Determining Right and Wrong

Joe Wiesenthal is ‘infuriated’ at the fact that ‘Fed Haters’ haven’t put their collective hand up in admission of error in assessing the economy in the wake of the actions taken on by the Federal Reserve. This group, which I am sympathetic to, for the most part predicted that the Federal Reserve policies of the last 5 years would eventually lead to high levels of inflation. That they haven’t, at least in terms of the CPI, hasn’t moved these ‘haters’ to reassess their views, which annoys Wiesenthal. He writes:

This is what makes folks like Paul Krugman so infuriated and why he is so harsh toward his critics, because he regards them as intellectually dishonest.

There’s more evidence of that Thursday, courtesy of a great Bloomberg piece by Caleb Melby, Laura Marcinek, and Danielle Burger in which they called up various signatories to a 2010 letter that warned former Fed chair Ben Bernanke about impending inflation.

The upshot: For the most part, they don’t accept they were wrong.

My faction of the ‘haters,’ the Austrians, have a basic framework for assessing the current economic situation, which is as follows: in attempting to mitigate the bursting of the previous bubble, of which falling prices was a result, the Federal Reserve will introduce upward pressures on prices by flooding the system with liquidity. This upward pressure on prices will ultimately pose a problem for a broader consumer base which is fundamentally unable to support rising prices indefinitely; in other words attempting to breathe new air into a dead bubble will lead to the same ending as before – namely another massive economic downturn.

Inflation, a word which has been distorted over the years to now mean rising prices, is only a part of the story, which in totality is about imbalances, and the market’s attempt to address those imbalances. Jim Grant, a proponent of the Austrian theory is featured in Wiesenthal’s piece:

Here for example is Jim Grant, editor of Grant’s Interest Rate Observer and an intense critic of Fed easing:

“People say, you guys are all wrong because you predicted inflation and it hasn’t happened. I think there’s plenty of inflation — not at the checkout counter, necessarily, but on Wall Street.

“The S&P 500 might be covering its fixed charges better, it might be earning more Ebitda, but that’s at the expense of other things, including the people who saved all their lives and are now earning nothing on their savings.

“That to me is the principal distortion, is the distortion of the credit markets. The central bankers have in deeds, if not exactly in words — although I think there have been some words as well — have prodded people into riskier assets than they would have had to purchase in the absence of these great gusts of credit creation from the central banks. It’s the question of suitability.”

Grant is not 100% wrong in his concerns about the recovery. It has been disappointing. But a rising stock market is not how people measure inflation, and the labor market has recovered significantly, bringing real relief to millions of people. It is true that it hasn’t been a great time to be a saver who has been 100% in cash, but if you’ve been in stocks (or even bonds!) you’ve done quite well.

Grant is pointing out that while not much inflation has occurred in the sense of consumer prices (which is arguable), there has been significant appreciation in asset markets as a result of Fed actions. This appreciation has not necessarily been reflective of real economic conditions, but rather ‘great gusts of credit creation from the central banks.’ According to the Austrian school, this sort of appreciation is problematic precisely because of this unstable sort of foundations. What the central banks giveth in easy conditions, they can taketh away with tighter conditions. The Austrians would rather see an economy founded on savings, investment, capital and labor accumulation. Wiesenthal admits that there is some truth to what Grant is saying, but he belongs to a coterie which holds a simplistic view that prices rising = good, and falling prices = bad. As the prices in question are currently rising, Wiesenthal has no qualms rationalizing it, but within that rationale are shades of concern, namely the fact that wealth has merely been transferred from savers to speculators in financial assets. This is not real wealth creation, which is what an economy interested in improving the standard of living of its people should be focused on.

So when are the ‘haters’ actually proven wrong? Quite simply, when the Federal Reserve exits accommodation, and normalizes policy with no adverse effects. The economic theory the Fed subscribes to dictates that it can ride in to rescue the financial system, prop it up with emergency funding, and then remove it at a later date when it is confident the economy can stand on its own. The ‘haters’ bet, at least the Austrian version, is that the economy cannot stand on its own absent the Fed. Until the Fed withdraws, a process Chairman Janet Yellen suggested ‘could take to the end of the decade’ at the last FOMC policy press conference, the jury is out. To Wiesenthal, Krugman, or any of the self-proclaimed judges in The Case of the ‘Missing’ Inflation: reaching a verdict before the Fed finishes its work is nothing more than celebrating at halftime.


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