Posted on 04/21/2004 9:05:17 PM PDT by jedi
Most Americans have been led to believe that the Consumer Price Index (CPI) actually measures, from one year to the next, the "cost of maintaining a constant standard of living" as the prices for goods we purchase increase. Indeed, we are foolish enough to believe that the index is an accurate measure of the price increases for the same basket of goods we buy every year.
If this were actually true, the index would show an honest increase of 3% - 4% in price, there would be no productivity miracle, interest rates would be much higher, and bond and stock prices would be lower. Of course, with an election approaching, our elected officials don't want the CPI to be an honest measure of the cost of maintaining the same standard of living or quality of life. They want a politically convenient index, cleverly devised to hardly ever rise at all!
What you should find unsettling and fraudulent are the ways that the CPI is manipulated to ensure there is no inflation, regardless of how high the prices rise for things we must buy to live. Manipulating the CPI - specifically because the benefits to the retired on Social Security, Medicare and Medicaid are tied to it - and making people believe that inflation is low, will keep the "fraud" of monetary inflation alive.
The government simply can't afford to keep the promises it has made, and it needs to use this clever accounting fraud. If productivity is really so high, why isn't government policy pushing through a 10% flat increase in Social Security benefits so that the retired can get their share of the productivity miracle? (Maybe the real miracle is robbing them without them noticing!) By changing the definition of "what inflation is", our government won't have to pay nearly as much to retirees as they were anticipating. The implications of defining inflation away are vast, and the magnitude of the fraud is extraordinary!
The primary sources of manipulation are:
1) Making sure the wrong items are in the index;
2) Taking "hedonics" to ridiculous extremes;
3) Getting consumers to do more of the work and receive less services; and,
4) Changing to a Chain Weighted Index.
First, it is not a coincidence that the CPI assumes that everyone in the country rents their home. (Rents have been declining over the last year in some major cities, such as San Francisco -6%; Denver -4.3%; and, Atlanta -4.5%). Making sure that the CPI does not pick up the real cost of housing is critical because the very reason that rents are soft is that with easy mortgage credit available, former renters are leaving the rental market and buying houses instead, which has pushed up housing prices. Over the last four years, housing prices have risen 45%, so how could the index possibly be kept so low if housing prices were actually part of the "cost of living"?
The drop in rents is very material since the cost of housing is a full 30% of the CPI. Unfortunately, for those 80 plus million Americans with incomes tied to the CPI, 69% of households own their home. So, over two-thirds of Americans are forced to use a Consumer Price Index that has absolutely no relevance to them! To say the cost of living is going down for homeowners is just ridiculous! If the CPI was honestly set to measure the costs associated with owning a home for those 69% (vs. renting), the index would be rising over 3% a year! Those 80 plus million Americans who are short-changed include recipients of Social Security, Medicare, welfare and food stamps, as well as retired military and many private pensions.
To take a closer look, my wife and I prepared a monthly "nut" spreadsheet on our own personal expenses. We own our home and car outright (so we don't have a mortgage or car payment), but we still have all the usual expenses, including: Insurance for Health Care, Automobile and property; electricity; DSL connection; telephone; property taxes; monthly maintenance; etc.
Before we have even purchased a gallon of gas, a piece of clothing, or a single grocery item, our annual nut amounts to over $25,000 and it is rising around 8 to 10 percent a year. We recommend you do the same and then compare your "housing cost" to the CPI. You'll notice that you probably do not live in the world the government describes!
Second, the CPI is managed down by arbitrary decisions made by bureaucrats on the "quality improvements" in goods and services, pleasantly referred to as "hedonics". When you buy a computer that has "more storage" or purchase a new car made with more plastic rather than steel, the bureaucrats at the Bureau of Labor Statistics, Bureau of Economic Advisors and the Federal Reserve, get all excited because productivity and deflation can be "defined into existence" the same way that the Federal Reserve can "print new money out of thin air".
While there are some benefits from quality improvements in the cost of goods and services, the extent of the "arbitrary hedonic adjustments" are breathtaking and, alone, are adding 1% to 1.5% of real Gross Domestic Product (GDP) growth by "magically lowering inflation" by the same amount. All you need to do is look at the actual number of dollars spent on "technology equipment" in the GDP. Dollar spending hardly changes, but "real spending" is rocketing up. Take a look at the price deflator for tech equipment, falling from 90% to 60% over the past few years, to realize how arbitrary these hedonic adjustments are and how devoid the adjustments are of any common sense.
