Thursday, September 20, 2012

The Myth that Inflation steals from Workers

I haven't found the original quotation, which perhaps was reiterated by some Austrian economist (like the haplessly wealthy von's).  But it goes something like this:

     Inflation robs workers of their wages.

Many people would probably agree with this nowadays.  It has been a wonderful example of mind control (P.R.) how this has been achieved.  It is transparently wrong at first glance (see The First Level of Error below).

But it is worse than wrong.  Not only does inflation NOT rob workers, a small amount of inflation which seems to be about 5% makes decent jobs possible.  It is lack of needed inflation that robs workers of their jobs!  (But to understand that, you have to understand some economics that is almost universally accepted by the English speaking profession, but still somehow not understood by the Bank of Sweden award winners in funded prestige chairs at the University of Chicago.  I will discuss that shortly below.)

Among the brightest of the bright of current well known younger guys in close-to-mainstream economics (the actual mainstream is deadwood) is Steve Randy Waldman.  He's no lefty like me, not even close (he is touted by some writers at The Financial Times) but is is a serious radical in the sense of thinking down to the roots of things.

He has written a provocative article that stabilizing prices is immoral.  He is right, and that is actually what government banks have been doing mostly, deliberately, and by design.  Not robbing savers via inflation, but starving the economy of needed grease by systematically engineering high rates of interest.

Paul Volker was one of modern pioneers of this form of central bank repression, and it was the reason why (as is now known to many) the period of the Carter administration had some of the best job growth in private industry in recent US history.  That was mainly an outcome of what had gone before--New Deal capitalism with reasonable tax rates and moderate regulation bounding back after the malaise of the early 1970's brought on by external forces like oil shocks.  But Volker systematically changed US central banking by dedicating it mainly to fighting inflation.  And it was very successful, we have had low rates of inflation, well below 5% per year, ever since.  And as another result (explained well in Jamie Galbraith's book Predator State), we have had an incredibly poor economy for creating jobs in most of the time ever since (except for the Clinton administration, which was at best a one-off).  So that's really why the job creation of the Carter administration hasn't been reproduced.  Carter appointed Volker who re-engineered and ultimately ruined the banking side of the job creating machine.  OK, it's only one reason.

In Randy's view if a person wants protection from inflation, that is their problem, and they should have to buy it somehow (through inflation protected bonds, for example).  I agree with that as far as it goes.

I don't at all agree with others (not Randy) that the problem goes away if you eliminate something like cash and only have EFT. Inflation, modest inflation, is an inevitable result of any reasonably well working economy, and especially important in quickly developing economies (example: Korea from 1970 to 1990) where 20% inflation might be the correct amount.

You might get more out of Randy's widely praised piece and it's extensive commentary than mine.  Sometimes I think I should spend all of my waking hours reading everything he has written until I have completely finished, and then start over.  Even though I always disagree at a few points.

The First level of error

Inflation is by definition an increase in all prices, including wages.  So, at this first level of analysis, inflation is neutral with regard to workers, positive with regard to debtors (it decreases the relative worth of debts), positive for owners of real assets like real estate (they increase in value and therefore potentially could be sold for more), and negative for just one group: savers.

Not all workers are savers.  In fact, in much of the world, very few are.  I am not, even though I'm middlingly wealthy and in a wealthy country I'm a debtor/owner as are most of my friends.  If I happen to save a small amount, it may be useful to grease various transactions, but basically until I pay all my debt, or even if I never do so (in the grand tradition of Jefferson himself) it makes no sense to save cash, since I can always get a surer deal by paying down debt instead.  So why should I save significantly?  My wealth consists not of money but real stuff and real relationships, and my greatest income generating asset is myself.  My greatest real assets are my house and car, which house me, store my stuff, and bring me to work and back.

Therefore for me and most of my friends inflation would be a net positive.  It is curious, very curious to me, that most of them don't realize that in this Greed is Good country.  A few of my fellow owner/debtors are actually quite rich people, people somewhat on the selfish side who would personally benefit financially from inflation, yet resonate with the Inflation-is-Theft myth so well they become the most ardent supporters of it.

