The Fed and Mr. Krugman: The Price of Nuts

The pine nuts I like to sprinkle on my salads have become so precious the price jumped from an already outrageous $5.99 per 4 ounce pine-nutscontainer to $6.99 this past week. One person who is happy about this is the New York Times’ Paul Krugman, for instead of being like Europe, that is “clearly in the grip of a deflationary vortex,” America only teeters on the edge of a general price plunge. “And there but for the grace of Bernanke go we,” writes the voice of Grey Lady economics wisdom.

Google “grocery prices last 12 months” and it’s post after post beginning with “Consumer prices rise” or “Rising food prices bite.”  However, Krugman claims there is something called a “deflation caucus” keeping the Fed from doing even more than quadrupling its balance sheet. Monetary policy is partisan politics and the right wingers “demand tight money even in a depressed, low-inflation economy?”

Krugman then uses a word coined by Stephen Colbert, truthiness, meaning something that sounds true that isn’t to describe “The Fed is printing money, printing money leads to inflation, and inflation is always a bad thing.” He writes that this “is a triply untrue statement, but it feels true to a lot of people.”

The Nobel winner evidently hasn’t asked anyone from Zimbabwe, or Argentina, or any of the other 20 countries that have experienced hyperinflation in the last 25 years how their country’s inflation policy worked out for them.  Krugman hasn’t noticed the Fed has expanded its balance sheet from less than $900 billion before the crisis of 2008 to the current $4.5 trillion (money printing).

His argument is really that prices haven’t gone anywhere, contrary to what Austrian economists might have predicted. Sure, John Williams reports that using 1990-based CPI calculations, price inflation is running at almost 6%, and calculating it the way the government did in 1980, price inflation is 10%. But Krugman would still wonder, “Where’s the hyperinflation already?”

It turns out the central bank can print money but it can’t print velocity. The PhDs over at the St. Louis Fed say prices aren’t going anywhere because consumers are hoarding money.

Since the government strips gas and food out of their inflation calculations, prices are increasing at less than the Fed’s 2% target. There’s good reason to believe that’s nonsense, but let’s say that’s right for the sake of argument.

So where’s the money? Banks have close to $2.8 trillion in reserves parked at the Fed, and households are sitting on $2.15 trillion in savings, nearly a 50 percent increase over the past five years.

“So why did the monetary base increase not cause a proportionate increase in either the general price level or (gross domestic product)?” economist Yi Wen and associate Maria A. Arias asked in the St. Louis Fed paper. “The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money.”

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According to Yi and Arias during the first half of this year, “the velocity of the monetary base was at 4.4, its slowest pace on record.”  Prior to the Great Recession base money turned over 17.2 times.

So the Fed’s been injecting more and more money and it simply has gone nowhere. No GDP growth, no price inflation.  The two Fed researchers think people are hoarding because they are generally gloomy after the financial crisis and low, low interest rates  provide no incentive to buy interest-bearing assets.

By all accounts the Fed has gone where no central bank has gone before, but according to the Times columnists, not far enough. However, note to Mr. Krugman, the two Fed researchers have this conclusion:

In this regard, the unconventional monetary policy has reinforced the recession by stimulating the private sector’s money demand through pursuing an excessively low interest rate policy (i.e., the zero-interest rate policy).

So it’s not the Fed responding to right wing deflation nuts that’s keeping growth and price increases (the government can see and measure) from happening, it’s Joe and Jane Lunchbucket being, dare we say, prudent.

What’s been left out of this discussion is the primary money creation engine–commercial banks.  Up until now they’ve been kow-towing to regulators and licking their real estate loan wounds.

No more. “Lending Appears Back for Good in FDIC’s 2Q Data” reports American Banker.

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Three-quarters of all institutions reported higher loan balances in the 2nd quarter with almost all major loan categories participating.   “The growth is more pronounced at community banks, where balances over the past year have increased 7.6% versus 4.9% for the industry as a whole,” reports AB.

FDIC Chairman Martin Gruenberg said the industry that once was “preparing balance sheets, strengthening capital and liquidity and recovering from the aftermath of the crisis and ensuing recession, … [is] moving into a period of higher growth for the economy” with “increasing credit demand and greater opportunity for the industry.”

That’s not all. The commercial banks’ un-taxed competitors, credit unions, increased their lending 9.8% in the second quarter.  The Wall Street Journal reported, “New-auto loans jumped 17% to $77.7 billion in the second quarter, and used-auto loans rose 12% to $135.3 billion, the credit-union regulator reported. Net business loan balances increased 12% to $48.8 billion.”

Mr. Krugman shouldn’t declare defeat to the deflationists just yet. Bankers are learning to say ‘yes’ again, and that means velocity and price increases.

We’ll see how much pine nuts will cost then.

Douglas E. French is a Director of the Ludwig von Mises Institute of Canada. Additionally, he writes for Casey Research and is the author of three books; Early Speculative Bubbles and Increases in the Supply of Money, The Failure of Common Knowledge, and Walk Away: The Rise and Fall of the Home-Owenrship Myth. French is the former president of the Ludwig von Mises Institute in Auburn, Alabama.

The Ludwig Von Mises institute of Canada (“Mises Canada”) was founded in November of 2010 in order to spread the teachings of the Austrian School of Economics to Canada.  It is an independent organization making up one of the many Mises Institutes now operating in over 20 countries.

It is the mission of Mises Canada to educate the public on the importance of placing human choice at the center of economic theory, to encourage a revival of critical historical research, and to advance the Misesian tradition of thought through the defense of the market economy, private property, sound money, and peaceful international relations.