gives it a good shove…with interest rates over 15%.

Faced with what appeared to be a ‘70s style slump, Bernanke rushed off in the opposite direction – offering lower interest rates and more cash. He hopes to avoid a recession…and who knows…this morning’s news suggests that he may have done the trick.

A regional Fed governor is in the news, saying he believes there will be no recession in 2008. And the papers are reporting a resurgence of inflation in consumer prices.

“Global inflation climbs to historic levels,” says a headline in the International Herald Tribune. Here in London, officially, inflation is running at a seven month high. On the opposite side of the world, in Japan, inflation levels are higher than they’ve been in 27 years. And all over the world, prices are rising.

No wonder. The Fed’s key rate is only 3.5%. Whatever the real rate of consumer price inflation is, it is surely higher than 3.5%. Maybe 4.5%...maybe much higher.

And the US federal government’s Open Cheque Book policy helps too. Business Week reports:

“The federal budget deficit is running at a pace that is more than double last year's imbalance through the first four months of the budget year. In its monthly review of the government's finances, the Treasury Department said Tuesday that the budget was in surplus in January, but totals $87.7 billion so far this budget year, double the $42.2 billion imbalance recorded during the same period in 2007. The new budget year started last Oct. 1.

“The Bush administration sent its final budget request to Congress last week, projecting that the deficit for all of 2008 will total $410 billion, very close to the all-time high in dollar terms of $413 billion in 2004.

“So far this year, federal spending is 8.3 percent ahead of last year's pace, at $949.1 billion. That is far ahead of the 3.2 percent increase in revenues, which have totaled $861.4 billion in the current budget year...

“It is hoped the stimulus plan will keep the economy out of a recession or at least make the downturn milder and shorter than it otherwise would have been. The rebate cheques are expected to start being mailed out in May with most Americans getting cheques of $600 for individuals and $1,200 for couples filing their tax returns jointly. In addition, families with children will get an extra $300 per child.”

Do you see how wonderfully sophisticated this new “improved monetary [and fiscal] policy” is, dear reader? You jack up the whole economy with cheap money and credit…and then, when the thing starts to wobble, you put on another, bigger jack.

We don’t know what lesson Ben Bernanke drew from the ‘70s, but the lesson we recall is that you can’t keep jacking an economy up forever. Eventually, you have to let it down, or it will fall on your head.

But central banking is not a science. At best it is one part bad theory, one part low art…and one part pure flimflam.

*** Sentiment in the housing market doesn’t turn on a dime. House prices made their biggest advance in history, between ’97 and ’06. It takes time for the momentum to exhaust itself.

Putting the question to homeowners, pollsters found that the 77% of them believed their houses had either stayed even or gained value in 2007. This result is completely at odds with the research results of the Case/Shiller Index, which puts the average house down about 10% for the year.

In Sacramento, the average house went down nearly 19% in the 12 months to the end of November ’07. In Las Vegas, the average loss was 17%.

*** Son Jules, at school in California, sends this little item:

“Exxon Mobil pays as much in taxes ($27 billion) as the entire bottom 50% of individual taxpayers, which is 65,000,000 people. The tax rate for the bottom 50% is only 3% of adjusted gross income; the tax rate for Exxon was 41%."

Conservatives will be quick to spot the corruption. The people who pay little in taxes discover that they can vote themselves someone else’s money. Social Security…Medicare…Education…Protection – they want it all – as long as they don’t have to pay for it themselves.

But while the poor are trying to steal from the rich, the rich are doing their share of larceny too. Publicly-funded universities educate the sons and daughters of the well-to-do, not the poor. Retirement programs benefit those who live longest – again, the well-to-do, not the poor. Farmers want price supports…factory owners want tariffs…lobbyists want tax breaks hidden in the pleats of worthy legislation… And people with financial assets want protection from losses. In step the feds with money and credit – holding off crashes, avoiding bankruptcies and disguising losses with inflation…thus, shifting the burden of mistakes from investors to consumers.

As a democracy matures, the web of connivance and corruption becomes so tangled, that people don’t know whether they come out ahead or behind. Then, the weight of it causes the whole society to sag.

*** Colleague Chris Mayer reports:

“ China added more to global economic growth in 2007 than the US. That’s the first time a country other than the US pulled the bulk of the global economic sled since at least the ‘30s.”

Buffett says it is not smart to sell the United States short. But selling the US short has been a very good investment for the last eight years. Our guess is that it will continue to be a good investment, generally, over the next eight years too.

The US is the General Motors economy – it is losing money on an annual basis, with high legacy costs, high debt, worn-out equipment, and a declining market share. Could it turn itself around? Yes. But not without a major upheaval - war… revolution…or bankruptcy.

Chris passes along another friend’s advice: “Get out of the dollar, teach your children Chinese, and buy commodities,” says Jim Rogers.

