There’s a certain economic platitude that outrages me every time I hear it repeated by the financial press and political economists. Put simply, it’s the familiar comment that economic growth causes inflation. It has many variations, including “high employment causes inflation”, “slowing growth eases inflationary pressures”, and “above a certain limit, high employment or economic growth generate inflation”.
Happily, last week I saw a clever criticism of this thinking, written by media critic Ira Stoll about the NY Times:
“In most disciplines, the existence for several years of a reality that contradicts the theory might lead to a reassessment of the theory. If, for instance, the laws of gravity stopped working, you wouldn’t expect the Times to blithely report that “For the last several years, objects have not obeyed what most physicists consider to be the laws of gravity.” You would expect the physicists to reassess the theory. Yet the reaction of the Times and its “most economists” to several years of strong noninflationary growth is not to reassess the theory that says it is impossible, but to tremble at the possibility [of higher growth,] causing inflation.”
The faulty economic theory that most economists, journalists, and policymakers are relying upon is called the Philips Curve.
This curve, now viewed by some as an economic law, was constructed decades ago and asserted that there was a “trade off” between unemployment and inflation — that high inflation provided lower unemployment and low inflation created higher unemployment. But almost as soon as the Philips Curve became economic orthodoxy, actual experience contradicted it. Inflation coincided with increasing unemployment in the 70’s, while falling inflation coincided with reduced unemployment during key periods of the 80’s and 90’s.
Keep the following in mind: Inflation is a reduction in the purchasing power of a unit of currency. As governments control currencies, they create inflation. Inflation can be observed by tracking changes in currencies relative to precious metals and other currencies. Over time, a currency’s decline manifests itself in higher prices for industrial and consumer goods. An economy reacts poorly to the uncertainty and confusion of inflation, which hurts growth, and an economy responds favorably to the stability of low inflation, encouraging economic growth. In either case, an economy reacts to inflation and government currency policy; it cannot create it.
Last Thursday (31.Aug.00), the European Central Bank (ECB) hiked interest rates 0.25%. While the ECB is right to be concerned about inflation, it is taking the wrong actions. The fact is, a rising CPI is quite likely in Europe, thanks to the ongoing weakness of the Euro, and the solution would logically be to strengthen the currency and create a mechanism for future stability. Rather than stabilizing the Euro’s value, instead, the ECB attacks economic growth as the carrier of inflation, lashing out at growth with higher interest rates. And this confusion thrives around the world.
A recent economic analysis of Poland was incapable of explaining why inflation, despite a slowing economy, remained high. Apparently, it never occurred to the economist that Poland’ s inflation was a direct result of the government’s policy of devaluing the Polish Zloty (Poland’s annual CPI inflation has been 11% to 12% lately, while over the past seven years the Zloty has been devalued by about 11% annually relative to the dollar). Conversely, when analyzing Singapore, orthodox economists have had great difficulty explaining the opposite situation: decades of sizzling economic growth rates and low unemployment, and, because of its framework for a stable currency, consistently low inflation.
When will these journalists, economists, and bureaucrats learn from their mistakes? Probably never. But fortunately, mistakes can often create investment opportunities – at least for independent thinkers who are able to see through such economic platitudes – and at this rate, it looks as if these opportunities are going to exist for a very long time.