Looking forward, the good news is all the attention being paid to the rising cost of health care, but these costs may prove to be "embarrassing" in an election year. So much so, that the CPI is in the midst of a major "make-over" to include all those tremendous "hedonic improvements" in health care that granny is getting from her HMO. The government staticitans have entered the world of science fiction: "Please beam me up Scottie".
Third, every time we pull into a gas station in the rain and have to swipe a credit card and pump our own gas, we remember the old days when a gas station attendant actually provided service, checked the oil, and cleaned the windshield free of charge!
In my own business, travel reservations are made over the internet which is convenient but time consuming when researching flights. For other services, just try and get through to technical support (which is generally a fee-based service) or speak to a customer service rep; the whole day could be spent on hold waiting to speak to someone in Bangladore or Calcutta. Everywhere we look, the consumer is now providing a portion of the labor in order to receive normal services. Yes, this holds measured prices down but the downside is the loss of the purchaser's valuable time. The government masters of the CPI who welcome "hedonics" turn a "blind eye" to this significant cost phenomenon. Moreover, we spend an additional 30 minutes a day cleaning "spam off of our computers. Not one minute of this lost time shows up as a cost and drain in productivity.
Remember, "Only the good stuff counts." Do you honestly think the time you spend delayed in traffic, on a train, or on an airplane, would be calculated in the CPI? What about the extra hour we get to spend at the security gate at the airport? What does that do for your "productivity"? Isn't that a real material cost?
Fourth, in order to guard against anyone actually seeing inflation, the Bureau of Labor Statistics, at the Federal Reserve's urging, wants to use an "Expenditure/Chain-Weighted Index." This price weighting idea works something like this: If you consume a very small amount of something and its price goes up a lot, it will affect the CPI very little because it has a very small "Weight in the Index". This, of course, is correct. What the Federal Reserve and the Bureau of Labor Statistics want to do next is insidious and should be criminal fraud - the Fed wants the Bureau of Labor Statistics to change the weights as the prices change.
This is the way the Index will be constructed: As the cost of some items goes up and you can no longer afford to buy them, you are then forced to use that item less and find a less expensive alternative. Then, the weight of that expensive item goes down, but the weight of the less expensive item goes up, resulting in prices that have hardly changed at all! (George Orwell would simply love this!) Indeed, think about Granny in the kitchen: She used to buy steak and croissants but the price got so high that she now has to eat spam and dough balls fried in lard. Since she doesn't buy steak anymore and now eats spam and uses lard (items she never used to buy) her cost of living has gone down! (Granny's weight for steak is now zero.)
Obviously, Granny's standard of living went down when the price of steak went up. What matters in today's world is not Granny's standard of living, but her cost of living! Granny's costs need to be kept down and the way to do that is to keep her CPI down! If Granny receives $400 a month to live on, it is truly convenient to make sure her "cost of living" stays the same even if surviving on $400 a month means she freezes in the dark, cancels cable, and eats what her dog eats. Yet, she should feel good because the CPI tells her that costs haven't gone up. The real miracle in America isn't the productivity miracle; it's the never rising Consumer Price Index.
The Federal Reserve wants to run an easy money policy and keep interest rates down; the Treasury wants to short-change social security recipients and buyers of TIPS and I-Bonds. Fudging the CPI is the way to go; however, this strategy is intellectually dishonest, morally fraudulent and will remain quite effective until Americans start looking at their actual cost of living, or discover one day that what's good for Rover is good for them.
Looks pretty much bi-partisan, too.
Good grief! it's wonderful to find someone who knows. Everybody and his uncle will get a copy.
http://www.jsc.nasa.gov/bu2/inflateCPI.html
Compare $1,000 in 1913 against 2003; imagine what it would be if the liars hadn't figured.
I have to get up early but I'll be back tomorrow. Thanks again. You've made my night...
It ticks me off that people wander around the store with sad faces, and sealed lips. Speak UP!
T.V. viewing used to be free. It was a heck of a lot better then.
Thirty years ago, I used to buy frozen "slipper" lobster tails, small ones but a few bites to one, 6 to 7 in a bag for exactly $1.00. No tax. That was on Katella Ave. in Orange, California. They don't come packaged that way anymore and you'll pay something like $19.95 a pound.
