A little
is all right. That’s the message Federal Reserve Chairman
Ben S. Bernanke has been giving out recently when asked about
the evidence of inflation in the U.S. recovery.
Sometimes
Bernanke doesn’t even go that far. He simply says he doesn’t
see inflation. The Fed chairman recently described the prospects
for price increases across the board as “subdued.”
“Sudden”
is more like it. The thing about inflation is that it comes out
of nowhere and hits you. Monetary policy is like sailing. You’re
gliding along, passing the peninsula, and you come about. Nothing.
Then the wind fills the sail so fast it knocks you into the sea.
Right now, the U.S. is a sailboat that has just made open water,
and has already come about. That wind is coming. The sailor just
doesn’t know it.
“Sudden”
has happened to us before. In World War I, an early version of
what we would call the CPI-U, the consumer price index for urban
areas, went from 1 percent for 1915 to 7 percent in 1916 to 17
percent in 1917. To returning vets, that felt awful sudden.
How did
it happen? The Treasury spent like crazy on the war, creating
money to pay for it, then pretended that its spending was offset
by complex Liberty Bond sales and admonishments to citizens that
they save more.
Country
in Denial
In other
words, the Woodrow Wilson administration was in denial, inflating
in all but name. Commenting on one complex plan to make more money
available, Representative L.T. McFadden, a Pennsylvania Republican,
said, “I would suggest that if the administration believes
that inflation of this character is necessary to finance the war
the more direct way would be to issue the notes direct.”
Or, to return
to sailing terms, the Treasury and Fed had tilted the U.S. monetary
craft so far one way that it needed to lean back the other way
before it could right. That leaning was the true tight money policy
of subsequent years, including deflation of 10 percent and wrenching
unemployment.
History
has other examples. In 1945, all seemed well: Inflation was 2
percent, at least officially. Within two years that level hit
14 percent.
All appeared
calm in 1972, too, before inflation jumped to 11 percent by 1974,
and stayed high for the rest of the decade, diminishing the quality
of life for whole cohorts. They paid the higher interest rates
needed to reduce the inflation, and got a house with one less
bedroom. Or no pool.
The thing
about inflation is that it accelerates. The acceleration hit storybook
levels in the most sudden case of all, that of Germany in 1922.
Many financial analysts thought the Weimar authorities weren’t
producing enough money.
“Tight
Money in German Market: Causes of the Abnormally Rapid Currency
Deflation at Year-End,” read a New York Times headline.
The Germans didn’t know it, but they had already turned their
money into wallpaper; the next year would see hyperinflation,
when inflation races ahead at more than 50 percent a month. It
moved so fast that prices changed in a single hour. Yet even as
it did so, the country’s financial authorities failed to
see inflation. They thought they were witnessing increased demand
for money.
The greater
the denial before, the faster the inflation accelerates after.
Author Daniel Yergin tells the story of a student in Freiburg
who ordered a cup of coffee in a cafe; the price was 5,000 marks.
Then he had another. When the bill came, it was 14,000. “If
you want to save money and you want two cups of coffee, you should
order them both at the same time,” he was told.
Extreme
Example
Germany
in the 1920s is always the extreme example. But one form of denial
then warrants comparison to the U.S. today.
Bernanke
talks about prices in one area - energy, for example -- as different
from those in the rest of the economy. The Germans, in their denial,
thought their problem was limited to exchange rates, and that
their domestic economy had hope. Risibly, Chancellor Joseph Wirth
tried to tie down prices by regulating foreign currency. The equivalent,
and equivalently risible, move today is the Ralph Nader effort
to get the administration to push down oil prices.
The reason
a little inflation is not all right, and the reason inflation
comes suddenly, is expectations.
The phrase
“perception is reality” is overused generally. But perception
can be reality in monetary policy. The bond market doesn’t
act merely on what it sees. It acts on what it expects of the
Fed or the government. And our own Fed has let us know it’s
capable of just about everything, which includes inflationary
monetary policy. Disillusionment can come as fast as a gust, but
building faith that the government won’t inflate again is
like building a new sailboat, a project of years....
The reason
that markets haven’t jumped yet is that the last great inflation
and correction happened in the late 1970s and early 1980s, just
long enough ago that most adults in the financial markets don’t
remember it.