This is often painted in moral terms.  Savers are the good guys whose savings make investment possible.  It turns out that is itself wrong in many ways to be covered in future levels of analysis.  What makes investment possible, and indeed what investment is, is spending, often financed by borrowing.  It might be more fair to say that savers, or at least some of them, are the cranks who think their money can continue growing when everything else is collapsing, and that is not their problem.  From the standpoint of an entire economy, savings is an option, but spending is absolutely necessary because spending is the economy.  One person's spending is another's income.

I personally see no immorality in never paying off all my debt, though I will likely do so from time to time for convenience.  I would not likely be leaving the world a net negative thereby.  For starters, I would be leaving real assets worth far more than the debts.  Jefferson left many assets also, and enabled a far wealthier country.  It would be ridiculous to say Jefferson left the world worse off, unless you disagreed with his his larger ideas and contributions, such as the Declaration of Independence, the Religious Statues of the State of Virgnia, etc., or even then.

The world is not all about money and accumulating money.  Money should be seen as just the grease that makes a decent society possible.  And it's good to have a nice free flowing grease, rather than one that tends to get clogged.

The myth that inflation steals from workers has been highly promoted not by hapless workers (or unemployed!) but by wealthy...savers.  Not surprisingly, most savings are from the most wealthy people.  And they have done a very good job of convincing people that what is in their short sighted self-interest--lowest inflation--is in everyone's interest. And it's wrong, wrong, wrong.  As Brad DeLong has pointed out, it's not really even in their interest.  Full employment is in everyone's interest, even the top 1%.  Full employment is how you get to maximum production, maximum output.  They just haven't figured that out yet, because they more interested in fighting tribal class warfare.  Or perhaps you could say they aren't interested in the total output, but only in how much they can skim.

The sad part is that lack of interest in full employment ruins real people's lives by not creating the jobs they need, depresses the real value of the labor force, and ultimately the wealth, the real wealth, of the future.

The lessons about the need for a soft money have been learned many times.  My favorite example is the Progressive Era, during which William Jennings Bryan gave his famous Cross of Gold speech denouncing the gold standard and explaining the bad effect it had on farmers--most of the population of the time.  He was right about that, if not everything.  And at the time, it was common knowledge, which quickly got rubbed out through the rising public relations industries, shilling for, among other corporations, banks.

But really it was all figured out by Keynes and others in the 1930's.  And have I mentioned that Hitler did one thing right.  He was able to put everyone to work with Keynesian economics.  If only he had done a good thing with all that labor power.  I concede that doing the right things with our labor power is the very most important thing, or at least not doing something disasterously wrong.

Which is precisely why it shouldn't be left to greedy jerks, but decided by a democratic consensus process.  Leaving everything to be decided by greedy jerks is the essence of neoliberalism, laissez faire, and the like.  The entire process we need hasn't been worked out, but some countries already have done better than others by having industrial planning and the like.  The very thing that neoliberal (or worse) jerks like Romney decry above all else.  His pals in Wall Street should decide what will be.

The lesson is learned many times, but then completely erased from memory by the machinations of the most regressively wealthy, who once again convince everyone, once most people have jobs, that low inflation is the most important thing, and before long after an era of systematically lowered inflation here were are back again in economic depression.  It's no coincidence, that's the way the economy works.  An economy that can't inflate can't grow or meet changing needs, or even make needed adjustments.

Which gets to another level, the "needed adjustments" level.  But first, the evidence.  I do believe not in just wild speculation, but in actually checking the evidence.

The Evidence: The Philips Curve

The evidence is the most compelling evidence in modern economics, replicated endlessly, in fact it is the basis of the game that Central Banks universally play in reverse to fight inflation.  It was even part of the basis of the (bad) arguments Milton Friedman used to discredit the dominant Keynesian economics of the 1960's.  (By the way, Keynes is back big now, Monetarism hasn't been used since 1982.)

By the way, Keynesian economics is now back on the table and Friedman's version of Monetarism--which actually turned out to be identical to Keynesianism when it was correct, was officially dumped in 1982 because it didn't work for a technical reason, central banks can't actually control the money supply, but they can to a point set interest rates...that should be read as meaning they can raise real interest rates.  Since then, that bastard bastion UofC has been proming a different theory, Real Business Cycle theory, which is a step back to before Say officially repudiated "Say's Law" in 1829.