I really do have to retire for the night. 'nite
There's a reason why rents are used as a surrogate for housing costs instead of home prices. While the price of homes may have risen 45% over the last four years, this increase only really affects those people who are buying their first homes at any given time. In theory, someone who moves from one "owned" home to another will be paying an inflated price for their new home but will also benefit from an inflated price of the home they are selling.
If home mortgage costs were incorporated in the consumer price index, we would probably find that housing costs have actually declined substantially over the last few years. This is because at any given time the vast majority of homeowners are not buying or selling their homes. They are living in them, paying off long-term fixed-rate mortgages in monthly payments that do not change at all -- unless the homeowner refinances the mortgage at a lower rate, in which case his housing costs have declined.
Oh no, millions of Americans are buying their own homes! Run, the Sky IS Falling!
Each year, millions of American retirees and inheritors pay off their houses. If that were factored into CPI (it's not), the CPI would be declining, especially with the declines that we've seen in rent, cellular phone service, long distance, watches, computers, air fare, internet access fees, clothes, and used cars.
The number of products that line the shelves today are far greater than 40 years ago. But if you look at staples, eggs, milk, butter, flour, etc. the price changes in 40 years is uncommonly low. (In other words - products that have always been on the shelves.) I bought a pork butt the other day to make some 'Q' and it was 89 cents a pound. I was in the supermarket today, and it was $1.49 a pound. I would buy at either price - but I certainly did like the $.89 price better. (Just as an aside, I invited all the Muslims in the neighborhood over for the BBQ.) But back to the topic, a lot of the price that is paid today is for time. Prepared foods, quick dinners, etc., all cost more than if you make them yourself, but you need time to make them yourself. Most people make a decision at some level, I want this food, I can't make it, or I don't have the time to make it, I'll buy it prepared and the cost is worth it. Most people's standard of living would increase if taxes were cut, and the wife could stay home and cook. I say most, because some wives can't cook. (Don't tell my wife that, I don't want to hurt her feelings.) I do most the cooking in my household, and much of the time it is from scratch. To take things to an extreme, you can buy bread for $.99 and on up, depending on the quality or make it yourself. The quality part is my problem, it difficult to get good quality bread where I live, so I bake it. I probably spend about two hours a month making bread (that doesn't account for time waiting for bread to rise or bake (I'm on FR during those inactive times) and all I pay for is flour. I have a starter that I replentish each time I bake bread so I don't even have to pay for yeast. Not that I am cheap, I just like really good bread. People have the choice of time, quality and cost. That is a personal decision. The one thing that people should not do is put the groceries on the credit card without paying off the balance every month. If they are doing that, they need to spend more time in the kitchen or get a second job.
My guess is that these are already in the basket.
Have been reading it this afternoon, Paul, Greenspan, & Sarbanes's comments. Will try to paste it in here - I've never done that.
You gotta love Ron Paul
May, 2003 http://www.prudentbear.com
Official Foreign (central bank) Holdings of U.S. Debt jumped an eye-opening $20 billion last week to $916.8 billion, with these holdings up an unprecedented $170 billion (22.7%) from one year ago. Official Holdings have been expanding at a 25.4% rate since early November. This unparalleled ballooning of dollar reserve positions (as private dollar liquidations are accommodated by local central banks) is a key inflationary mechanism liquefying financial markets globally. In contrast, Federal Reserve Bank Credit is up only about $5 billion so far this year (1.9% annualized) to about $712 billion. Largely because of last December’s $31 billion surge, Fed Credit is up almost $70 billion, or 10.5%, from one year earlier. Curiously, I still read capable analysts referring to the growth of Federal Reserve Credit as "the real inflation rate" and the "currency debasement rate" when it is clearly neither. Such analysis misses the very essence of securities-based contemporary finance with its myriad institutions, Credit instruments/vehicles, and markets. To come anywhere close to garnering insight as to what a true "currency debasement rate" might be, we must first look broadly to the growth (inflation) of new financial claims – Credit creation. In this regard, it is worth noting that Total US Credit Market Debt Outstanding is up almost 50% since the beginning of 1998 to $31.7 Trillion. This $10.4 Trillion increase in claims compares to the $235 billion (50%) increase in Federal Reserve Credit over the same period. The US financial sector increased its liabilities (dollar claims) by $4.9 Trillion, or 90%, since the beginning of 1998, and will almost surely inflate liabilities by an additional $1 Trillion this year. Today, one might look at the Fed’s tepid balance sheet growth and discern positive signs for the dollar, when in fact rampant "currency debasement" runs unabated with the inflation of dollar financial claims throughout the U.S. financial sector. On a weekly basis I