That 70's stagflation is back!

Recent articles on the specter of stagflation are right on. What is not made explicit is the cause of stagflation: the Federal Reserve. Since its creation in 1913 when the federal government nationalized our money supply, we have allowed the hand of politicians inside the cookie jar of easy money. As expected, they can’t stop eating.

The root cause of stagflation has been known for over a hundred years. As the Fed creates money out of thin air to finance politicians’ expenditures, prices must increase (inflation). Printing of money also causes a reduction of the interest rate below its natural level. The natural rate of interest is not controlled by the Fed but is controlled by the proportion of income consumers save versus what they spend. The more they save, the lower the natural interest rate, the higher the level of investment, the higher the productivity of labor and the higher the level of economic prosperity. But an interest rate artificially below what real savings rate supports gives investors, entrepreneurs, businesses, banks and homeowners the wrong economic signal: projects that would not have been profitable and would not have been started now become viable, at least for a while. But the inevitable correction necessary to liquidate all of these malinvestments always come because the distorted capital structure in the economy is not supported by real savings. Instead, the capital structure is supported by nothing, by thin air, by paper money. As this paper money flows from the Fed to the central government to banks to businesses and finally to consumers in the form of higher wages and as consumers save at their natural rate rather than the higher rate implied by the artificially low interest, they spend more on consumer goods and less on savings. As the economy grapples with an amount of consumer savings that is insufficient to support the total investment in capital to which business and entrepreneurs are committed, like a pyramid scheme, those now unprofitable capital projects on the bubble collapse (it could be investments in the stock market, businesses, dotcoms, mortgages, whatever) and are liquidated (recession).

If at the same time that the bubble bursts the Fed accelerates the money printing machine, as it is doing now and as it did back in the 70’s, we get a recession caused by manipulation of the interest rate with inflation caused by printing money (stagflation). Boom and bust cycles and inflation are not inevitable characteristics of capitalism free from government intervention. But these cycles are the predictable consequence of the actions of the Federal Reserve. Politicians cannot fix the mess they got us into by printing more money and lowering interest rates because that was the cause of the mess to begin with!

The only way to manage our politicians’ addiction to the cookie jar of paper money is to smash their jar once and for all: dismantle the Federal Reserve, privatize our money supply and bring back the gold standard. Until politicians can figure out how to create gold out of thin air, the gold standard is the only way to force stability on our supply of money and the only way to stop them from causing inflation and recessions. Plus, it is the only way to keep politicians at the federal level honest: with their ability to get their hands in the cookie jar gone, they would be forced to increase taxes rather than print money in order to finance federal expenditures, just like state and local governments are forced to tax to spend. This was one of two critical elements of the vision for sound money of our Founding Fathers (the other one was to severely restrict the ability of the federal government to impose taxes on individuals). Thomas Jefferson fought hard and eventually succeeded in closing down Alexander Hamilton’s federal reserve/central bank scheme. Jefferson knew that giving the power to create money to the federal government would be the beginning of the end of the American experiment. Jefferson was and still is right. I mean, if we all intuitively know that printing money is wrong for private individuals, what in the world makes us think that it is right for the Fed to counterfeit at such monumental levels?