*** Colleague Byron King…with more reasons you might want to be short the USA:

A story in USA Today reports that, "The US population will soar to 438 million by 2050." Most of the population growth will be driven by immigration and live births to immigrants. How depressing. And it ought to make you mad, so that you want to "do something" about it... like build a wall or something.

Really, why is it that the so-called "immigration debate" in the US is often tied up with terms of race and seldom tied into the discussion of depleting resources and declining infrastructure? If the immigration debate was framed in the latter terms of resource depletion and infrastructure, people would focus on the point that the nation is "full". The irrefutable fact is that the US resource base is fast-depleting and the infrastructure system is overloaded. There is no more room at this inn. It's time to hang out the equivalent of the "No Vacancy" sign for very some practical reasons.

The US is already a net food-importer, yet the nation will now - according to the Pew Research study - grow its population from 300 million to 438 million within the next 43 years.” In what soil will the food grow? How much food will be imported, and from where, and how will the nation pay for it? With the national credit card, that is now broken?

And while we are discussing eating, let's wash it down. Water is in critical shortage in many regions of the US, so what will all of these "new" people drink? For that matter, what will the existing population drink? At the other end of the alimentary canal, the US infrastructure of sewers and pollution control systems has long been inadequate. Water and sewer system construction has traditionally lagged population growth even in the best of times. It is both expensive and politically difficult to gain approvals even for replacement sewage systems, let alone new build construction. Really, who wants a sewage treatment plant in their back yard? C'mon... raise your hand.

Let's think about energy. The US is already the world's largest oil-using nation (21 million barrels per day) and the largest oil importer (13 million barrels), so again... how much more oil will these new immigrants consume? While we are at it, the electricity system is strained to its limits in several regions. Each year, the system requires more and more juggling and wheeling of power just to remain up and running. (For example, within the US, power companies move electricity from Montana to California; from North Dakota to Illinois; from Tennessee to South Florida.) From where, and from what power plants (few are being built), will the nation obtain its electricity? As things stand, the world is at the cusp of long term oil depletion and output decline (and the high grade coal reserves have been dug and burned as well). Thus the existing US population base will have its work cut out just to maintain some semblance of an energy-based lifestyle for the current numbers. That is, the US should expect the volumes of oil available on world markets to shrink. There will be less and less oil available to import, and at higher and higher prices. Ditto with coal. And as for "alternative" energy sources? Hey, these are great present investments. But they are lousy overall solutions to the future energy problems of 300 million people, let alone 438 million. Something is going to have to give.

Let's think of some other resource constraints in the US as well.

Have you tried to find a parking space? The major cities are full-up, surrounded by sprawling suburbs and built-out exurbs. Roads are packed and traffic congestion is chronic. Yet few new roads are being built anywhere - for lack of space, let alone the NIMBY-ism [i.e. Not In My Back Yard] that permeates the culture. The nation is having trouble maintaining its existing road and bridge infrastructure. Yet won't "another" 138 million people need a few more paved roads, bridges, tunnels and exit ramps within the next 40 years or so? Who will build those structures, and how will the nation pay for them?

Where would these roads go in any case? You can already get to most places that you want to go, using a highway or road - in some state or repair or another. But when you arrive at your destination you typically find that much of the formerly rural landscape has been transformed into development and track housing, all of which uses energy and water in wasteful ways that will be untenable in years going forward due to scarcity and high costs. While we are at it, for some strange reason most of the US population wants to live within 200 miles of a coastline. So let's add the majority of those 138 million new bodies to the existing coastal bands. Tell me when you feel crowded.

How else can people move about? Not on trains. The US rail system is essentially max'ed out with trains hauling freight shipments, hence there is no room in or near any urban area to acquire new railway rights of way. So rail and light rail - which very few Americans currently use in any case - will not grow in any big sense in future years.

Other US public infrastructure - such as the hospital and public health system; court system; public schools and higher education system - are similarly max'ed out. The US can barely serve the population base of 300 million with the existing sets of buildings and personnel. In many jurisdictions, the fact is that the public IS NOT being served in any adequate sense. And in many locales, people are being treated, served and/or allegedly "educated" in trailers, for lack of space in the "real" buildings. Many of the "real" public buildings in the US are aged and long-past replacement. (In Pittsburgh, for example, no new public high school has been constructed since 1923.)

This does not even address the profound national issues of "borders, language and culture" that will be affected by new waves of mass immigration. 438 million? That number is just too many to allow any sort of society to function on half a continent, mostly near the coastlines. But one could also focus on the "depletion" of the traditional American concepts of national boundaries, or the decline of the nation's common English language and some semblance of an "American" culture based on a shared history. No, if you focus on that kind of thing, people will think that you are talking about immigration in terms of race.

So better just to focus on the fact that an increased US population - from whatever source - will lead to massive shortages of food, water and energy. And the public infrastructure will simply break down. Vast swaths of the country will become unrecognisable slums filled with broken-down housing, bad transportation, and hungry and thirsty people living on the squalid edge of human survival.