underscore the harsh reality that not only are we experiencing a seemingly everlasting inflation of dollar claims, but that these claims (primarily mortgage and consumption-based borrowings) are increasingly underpinned by little in the way of true economic wealth (non-productive Credit). This, in a nutshell, is the essence of today’s intractable dollar dilemma. The dynamics are analogous to the proliferation of initial public offerings - IPOs of increasingly dubious quality - at those fateful late (terminal) stages of equity bull markets. Yet it is the seductive nature of runaway asset inflation that in the midst of heady price gains, near manic demand for these inflating assets can for sometime outstrip surging supply. It is as if the immutable law of supply and demand is suspended for a period; and the longer this abeyance the greater the inflation of increasingly dubious claims. But make no mistake, this suspension waits patiently for manic expectations and bull market extrapolations to be inevitably disappointed – for greed to commence its destined transformation to fear. The consequent reversal of speculative flows then exposes the risks and vulnerabilities associated with the previous inflation of securities (many of suspect value), along with attendant distortions to supply, demand and pricing relationships. The misery of the bear market takes over. Importantly, the abrupt closing of the IPO spigot is a fundamental aspect of the marketplace’s self-correcting mechanism, working to bring the new supply/demand dynamics into better balance. Traditionally, currency markets have operated under similar dynamics. A reversal of speculative flows would see local central bankers tighten Credit conditions to constrain the creation of new claims and restrict liquidity (shut down the "IPO" machine). It may prove quite painful, especially to highly leveraged players, exposed speculators, and vulnerable Bubble economies, but it is a central aspect of the inescapable adjustment process – adjusting to the new supply/demand constraints imposed by the bursting of a Credit/currency Bubble. We have witnessed such dynamics repeatedly with the bursting of past Credit Bubbles in Mexico, SE Asia, Russia, Turkey, Argentina, etc. In all instances – the Argentine experience providing the clearest example - the issue was the bursting of a Bubble of inflating broad financial claims (Credit creation), as opposed to (narrow) central bank Credit and/or government fiat currency. But in the U.S. today something very different has set course. Despite the inevitable bursting of the dollar bubble and the apparent reversal of speculative flows, the Federal Reserve is only more aggressively accommodating the unyielding inflation of dollar claims (running rampant throughout the financial sector). A mighty bear market is slamming the dollar, yet the Fed steadfastly guarantees that the dollar claims "IPO spigot" will run wide open (with its endless torrent of "crummy deals".) This surely does keep liquidity flowing and the Credit Bubble inflating, but it also dangerously ignores the unfolding new reality. Not only does this recklessly disregard developing (bear market) supply/demand constraints, it sets the stage for the inescapable devastating adjustment for both the Credit system (the creator of dollar claims) and the U.S. Bubble economy (addicted to inflating doses of new claims). Postponing the Day of Reckoning is Central Banking at its Worst. There must be some constraints placed on dollar debasement or a collapse in confidence will usher in irreparable global revulsion to dollar financial claims. There is certainly no inflating away our currency problem. Greenspan’s Wednesday "testimony" before the Joint Economic Committee was especially fascinating, if not constructive to dollar confidence. I have included extensive quotes from the Q&A. Mr. Greenspan again proved that he is lost in a sea of flawed reasoning and economic spin. And our hero Dr. Ron Paul once more demonstrated that he is the only individual in Washington that is operating within a sound analytical framework and truly grasping the seriousness of key issues (dysfunctional monetary regimes, flawed central bank policies, the vulnerable dollar, etc.). Mr. Greenspan went so far as to make the ridiculous claim that central banks "essentially have restrained the expansion of credit enough that many aspects of the gold standard, which induced deflationary patterns in past periods, had been replicated in our monetary systems." (Say what?) Dr. Paul gets to the truth of the matter: We deal in the world today with fluctuating exchange rates and all currencies are inflated at different rates… there is no soundness to it, no restraint on the monetary authorities. And right in the thick of truly astounding mortgage finance excess, Mr. Greenspan fails to deliver even a word of caution. Rather, he once again invokes the wonders of "technology" and innovation emanating from our contemporary Credit system and New Economy. But how is it not possible for our leading financial authority to recognize the clear similarities between the forces fueling today’s mortgage boom and the "innovations" that fostered the lending and speculating excess that created recurring global Credit booms and busts, the telecom Bubble, and equity Bubbles just a few short years ago? It doesn’t make any sense and lacks credibility, things that all the sudden do matter in The New Era of Faltering Dollar Confidence. Alan Greenspan: "…It’s important to recognize that a goodly part of the extraction of equity has been an ongoing issue related to a very high level of existing home sales, which has not deviated very