Hidden Inflation and Debilitating Deficits

by Anthony Gregory
May. 26, 2011

After the 2008 financial collapse, many of us called on politicians to let the market correct itself. The government’s expansion of the housing sector and the Fed’s artificially low interest rates caused an unsustainable and thus ultimately destructive boom, which eventually leads to a bust. This explanation of the business cycle won F.A. Hayek the economics Nobel Prize in 1974.

Two years ago, we needed a recession, including falling prices and wages, to reallocate wasted resources to more productive uses.

But that would be cruel, we were told. Without “rescue” and stimulus packages, we’d have high unemployment for a year. But more than two years later, we still have high employment, and the Fed’s attempts to reinflate the bubble have ensured that the economy is as fundamentally unsound now as back then.

Meanwhile, price inflation has begun. Mainstream economists say it’s under control, which seems true when you exclude prices for food, energy, transportation, housing, health care, gold, silver, and stocks. But what else is there?

This speaks to the irrational fear of deflation. Especially during a recession, we should want prices to drop, yet we’re told this would spell calamity. Even in real estate, politicians want to keep prices high (even as they paradoxically want low-cost housing). This has mostly hurt renters, the poor, and minorities.

In an economy with sound money, prices should generally fall. Innovation means more production for less. The question shouldn’t be, why are prices now rising, but rather, why haven’t they been dropping?

The answer is: the government and especially the Fed. The Fed inflates by expanding the money supply. In the last decade inflation was hard to detect, as the wonders of the market have mercifully lessened the effect on the consumer at the checkout stand.

But we’ve long had inflation. We see it in our potato chips bags, which have shrunk even as the prices haven’t. Producers will tend to cut corners before charging more at the register. Candy bars have gotten smaller, airline fares are often accompanied by luggage fees, and the quality of many products has declined.

People blame inflation on greedy producers, who supposedly raise prices for the heck of it. Unions and foreigners are other scapegoats. But the real culprit is government, which spends money it doesn’t have, prints dollars out of nothing, and inflates us all into a gradual impoverishment.

Since 2008, most of the economy has suffered, but one sector has not: government. At every level, government has been expanding for decades, and this trend has continued and even accelerated in the last few years. At home and abroad, Washington spends more than ever, digging us deeper into debt every day, even as Republicans and Democrats bicker over two percent of the deficit. The bureaucracies, defense contractors, and favored Wall Street firms laugh all the way to the bank.

America can’t afford its growing welfare state or expanding wars, the burgeoning public-sector pensions or failed policies like drug prohibition. High unemployment is a cost of the government strangling the economy. Inflation will continue so long as the Fed devalues our dollar.

Raising taxes can’t close the federal deficit. San Jose State economics professor Jeff Hummel has written that federal tax revenue “has bumped up against 20 percent of GDP for well over half a century. That is quite an astonishing statistic when you think about all the changes in the tax code over the intervening years. Tax rates go up, tax rates go down, and the total bite out of the economy remains relatively constant. This suggests that 20 percent is some kind of structural-political limit for federal taxes in the United States.” Increasing taxes might slow down the economy, but even dramatic changes in tax rates are unlikely to raise much more money for Uncle Sam.

We must slash government spending across the board. Obama promised to go line-by-line through the budgets and eliminate waste. His recommendations for cuts have been even more pitiful than the tiny ones proposed by Republicans. It’s too late for this child’s play. It’s time to take a sledgehammer to government programs at all levels, foreign and domestic. Better yet, it’s time to start talking termination of programs and policies rather than reform.

They say we can’t throw the baby out with the bathwater. But the dirty water is the government and the economy is the baby. It’s going to drown unless we drain the tub.
__
Anthony Gregory is a research analyst at the Independent Institute, a policy adviser for the Future of Freedom Foundation, and a columnist at LewRockwell.com. Anthony's website is AnthonyGregory.com. Send him email.