Inflation Hawks Are Waging War Against Their Own Hallucinations

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The golden phantom menace.

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Reuters

Earlier this week the Bureau of Labor Statistics released its monthly inflation report. The numbers came in at 1.7 percent a year for all items. Excluding the ever-volatile food and energy, it was 1.9 percent.

That's about as low as inflation has been in the last 50 years.  Only 1986 (1.1 percent), 1998 and 2001 (1.6 percent), 2008 (0.1 percent) and 2010 (1.5 percent) have come in lower, and a few years in the mid-2000s registered the same.

The disappearance of inflation over the past 20 years, however, has barely dented the pervasive belief that inflation remains one of the greatest threats to economic stability. These convictions persist in spite of all evidence to the contrary: Inflation is nowhere visible. For many, that is just proof that we are living in a lull -- a phony war soon to be disrupted when that age-old enemy reappears and wreaks havoc.

At the Federal Reserve -- legally mandated guardian of price stability and responsible for monitoring and containing inflation -- the president of the Richmond Fed, Jeffrey Lacker, has been warning that the current policy of very low interest rates and expansion of the balance sheet is almost certain to spark inflation in the near future.

In Europe, those views are even more deeply held. The German Bundesbank -- still seared by memories of hyperinflation in the 1920s and the collapse of political order that gave rise to the Nazis -- remains ever vigilant. Its president, Jens Weidman, is strongly opposed to many of the recent sovereign bailouts to preserve the euro on the grounds that good money chasing bad will spark inflation.

These officials tend to be firm yet measured in their concern ‑ something that cannot be said of populist politicians and analysis. The Tea Party is fueled not just by debt animus but by a deep-seated belief that "real" inflation is much higher than what the government reports, and it insists that the spending habits of the government will end in the collapse of the dollar, hyperinflation and the government's de facto stealing from hard-working Americans' money.

That is the fear of gold bugs, and added to the mix are the views of former Representative Ron Paul and his son, Senator Rand Paul (R-Ky.), that the Fed is putting the United States in inflation peril. Many professional investors and economists are similarly convinced that the current policies of zero interest rates and deficit spending are setting the stage for massive inflation.

How to explain the inverse relationship between inflation concerns and inflation realities? Yes, low inflation in recent years has been juxtaposed with modest economic growth and wage stagnation for most Americans ‑ as well as for most Europeans and Japanese. Given that perceptions of economic well-being are ultimately tied to disposable income, these forces have largely canceled each other out.

In addition, people tend to be acutely aware of the volatility of energy and food prices, which have spiked - and then receded - many times in past years.

Yet even with food and fuel, inflation perceptions can be deceptive. Many people are aware that the price of a loaf of bread has risen from less than 40 cents in the 1970s to an average of more than $2 today. Food prices have also risen periodically over the past few years in the face of global demand and droughts. That cements a perception of inflation.

Yet over the past few decades, food as an overall percent of income has gone down, down and down. In 1972, Americans spent 15 percent of their disposable income on food; today, that figure is 11 percent. The only shift has been in eating out ‑ people spend more on restaurants and much less on food at home. And that has happened even as incomes have stagnated. Gasoline, which has fluctuated widely, has maintained a steady share of disposable income for decades, at about 3.5 percent, which is now decreasing because of production from shale oil deposits and ever-more-efficient vehicles.

One of the strongest arguments for vigilance against inflation comes from economists following the dicta of Milton Friedman that "inflation is always and everywhere a monetary phenomenon." In that view, the actions of governments and central bankers are the determining factor, and the experience of the 20th century was that inflation often followed government policies, especially promiscuous government spending. Since that is what happened in the past, many are firmly convinced that it will, perforce, happen in the future.

One pernicious cliché is that history repeats itself. It doesn't. Historians repeat each other ‑ and economists then pile on with theorems based on a limited amount of history that then constitute "laws" of economics.

Unquestionably, inflation was a systemic threat not just in the 20th century but for centuries before. Thus the absence of inflation today is explained as an anomaly soon to end; an artificial state of affairs generated by easy-money policies of governments and central banks around the world; or a false statement in that inflation is underreported by governments interested in pretending it doesn't exist.

The virtue of these arguments is that they are not falsifiable. You can't prove there isn't a government conspiracy about "real" inflation, and you can't prove that something isn't about to happen. If you argue that there has been a systemic shift - that, say, technology and globalization have combined to send manufactured goods ever lower (with food as much a manufactured good as a computer) - you can easily be dismissed for foolishly contending that "this time it's different."

What, then, is the statute of limitations for inflation? How long must there be low, low inflation before the risk of it is judged as de minimus?

Yes, it might rear up in future. Yes, past patterns may prove correct. It would be foolish not to be on guard about the possibility and the risk ‑ just as it would be foolish not to forget that we still live in a world suffused with nuclear weapons.

Yet it would be equally foolish to ignore the weight of evidence about low inflation everywhere around the globe, not just for the past few years but over the past few decades. The consequences of planning for a war that never happens can be just as deleterious as fighting that war unprepared.

If inflation is not the proximate risk of today's economy, then we are radically misjudging our problems and missing solutions. If inflation is not a dire threat, then we need not be so concerned about government spending or central bank policy. We should instead focus on the ability of our national economies and the global economic system to generate sustainable living standards for billions of people.

Right now, so many are so fixated on inflation that these other challenges receive short shrift. If inflation revives, that fixation may be justified. If not, we will have squandered our time chasing echoes instead of meeting our present with eyes wide open to the possibilities of the future.

This post originally appeared at Reuters.com, an Atlantic partner site.

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Zachary Karabell is Head of Global Strategy at Envestnet, a financial services firm, and author of The Leading Indicators: A Short History of the Numbers that Rule Our World. More

At River Twice Research, Karabell analyzes economic and political trends. He is also a senior advisor for Business for Social Responsibility. Previously, he was executive vice president, head of marketing and chief economist at Fred Alger Management, a New York-based investment firm, and president of Fred Alger and Company, as well as portfolio manager of the China-U.S. Growth Fund, which won a five-star designation from Morningstar. He was also executive vice president of Alger's Spectra Funds, which launched the $30 million Spectra Green Fund based on the idea that profit and sustainability are linked. Educated at Columbia, Oxford, and Harvard, where he received his Ph.D., he is the author of several books, including Superfusion: How China and America Became One Economy and Why the World's Prosperity Depends on It (2009), The Last Campaign: How Harry Truman Won the 1948 Election, which won the Chicago Tribune Heartland Award, and Peace Be Upon You: The Story of Muslim, Christian, and Jewish Coexistence (2007), which examined the forgotten legacy of peace among the three faiths. In 2003, the World Economic Forum designated Karabell a "Global Leader for Tomorrow." He sits on the board of the World Policy Institute and the New America Foundation and is a member of the Council on Foreign Relations. He is a regular commentator on national news programs, such as CNBC and CNN, and has written for The Wall Street Journal, Newsweek, Time, The Washington Post, The New Republic, The Los Angeles Times, The New York Times, and Foreign Affairs.

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