much, as you well know, in recent quarters. What has changed is a very extraordinary shift in the way the mortgage market functions…. Let me also point out that surveys by the Federal Reserve indicate that equity extraction from homes, especially refinancings - tend to be very significantly employed to repay other debt. And first of all, they’re a major source of repayment on home equity loans, but they have also shown up as a major factor in reducing the burden of consumer debt. So all in all, it’s turning (out) that the technology, which is obviously at the base here of where this refinancing’s coming from, has changed the housing market in a rather fundamental – I should say, the financing of the housing market - and it has made it a vehicle for liquefying household wealth. And it’s been a major factor in consumer activity. And I might say to you that my suspicion is that it’s going to increase rather than decrease as a factor in the American consumer markets as home ownership continues to increase." (Has our Fed chairman been chit-chatting with Franklin Raines?) And Mr. Greenspan makes reference to the current "low risk" environment for implementing aggressive Federal Reserve accommodation. This is a view of a central banker fixated on "core" consumer prices, with the blinders fixed to avoid the ghastly sight of gross financial excess. Mr. Greenspan speaks as if there are no risks or costs associated with ultra-easy monetary policies, when they are today expanding exponentially. And yes, central bank interest-rate manipulation immediately affects our speculation-rife Credit market, but what are the long-term consequences of so abusing this mechanism? Alan Greenspan: "I still think that monetary policy should take the lead (over fiscal policy) in the short run, largely because we can move on 20 minutes’ notice in 10 minutes, if necessary, where that is obviously not feasible in the fiscal ring. Having made the judgments, then the question is, to do what. And there is the obvious problem of short-term fiscal stimulus which we could arrange. In other words, you can get a very significant short-term surge, perhaps in retail sales, with a very marked short-term decline in taxes, for example. The problem is that if you succeed, the difficulty is that it is short term and it tends to fade, and if it creates levels of production which reduce unemployment as a consequence, over time it reverses, and it’s not a longer-term phenomenon." My comment: The use of aggressive "activist" monetary policy over an extended period categorically nurtures speculation, over-lending, asset Bubbles and generally dysfunctional Monetary Processes. The risks and eventual cost of associated Credit Bubbles are manifestly greater than those engendered by fiscal deficits. Importantly, an economy can be much more easily weaned from government deficits than they can from easy money, endemic asset inflation, highly leveraged financial systems, and all-encompassing Credit Bubbles. Fiscal deficits tend to spread conventional inflation throughout the economy, not desirable but at least not unmanageable. Conversely, perpetual monetary ease nurtures divergent inflationary manifestations that are more sectoral, uneven, destabilizing and uncontrollable for the financial system, economy and underlying currency. Joint Economic Committee Chairman Senator Robert F. Bennett: "Let me just ask two questions. Last November, when you were here, Mr. Chairman, we discussed the downward pressure on prices and options available to the Federal Reserve to combat it. Yet some still seem to believe that low short-term interest rates limit the potency of monetary policy… Could you explain how the Fed could address unwelcome downward pressures on prices through the purchase of long-term Treasury securities?" Alan Greenspan: "As I and a number of my colleagues have stated recently, we have chosen to act solely in overnight funds, essentially addressing the reserve balances of the banks. There are a number of reasons why we did that, but the point at issue is that there is no legal requirement that we do so, nor indeed an economic one. And should it turn out that, for reasons which we don’t expect, but we certainly are concerned may happen, the pressures on the short- term markets drive the federal funds rate down close to zero, that does not mean that the Federal Reserve is out of business on the issue of further easing and expansion of the monetary base. We indeed, as you point out, can merely move out on the yield curve, because as you’re well aware, even though short-term rates are something slightly over 1 percent, longer-term rates are up significantly above that. And we do have the capability, should that be necessary, of clearly moving out on the yield curve, essentially moving longer-term rates down and in the process expanding the monetary base and the degree of monetary stimulus. And since there is such a significant amount of potential in that longer-maturity structure, we see no credible possibility that we will at any point, irrespective of what is required of us, run out of monetary ammunition to address problems of deflation or anything similar to that which disrupts our economy." (That could not have been clearer!) Representative Ron Paul: "Good morning, Mr. Greenspan. I have two questions. One is generalized and it deals with the dollar system and the monetary system that you’re required to operate, and then one more specific, a factor that affects the strength of the dollar. But the big debate now in financial circles is the weak dollar, whether it’s good or bad, versus what a strong dollar should do to us, or for us. And I would like