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Increasing Inflation or Playing With Fire

Posted by Larry Doyle on May 19, 2009 4:09 PM |

There is a reason parents tell their children not to play with matches. Small campfires can take down an entire forest. In similar fashion, heightened levels of inflation also have the potential to explode in a ball of fire. Are our central bankers playing this inflation-ahead1game as a means of addressing our massive government and non-governmental debt burden? In my opinion, they most definitely are rubbing those sticks together mighty hard. 

I have highlighted three means for central bankers to address excessive debt: default, restructure, devalue. Individuals and corporations are increasingly defaulting and will default at an increasing rate as evidenced by my post earlier this morning highlighting the surge in delinquencies. Individuals and corporations are looking to renegotiate and restructure debt burdens wherever possible. Our government is restructuring debt through the legislative process and not always consistent with generally accepted market and legal principles. Despite words to the contrary, I am convinced that Ben Bernanke and Tim Geithner are on course to devalue our debt, as well, via a promotion and acceptance of higher inflation.

I was somewhat surprised to read that two economists whom I highly respect are encouraging Bernanke specifically to raise the inflation target. Greg Mankiw, an Economics professor at Harvard, shied away from providing an actual inflation target but did offer that Bernanke should work towards a “significant” level of inflation. Kenneth Rogoff, also a Harvard professor and former chief economist at the IMF, believes Bernanke should target an inflation rate of 6%.

Rogoff and Mankiw are both highly regarded. In my opinion, they are calling for higher inflation because they are clearly concerned that the mix of stimulus programs (monetary, fiscal, and budgetary) will not be sufficient to jumpstart our economy.

Bloomberg highlights their concerns, U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff:

They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations. It might also help the economy by encouraging Americans to spend now rather than later when prices go up.

“I’m advocating 6 percent inflation for at least a couple of years,” says Rogoff, 56, who’s now a professor at Harvard University. “It would ameliorate the debt bomb and help us work through the deleveraging process.”

Such a strategy would be risky. An outlook for higher prices could spook foreign investors and send the dollar careening lower. The challenge would be to prevent inflation from returning to the above-10-percent levels that prevailed in the 1970s and took almost a decade and a recession to cure.

“Anybody who has been a central banker wouldn’t want to see inflation expectations become unhinged,” says Marvin Goodfriend, a former official at the Federal Reserve Bank of Richmond. “The Fed would have to create a recession to get its credibility back,” adds Goodfriend, now a professor at Carnegie Mellon University’s Tepper School of Business in Pittsburgh.

The concern about unbridled inflation truly unnerves me. Much as the development of credit derivatives swaps (CDS) played an enormous incendiary role in accelerating the credit crunch, are there similar vehicles in place that would serve to spark an inflation inferno? Well, as with any fire you need a spark, a steady supply of oxygen, and a fuel source. The fuel is the massive growth in money supply as designed by Big Ben Bernanke. The supply of oxygen may very well be a combination of $780 billion dollars of stimulus starting later this year. The spark could very well be a passing statement by a government official that an increase in the inflation rate would not necessarily be a bad thing.

Bernanke does not necessarily need to make that statement. In fact, I think for purposes of trying to maintain a degree of integrity Bernanke would not make that statement. Geithner may also be compromised in making such a bold assessment. Summers may be the guy.

Inflation is the bane of existence for fixed-income investors. Warren Buffett offers his take on that front while also implying that inflation is a fait accomplit. Bloomberg offers:

Billionaire investor Warren Buffett, chairman of Berkshire Hathaway Inc. in Omaha, Nebraska, suggested that faster inflation was all but inevitable.

“A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, it’s going to inflate its way out of the burden of that debt,” he told the CNBC financial news television channel on May 4, adding, “That becomes a tax on everybody that has fixed- dollar investments.”     

Why am I thinking, “Don’t Try This At Home” and “Keep Away From Children”?  This is a very dangerous game!!


  • fiscalliberal

    I would even suggest that the argument for inflation was set in the last half of the Bush II administration with the deficit from the out of control war costs for which we got nothing in return. We need to remember Osama has not been captured and The Chaney Oil fields are in other country hands. A lot of money was dumped from helicopters into Iraq, Afghanistan and Pakistan. GAO was constantly complaining about no accountability on how it was spent. We also need to mention the 3 Billion going to Isreal which further foments the middle East.

    We continued to borrow from surplus funds from Social Security. Now they are projecting outflow to exceed inflow for Social security about 2017 and of course the Medicare costs are going out of control. Medicare shortfalls can be managed by charging more for premiums. However the Social Security is too big and the surplus reserves will need to be paid back. The magnitudes are to big to raise taxes, so they have to inflate their way out. That way the full faith and credit of the US government can be maintained. That condition existed in the Bush II administration and Obama is continuing the trend.

    It is interesting that Mankiew and Rogoff in spirit join Krugman in terms of needing a little inflation to get things going. In his book “The Return of Depression Economics” Krugman maintains that the Japan lost decade can only be cured with more inflation.

    When it is all said and done, I am more comfortable with Bernanke in the Fed who is willing to tinker. Greenspan was such a market advocate and did not seem to have the understanding to reign things in when they had to be. Volker really proved that inflation can be controled. He had to deal with first order numbers. Hopefully Bernanke will look at inflection points and get ahead of it to manage it.

    The first sign of serious changes will be a independent non partisan commission to level off SS cost of living increases, let inflation raise and wring their hands saying they are doing it for the good of the country. Then the media will chime in and all will be good.

    Like Lake Wobegone, the children will be good looking, everyone will be the same (poor). The Lutherans and the Catholics will get along with the Muslems, and all will be good.


  • Fiscal –

    I truly appreciate and concur with your perspectives.

    Those who have lived their lives in a fiscally prudent fashion are being forced to accede to the will of the masses, and moral hazards are being violated in unprecedented fashion.

    If nothing else, this scenario provides a wealth of material on which to write but also an obligation to find one’s voice.

    You have certainly found yours and I commend you.

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