Anyway if you don't know about the Philips Curve, but you've ever thought about unemployment, you've haven't been educated.

The historical relationship is that lower inflation correlates with high unemployment, or conversely that higher inflation corresponds with lower unemployment.

Now you can argue that correlation does not imply causation.  But this is a very consistent relationship, has held up for a century, in different countries, so that strongly suggests a casual relationship of some kind, if you need that kind of thing.  Even hard scientists don't bother much anymore with concepts like causality...that's only a way of creating a certain kind of story.  What matters in most fields of science today is the probability of the association, how well you can say whether things are always related or not.  And this relationship, that lower inflation systematically corresponds with higher unemployment, is very likely true.  The probability of the hypothesis that they are unrelated is vanishingly small to many decimal places.  Nobody denies this actually, even current professors at U of C.  What the professors at U of C do is say that this overwhelming historical evidence doesn't mean this relationship always has to be true.  Some change in the system of political economy, such as reversal of some government regulation, could cause it to change.  Well, that's just blowing smoke against the most established evidence in Economics!  And it only gets worse.

Further you might ask what might change this aspect of economics.  What would make it possible to have low inflation with low unemployment?  The answer is odious.  It would seem to be efficient wage cutting.  Which is precisely what the Euro experiment is now trying to do in the southern european countries.

Efficient wage cutting has not been done in modern societies, except through disemployment (if you want to call that efficient).  Here you can see the relationship directly.  People loose their jobs and are then forced to find another job paying less.  That lowers the amount they are able to spend, and hence prices fail to rise, and total spending decreases.

So you can see this is the core of the issue, and it is much discussed in modern economics.  The Phillips Curve is widely explained as being caused by "sticky wages."

Now if we could just get those wages lowered, everything would be fine right?  Well not if you're the one whose wage is getting lowered!!!  You might quit.  You might try to sabotage the work.  So cutting your wage is something your boss is going to try very hard to avoid doing.  You might not get a raise.  But there's a large uncertainty cost in cutting a person's wages.  It's easier, much easier for the organization, to lay people off.  Because the people who remain in the hierarchy must remain committed to it.

This itself comes down to the fact that markets in fact comprise very little of the productive process or the economy as a whole.  Most production occurs in organizations, organizations which are mostly hierarchies, and not markets.  This is not avoidable.  Markets are actually very inefficient at getting stuff done, their function is to enable transaction and price setting, not production itself, which usually involves many stages.  One of the reasons most work is done in hierarchies and not markets is the transaction costs of markets can become the dominant factor in a complex and therefore large operation.

But Wait, Can't Prices go up but not Wages ?

Well, yes, of course.  But that's not Inflation.  That's particularly not the kind of inflation we had from 1933 to 1970, the golden age of Capitalism, the New Deal, and Keynesianism that conservatives often demonize.  Ironically, it's something entirely different, almost antithetical, that it seems most people haven't caught on to.  It's Wage Deflation !

It is very important to understand the distiction between Wage Deflation and Inflation!

Wage Deflation is largely a post-Keynesian era phenomenon, though it started with the supply shocks of the 1970's, when the US hit the first peak domestic oil, and was hit by high prices from monopolistic foreign producers unhappy with US foreign policy, not to mention the huge costs of maintaining US foreign policy through a military machine.  That's only how it got started though.  How it has continued is exactly this: wage deflation is caused by central banks improperly (though largely successfully) fighting inflation!

Basically what it comes down to is this.  Central banks cannot invent new gold or oil to bring the prices of those mined natural products down.  But what they can do is force the rates of wage growth down.  Lower wages means lower spending means a shove toward lower prices (FWIW).   And that is how modern central bank inflation controlling policy works, by depressing growth specifically in wages, and what it does.  By keeping interest rates high, that keeps the cost of funds to employers high, and forces them to not hire, lay off, etc.  By the way, there's no social benefit and in fact significant social cost from having things done by lower cost labor.  Consumer benefit but workers lose, from the standpoint of society it's at best a net wash, and then if you consider the deleterious effects of income inequality on politics, education, and health, it gets worse.  Societies should focus on creating the highest wage jobs possible for all their citizens.  That's exactly many of the best countries, such as Denmark, do.  In the US, legislators seem to gloat about having lowered average wages, which has a negative effect on employment as the lowered income-available to working people reduces general demand.

