Talking about inflation – or denying it – means choosing your words carefully...
DO YOU FIND Ben Bernanke's way with words just so much cant, mere sophistry learnt from the Maestro, Alan Greenspan?
Words matter when you're talking about inflation – or denying it. Selecting the mot juste can prove as crucial as selecting (or ignoring) the right data.
At the turn of the 20th century, for instance, Wilhelm Abel – a German historian – found that medieval chroniclers writing nearly seven centuries earlier had made a curious shift in their choice of words when describing higher grain prices.
Over the thirty years between 1230 and 1260, wheat prices rose by about one quarter in Italy, one-third in France, and nearly as much in England. Abel found that, in writing about these increases year-by-year, the chroniclers slowly switched from blaming fames – or shortages and famines – to blaming caristia, a word derived from carus, meaning costly or dear.
The middle of the 13th century, Abel concluded, saw a switch in how Europeans labeled what was happening to grain prices. The cost of living – as measured by the cost of having enough to eat – was no longer related to good or bad harvests; instead, the cost of living had become dearer. That changed the way people thought about prices. It also changed the way they thought about rising prices. It changed how they behaved in response, too.
General price levels kept growing more costly for the next century. All told, the phenomena has since been identified by David Hackett Fischer as the Medieval Price Revolution.
"People responded to the discovery of caristia [costliness] by deliberately expanding the quantity of money," wrote Hackett Fischer in his work, The Great Wave (OUP, 1996). "During the thirteenth century, a major effort was made to expand the supply of silver in Europe. Old mines opened again in Hungary...New mines were brought into operation. Output was increased by new technology."
Scratching in the dirt to uncover fresh supplies of money, these medieval miners knew better than any modern-day investor that extra cash doesn't simply appear out of thin air, as if by magic. It is "not a deus ex machina," as Hackett Fischer writes, "descending inexorably upon the economy. It [is] an artefact of human will and purpose."
Put another way, "the most important thing to remember," as Ludwig von Mises wrote in the late 1950s, "is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy."
Who's making policy today? Let's agree that words do matter. Let's also imagine for a moment that the word "inflation" only describes an increase in the money supply, the classical definition for pedantic economists. Now let's bend an ear to the latest choice of words, the current price of gold notwithstanding.
"Inflationary pressures have been a feature of the major industrial economies in recent times," says Gordon Brown, the UK finance minister.
"Inflation has risen not just in this country but in most of the major countries," says Tony Blair, his political partner and rival, the current UK prime minister.
"Inflation rates have been pushed upwards across oil-importing countries," noted José Manuel González-Páramo, an executive of the European Central Bank (ECB) at a seminar in Helsinki in March.
"How should central banks react?" asked the ECB man. More to the point, how should the rest of us react, too?
The same pattern that Hackett Fischer found in the Medieval Price Revolution of the 13th century – a pattern of higher price levels preceding a determined attempt to increase the money supply – was also seen in the Price Revolutions of the 16th and then 18th centuries. Steadily rising prices for basic foodstuffs are recorded long before new sources of gold and silver were first tapped.
The Price Revolution of the 16th century, says Hackett Fischer's research, actually began as early as 1480 – "many years before American silver and gold arrived in Europe. In England and Germany, prices nearly doubled during the half century before American silver could have had a significant effect on their economies."
Whatever the initial cause of rising prices – and Hackett Fischer cites population growth in all four of the Price Revolutions he identified between the 13th and 20th centuries – observing the age-old response of human nature to higher prices reveals the true problem of modern central banking. For the natural response to rising prices is actually a search for fresh supplies of cash.
Older, more studied and apparently wiser today, mankind of course knows to meet higher prices with higher interest rates instead. Pace the repeated shock to Western stock markets whenever Beijing reports a new surge in China's economic boom. Tighter reserve ratios are now expected in its commercial banking sector; higher interest rates to slow China's domestic investment bubble are sure to follow, too. That should slow the rate of price increases in the fast-awakening giant, by reducing the availability and growth of credit.
The supply of money must be restricted, not increased, when rising prices show up in the data. That's why modern central banking exists, to counter-act the free market forces trying to increase the money supply in response to rising prices.
But sadly for the tinkerers at the Fed, the Bank of England, the ECB and the People's Bank of China, it's not quite what happens.
In the compact and compressed little Price Revolution we've experienced so far in the 21st century, global interest rates slowly began turning higher in late 2003. The Bank of England moved first, followed a year later by the Fed...then the ECB in Frankfurt...and finally the Swiss National Bank and even the zero-rate crazy Bank of Japan.
Yet the global money supply has by no measure decreased. The broad supply of Sterling has risen at a double-digit rate annually for the past two years; M3 in the United States is now estimated by John Williams' ShadowStats to be growing at nearly 12% year on year; Eurozone money supply is growing at 10% per year, the fastest rate since 1990.
Let's give the Fed, ECB and Bank of England their heads for a second. Let's imagine that they actually want rising interest rates to counter rising prices by restricting money-supply growth. That's the raison d'etre of modern central banking – to act counter-cyclically at all time, smoothing the peaks and wales of the economy and guaranteeing a bump-free ride for all.
It simply hasn't worked, however, over the last 12 months and more. So could it be – gasp! – that modern central banking is impotent in the face of a genuine and sustained rise in living costs? Are the wonks undone by the rest of us – and most especially the commercial banks – scratching in the dirt for fresh supplies of money to overcome the loss of purchasing power that higher prices produce?
Or will it take a surprise and shocking increase in interest rates, a hike up to double-digits throughout the industrialized world, to cut money supply growth and so cut the rate of inflation in prices?
"In cultural terms," writes Hackett Fischer of the 13th century gold and silver seekers, "their actions helped individuals and institutions to cope with high prices, but had the collective effect of driving prices higher."
Higher prices demanded more money to make payment; more money led to increased prices.
If you ever thought today's rising cost of living would somehow slow down by itself, you might just have failed to account for human nature. And if you've yet to buy gold as defense, why wait for the price to double once again?