to suggest that there should be another alternative rather than arguing a temporary case for a strong dollar to help us, which it seemed to in the latter part of the 1990s, versus whether the weak dollar will now help us on our exports. Rather than this manipulation of the value of the dollar, I would hope someday that we will talk about a stable dollar, one that does not fluctuate so readily. We deal in the world today with fluctuating exchange rates and all currencies are inflated at different rates, and nobody advocates that we have 50 different currencies in this country; that would be totally chaotic. And yet the world is required to operate, and there is no soundness to it, no restraint on the monetary authorities. And the other challenge, I think, that we have to look at some day is whether we should continue to accept this notion that we can achieve positive central economic planning through the monopoly control of money and credit and setting of interest rates, which is really contradictory to true capitalism. And I think that’s where part of our problem is. The Austrian economists for years - Mises and Hayek and Rothbard - have argued that this is the source of our problem, that the manipulation of interest rates too low causes the boom, and then eventually the bust has to come. And we see this over and over again, but we talk about productivity and other events that are important, but we fail to talk about the initial cause of the mal-investment, the overcapacity, which then requires the correction. Because we operate the reserve currency to the world, we have the advantage of others taking our money and our dollars and holding them. But currently the expectations are that our current account deficit may soar to $600 billion next year. And we do know throughout history, and most economists agree, that these current account deficits cannot be maintained or it it’ll eventually lead to a weaker dollar and higher interest rates. So I think you’re under the gun. In one sense, you want to stimulate the economy with low interest rates, which weakens the dollar, at the same time the weak dollar will eventually push up the interest rates. And my question is when do you think, or do you think we will ever, talk once again about sound, stable currency? And the other question is more specific, because even though what the Fed does in the creation of new money is the key element, other things do have factors. The jawboning and the so-called speculators, for a day or two they have an effect, but they really can’t change it. Jawboning doesn’t work. Ultimately, in 1979, interest rates had to go to 21 percent to restore some order to the dollar. But you talked about the war and the supposed benefits after the war was over and after it started, but I think what has not been recognized is the ongoing foreign policy of our adventurism and our plans, really - those same people who planned and argued the case for Iraq are arguing the case for Syria and they’re arguing the case for Iran. At the same time we don’t have our allies close to us, we don’t have people pouring in the dollars like we did in the 1990s. So that in itself has a subjective relationship to the perceived value of the dollar. And I wanted to know whether or not you think that element in foreign policy today specifically has affected the future perceptions of what the dollar’s value is going to be." (Mr. Greenspan’s response was hopelessly inadequate at best, although I will include it below for the curious.) Representative Paul Ryan: "I’d like to put the word (deflation) right smack in the middle of the table and give you an opportunity to talk about it so that we can address the speculation, sometimes wild speculation, that has gone on in many of the columns that say, ‘We are on the verge of becoming Japan if we are not, in fact, Japan. Greenspan warns of deflation. And we’re looking at 10 years of falling prices and sluggish economy,’ and all of the rest of that. Can you just take that particular topic and deal with it in a way that we hope - I hope will put some of these specters to rest?" Alan Greenspan: "It’s a very serious issue and an issue which we at the Federal Reserve are paying extensive attention to. And the reason basically - and this indeed follows on naturally from my conversation with Congressman Paul - with the elimination of the gold standard in the 1930s and the development essentially of worldwide fiat currencies, almost no economists believed that you could create deflation with fiat currencies because the ultimate supply of those currencies, by definition, comes from government fiat. We went through most of the post-World War II period with the expectation that fiat currencies were essentially inflation- ridden and that the major focus of central banks was to suppress inflation. The notion that deflation would have emerged just never entered our minds until the Japanese demonstrated to us otherwise." (My comment: It is imperative to move beyond a narrow focus on government issued fiat currency in order to comprehend the expansive nature of contemporary Credit inflation manifestations.) Alan Greenspan: "As a consequence of that, not having had any experience in the modern world with dealing with deflation and fiat currencies, our knowledge base was virtually non-existent, in the sense that we know how to deal with inflation." (My comment: This clearly demonstrates a flawed analytical framework. For too long the Fed and economics profession have seemly gone out of their way to ignore valuable lessons that could have been garnered from relevant financial Bubbles such as the Roaring Twenties, Japan, SE Asia and even going