Milton Friedman must be quite happy that he isn’t alive today to witness the money printing by the major central banks, led by America’s Fed. He has probably turned over in his grave at least 3 times in the last 5 years (QE1, 2, and 3). In 1979 and 1980, when the Consumer Price Index (CPI) was rising at a very rapid rate (1979 = 13.9%; 1980 = 11.8%), the then newly appoint Fed Chair, Paul Volcker, killed inflation by raising interest rates to unseen levels (the effective Fed Funds rate was more than 19% in the summer of 1981). While a severe recession ensued, the killing of inflation ushered in a golden age for America, and from June, 1982 to August, 2000, the S&P 500 rose at an average annual rate of 15.7%.
The way the CPI was constructed in 1980 is very different from the way it is formed today. John Williams of ShadowStats.com has calculated that if the 1980 CPI construction were still in use today, then we would have officially seen a rate of inflation of 8.9% in 2010, 10.7% in 2011, 9.7% in 2012, and 9.1% in 2013. The double digit rates of inflation back then were enough to cause a violent policy reaction. But today, a near double digit rate of inflation (using the same calculation method) is ignored, and we are told that deflation is a bigger threat.
America’s middle class suffers from a falling real wage rate because the inflation measures are so biased to the downside and cost of living increases are nowhere near what is needed to preserve the purchasing power of the wage earner. I suspect that we wouldn’t be having the debate about the minimum wage or the strikes against the fast food industry if the official CPI in 2010, 11, 12 and 13 had shown John Williams’ results. Today, policy makers worry about deflation coming from a long-term downtrend in population growth (look at the popularity of the French Marxist Piketty -whose work has now come under criticism, as his data, according to the Financial Times, cannot be verified). But they ignore the real threat of economic stagnation coming from the bogus inflation numbers which reduce the purchasing power of the wage earner, and they ignore the potential for inflation, which comes from out of control money printing policies.
This Fed clearly isn’t your father’s Fed. I suspect that, before this is over, we will need another Paul Volcker.
For those interested in inflation in the 1970s and how Paul Volcker dealt with it, there is a three part series by William Silber available via Bloomberg News. The series deals with some technical aspects of how monetary policy is transmitted, but it is of interest because it shows how the Fed governors were split, and how a consensus emerged. I suspect that there has been dissent over money printing within today’s Fed, although recent departures and additions indicate that dissent may be dealt with in a different manner. You can access Part 1 by clicking on the link below, and Parts 2 and 3 are available as links within the body of each Part.
http://www.bloomberg.com/news/2012-08-20/how-volcker-launched-his-attack-on-inflation.html
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee. Robert is available to discuss client investment needs. Call him at (775) 284-7778.
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