Money and Inflation; L.M. Parks

It is subdued. There's no re-emergence. We've learned our lesson. So if inflation has ceased to be a problem, why does it occupy Mr. Greenspan's thoughts so much? Perhaps inflation is more of an issue than he is letting on. Why should inflation just be a measure of the prices of some arbitrary basket of items in the consumer goods market? Why ex clude the price level of the capital and real estate markets? After all, money isn't al ways spent on goods and services; some of it is invested in stocks and bonds and real estate. By any yardstick, stocks and bonds have gone way up in price in the last several years. Further, the government has enacted laws and regulations that effectively persuade prudent people to put or keep money in the capital markets, thereby decreasing money that might otherwise be spent in the conLawrence M. Parks is President of Systematic Asset Management Corporation, a registered investment adviser.

sumer goods market. For example, about $800 billion in IRA accounts by law must be invested only in stocks and bonds. Large amounts are also tied up in Keoghs, Pension Plans, 401-K's and other quasi-savings plans that must be similarly invested. Perhaps if people had free use of these monies, some might be used to improve homes, buy cars and other consumer items, which would certainly spike the price level of the consumer goods market and the nominal inflation rate. Clearly, there is vast deferred inflation. Some day people will spend that money, and that's when nominal inflation will pop. Similarly, because of inflation over the last two decades, if people sell appreciated property, capital gains taxes willmany times result in a loss of capital. The result is that money is kept in the capital markets for tax purposes, and is kept out of the consumer goods market. Thus, people have been mis led about the purchasing power of their savings which retain value provided they are never spent in the consumer goods market.

Again, there is vast pent up purchasing power postponed by government and, as a result, a tidal wave of latent inflation. The most widely reported measure of price increase is the Consumer Price Index (CPI). But the CPI is an untrustworthy measure of price inflation. First, the Con sumer Price Index fails to account for prod ucts and services that have been inflated out of existence. For example, when I was a child, our family physician made house calls for $2. (What would a doctor's house call cost today, assuming a doctor would make one?) There were ushers in movie theaters, and even middle-class folk employed do mestic help. First-class postage was three cents, and the post office made four deliv eries each day: two regulars and two spe cials. For the most part, these and many other services no longer exist or have deteriorated greatly. Hence, if the measuring rod is not consistent, then CPI comparisons over time cannot be useful.

Another major failingof the CPI is that the goverment must fudge every time there is an 207 208 THE FREEMAN • APRIL 1994 improvement in a good or service. For products where innovation is frequent, such as consumer electronics, there is no mean ingful way to compare price changes from year to year. Consider, also, the case of a more expensive automobile that is substan tially smaller and lighter than its same make and model predecessor. Because the new automobile is "improved," the govern ment reduces the price increase for CPI purposes. How can this methodology be objective? On top of that, the CPI "market basket" was last reformulated in 1982-1984and, for budgetary reasons, is not due to be revised until 1996, if then. When I told one of the senior government economists about this article and that it was my contention that inflation was substantially understated, he said: "We would concur with that."

Third, the CPI fails to report products and services whose prices are reduced by gov ernment subsidies. Continuing inflation many times causes certain goods and ser vices to become so expensive that they either disappear or their manufacture is arbitraged to foreign countries. Where there are politically connected constituencies and where the production of products or ser vices cannot be transferred out of the coun try, government many times subsidizes them, thereby reducing the price to consum ers and keeping the CPI artificially lower than it would otherwise be. For example, in some industries, govern ment subsidizes research and development. Even after considerable machinations and subsidies from the state, New York's Blue/ Cross Blue/Shield rates were recently in creased 25 percent. Depending upon whom one listens to, a subway ride in New York City costs anywhere from $3.50to $6.00, but the public is charged only $1.25. The rest is subsidized from taxes, whose increases are ,not in the CPI. Clearly, if the true cost of a subway ride was incorporated into the price, the CPI in New York City would be higher than it is.

Because of its historical link to gold, many foreigners still consider the dollar "as good as gold," even though the link is irrevocably broken. As foreign governments, such as Russia, debase their own currencies, rather than switch into gold, foreigners many times switch into the next best thing (in their minds): United States dollars. According to Grant's Interest Rate Observer, perhaps as much as 60 percent of the $363 billion in American currency is now circulating in foreign lands. The drain of dollars from the United States to foreign lands is price deflationary in the United States. But ifby accident some of these errant countries should get their monetary houses in order, then dollars will flow back to the United States. Again, there is substantial pent-up purchasing power that will someday be spent and, then, latent inflation will become obvious. Prices Should Be Falling As industrial processes and productivity improve, prices should decrease. In fact, the increasing productivity of the 1980s contributed to the lower rate of price infla tion. Decreasing prices improve every body's living standard. That is the benefit of an advanced economy: higher production of better products available to more people at lower prices. If prices do not decrease because of inflation, then the benefits of productivity increases are not shared. By gerrymandering the CPI and pursuing "price stability," the government obfus cates this fact.

During the past three years, by purchas ingTreasury securities, the Federal Reserve has monetized government debt at a high rate, and the most basic measurement of money supply, M1, has increased 37 percent and currency has increased 27 percent. That this has not been reflected in price inflation is due only to the flawed definition of price inflation and the fact that vast amounts have diverted to foreign countries. Inflation is a worldwide phenomenon and has been un derstated all over the planet. Perhaps long term interest rates haven't dropped that much for good reason. 0 Correction, Please! Will Keynes Ever Die? by Mark Skousen "It was here [The General Theory] that Keynes invented Keynesianism, disproving the classical laissez-faire theory of the self adjusting, self-regulating, selfsufficient market ... " -Arthur Schlesinger, Jr. New York Times Book Review (January 23, 1994) K eynesian economics should have died long ago. Ludwig von Mises, one of Keynes's chief critics, thought it was al ready dying out in 1948. "What is going on today in the United States is the finalfailure of Keynesianism. There is no doubt that the American public is moving away from the Keynesian notions and slogans.' ,1 Mises, Hayek, and other free-market econ omists thought The General Theory was a "tract of the times," not anything revolu tionary or permanent. Hence many conser vative economists miscalculated the persis tence of Keynesianism.