back to the John Law fiasco. Financial history is replete with lessons that should have been learned.) Alan Greenspan: "Inflation, obviously, is something that for a half century we’ve been struggling with. We know how to suppress it. We know the consequences of suppressing it. We know the impact of various monetary policy decisions on the levels of output growth and of unemployment. So we are familiar with the mechanism. It’s not that we can very easily and automatically just suppress inflation; it has been a struggle of very great dimensions for most central banks in the world. What’s happened now is that since I guess the middle of the 1990s, we’re beginning to see that it is possible for deflation to exist with a fiat currency, and in a way, it’s, I suspect, credit to central banks, which essentially have restrained the expansion of credit enough that many aspects of the gold standard, which induced deflationary patterns in past periods, had been replicated in our monetary systems and that, frankly, is quite good. We, at the Federal Reserve, recognize that deflation is a possibility. Indeed, we now have been putting very significant resources in trying to understand, without actually seeing it happen, what this phenomena is all about. We cannot say that in the marketplace that there is a severe increasing concern of deflation. Indeed, the various expectations of price by both business and consumers has been relatively flat for recent years, and the so-called TIPS inflation premium -- that is the implicit forecast of the consumers price index, which is embodied in our TIPS treasury yields - has not changed much over the last three or four years. So this is not something which the markets are beginning to sense is about to erupt and something which we must address. Nonetheless, even though we perceive the risks as minor, the potential consequences are very substantial and could be quite negative. So we have created fairly significant resources to try to address this problem, increasing our knowledge of what actually happens, what’s the process and what tools are necessary to fend it off. I think we’ve made very substantial progress in that intellectual endeavor. We do, obviously, have the problem that we never dealt with this before. We know as a consequence that when we don’t deal with something, we have a large element of uncertainty, which strangely we do not have with the implementation of policies against inflation because we’ve dealt with it over so many decades. We believe that because in the current environment the cost of taking out insurance against deflation is so low that we can aggressively attack some of the underlying forces, which are essential weak demand. And indeed, we’ve done that since we started a very aggressive easing in monetary policy in early 2001. Alan Greenspan: "So long as the costs of engaging disinflation are so low, we have moved fairly considerably and in statements we have made, specifically, as you point out, the statement we made at our last FOMC meeting, to recognize this not as an imminent, dangerous threat to the United States, but a threat that, even though minor, is sufficiently large that it does require very close scrutiny and maybe, maybe, action on the part of the central bank. Ron Paul: "Earlier we were talking about your (in)ability to talk about the value of the dollar and what it should be. I find that rather ironic. I mean, the Federal Reserve is in charge of the monetary system, and you, as chairman, have a lot to say about what monetary policy is and how much money will be printed and created and what interest rates would be. So we find it a bit ironic that you can’t comment on the value of the dollar, and we defer to Treasury. Now, Treasury can play a role, of course, by intervening in the exchange markets, but that’s very temporary. But I understand the policy and we don’t expect you to change that, but in a way you’re really in charge, and it’s too bad that we can’t get comments about the dollar. I did want to remind you about following up on the question about foreign policy - how foreign policy anticipation of what we might be doing around the world might affect fiscal and monetary policy and trade policy, how that might affect perceptions of the dollar and whether or not that’s important. But on the currency issue, I’m still not interested in going back to fixed currency rates, such as the Bretton Woods Agreement. That’s not my interest. Because even then Henry Hazlitt, I remember, wrote very correctly back then that Bretton Woods would break down, and it certainly did break down, it didn’t work with that so-called gold exchange standard. But if you have achieved what you hope you have achieved, and that is that central banks now have done such a good job in managing paper money that it’s starting to act like a gold standard - now, that would be an historic achievement, you realize that, because it has not been done in 6,000 years of recorded history. And history’s on my side of this argument, in that paper money doesn’t work very well. Paper money ends badly. And we may be seeing some signs today around the world that paper money is a very shaky system. But a more specific question dealing with that in a return to commodity money, at least on a voluntary basis, if we have a Third World nation that destroys its currency and they don’t have the advantages that we have politically, if they destroy their currency and they want to link their currency to gold because they know history, they’re not allowed to do it. The IMF prevents them from doing it. There’s an IMF rule that says you can’t do it. So wouldn’t this be a good time for us to become more neutral and not antagonistic toward gold and say to the IMF and to our position that, ‘If you choose to go back and get stability and soundness to your currency with a linkage to gold, we ought to permit that?’" Senator Paul Sarbanes: "On the trade deficit question -- of course, we now have this fall in the value of the dollar. How long can we go on running these large trade deficits and building up these very significant claims abroad on our productive capacity?" Alan Greenspan: "Senator, as you well know, the issue of how much you can build up net claims against American residents is a function of not only - and this looks at a large function – of the willingness of foreigners to hold and seek those claims. And indeed, what we have found over the years is that when the exchange rate for the dollar is rising, it, of necessity, means that there is a greater demand for dollars, and that’s what occurred during a significant part of the 1990s. But the obvious problem that you raise is, over the very long run, the ratio of cumulated claims against the United States, more specifically those which relate to debt, create interest charges which, in turn, are part of the current account deficit, which means that it is quite possible to get into an unstable equilibrium." (My comment: If Mr. Greenspan believes escalating interest charges is the chief issue he is clearly mistaken. Today’s "unstable equilibrium" is associated with Credit Bubble dynamics. The U.S. Credit system and Bubble economy require unrelenting lending, financial leveraging, and speculating excesses - the rampant liquidity that is at the same time creating an unmanageable accumulation of dollar assets globally. It is "unstable" precisely because it is unsustainable.) Alan Greenspan: "And that’s an issue which economists have discussed quite significantly with respect to the United States. And as I think I’ve mentioned to you, Senator, I’ve been raising this issue for years and forecasting a major contraction eventually of the current account deficit, and I raise it every five years. I’ve been wrong every five years." Senator Paul Sarbanes: "I know, but if we ever hit it, it almost would be like falling off the cliff, would it not? Alan Greenspan: "No. I would think not, largely because the stock of dollar assets is so huge and the ability to move them around is fairly limited, that I think adjustments don’t occur off the cliff… The question is, what do the holders do with those assets? They’re so heavily involved in dollar-denominated claims that while obviously they can move out of them, and would, there are limits to how fast these things tend to move." So we are to be comforted by the fact that foreign central banks have accumulated such "huge" dollar asset holdings that they have today little opportunity to sell. This Financial Twilight Zone becomes only more bizarre and harrowing by the week. Alan Greenspan’s response to Dr. Ron Paul’s first question: "Well, Dr. Paul, first, let me address the last question first. As I think you may remember that we in the United States government have made a decision in which the value of the American currency will be discussed only by our chief economic spokesman, which is the secretary of the Treasury. And we at the Fed have adhered to that for quite a good, long period of time and think it’s important to have one voice speaking on that issue. With respect to the more general question about the issue of sound, stable currencies, this, as you know, is a very fundamental debate amongst economists. You point out quite correctly that there is a single currency in the 50 states of the United States. The reason why we were able to function in a manner which others are not is that an exchange rate that is a unit-specific currency tends to bring together all of the imbalances in an economy in the exchange rate’s price. In other words, at the border the exchange rate essentially rebalances all of the imbalances between two contiguous countries or it might have been in the United States between two states. If you lock the currency in and you cannot adjust the currency at the border, then the adjustments must occur in capital flows or in labor flows; the only two other ways in which you can get major adjustments that are required between two disequilibrium economies. The advantage of the United States is that, because we have stripped out all barriers to interstate commerce essentially - I should say most - we are able to get equilibria adjusted solely through capital and labor market flows and we have a fixed currency. The reason why it is not, at this moment, feasible in a lot of other areas of the world is that capital and labor flows are not adequate to pick up the full adjustment process. And an endeavor to fix exchange rates in the face of imbalances induces financial breakdowns has occurred." Representative Ron Paul: "May I just interject? I’m not talking about fixing these rates. I’m talking about a single currency that could be universalized." Alan Greenspan: "That’s the algebraic equivalent of fixing rates. In other words, if you lock in legally all rates, it’s irrelevant what you call the currency in one nation and another; it's the lock that matters. And if you have, for example, as we did, the gold standard, which for a very substantial period of time was the single currency of the world, it didn’t matter what you called the other currencies, because they were all locked-in in units of gold. And so the notion of a stable world currency requires a degree of flexibility in capital and labor flows, which we have not yet achieved."
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