If this inflation fighting stuff has been so successful why hasn't inflation been kept at zero?  Even central banks face political limits.  They don't want to force unemployment too far up to get them into trouble.  So, from about 1983 to 2007 central banks got "good" at doing this (if by "good" what you mean is forcing wage deflation).  They could keep inflation below 5%, far away from the double digit rates of the late 1970's, and simultaneously keep unemployment fairly low.

Viewed properly in this way, inflation fighting by central banks by raising the interest rates improperly is the very thing that has caused the wage deflation that most people in the world currently suffer from.  We now have decades of wage deflation that now need to be reversed by wage inflation.

But haven't the Central Banks been suppressing interest rates by often setting rates below 2% in emergencies prior to 2000, and most recently been close to 0%.  No.  The natural interest rate has no lower limit if there is unemployment.  You can only have a positive natural interest rate when there is no unemployment.

What about Quantitative Easing?

It basically doesn't work, and to the degree it does work, it works by raising asset prices instead of wages, which is not kind of Inflation fighting we need.  It's quite possible that QE in fact causes wage deflation, just as normal central banking operations, specifically raising the interest rate, cause.

So here we have the asymmetry in banking.  Banks can lower wages to fight inflation, and they can raise asset prices, but they can't exactly control inflation, and it's possible (though I won't swear to it) that they can only cause Wage Deflation in one form or another.

What needs to be done is direct government spending.  The government can directly spend enough to put everyone to work, and the more they do so, the more wage-expansionary it will be.  I'm not saying the government should spend money, but actually it often does so far more wisely and with more social responsibility than private actors.  Currently we live in an economy which has systematically been started of public goods.  The most conservative steps we could actually take to restore full employment would be (1) more government spending and (2) more taxes, especially on the wealthy because that's where the money has gone to.

This gets close to the core of fiscal conservatism.  The truly wealthy benefit far more from (1) low wages, and (2) increase in asset prices, so it's no suprise they favor management of the economy through central banks as compared to through a political process that gasp people could control, especially a political process which might levy more taxes on them, compete with their goods, and raise nominal wages.

But that is precisely what we need.  I'm not qualified to judge how little good QE can actually do, many people I highly respect like Brad DeLong and David Glasner, who call themselves centrists (and are certainly not leftists like me, whatever their Republican critics might say) believe it can do a lot of good.  David Glassner argues very cogently in his blog that the pre-1937 recovery from the Jan 1932 bottom of the US economy resulted specifically from expansion of credit, NOT spending.  And I believe him, except the real test of spending came in WWII and that was what proved it really really (not halfway) works.  Not to say that spending on war forever will always do this...

I tend to agree with the great economist Stiglitz convinced me that at best QE can do little good, it may well do harm, and that what is needed, and the only thing that will work, is government spending.

Perhaps when we've tried everything else, we'll get back to that again, just as we did in 1933.

So What Does a Young Worker Really Want?

Of course, the means to create a good life, and thereby happiness.  And a fair society that rewards present work more than previous work (or mere appropriation) by others long ago.  Not to be held down by the big older guys.  Not to have to catch up from far back.  A progressive society with modest inflation, in other words.  And security, not to have to worry about losing everything from illness for example.

The material means for a good life include such things as food, clothing housing, healthcare when needed, transportation, entertainment.  None of these things need necessarily relate much to inflation in a credit-based-money society.  The young person buys big ticket items like house and car on credit, keeps a modest amount of money in the bank for transactions, but mainly uses income to pay down debt.  In this picture, inflation is a plus, since it decreases the relative value of the debt over time.  Not much inflation occurs in the week or two between when pay is deposited and debts serviced.

But isn't it better to save money first, and then buy?

No, it has much lower utility.  It might take 20 years or more to save up the money for a house, for example.  In the meantime, where does one live?  All the rent paid in that time is gone forever.  It makes far more sense to buy house on credit than wait until the full purchase price has been saved.  Now it may make some sense for lenders to require down payments, and that does usually require a year or so of disciplined saving.  If the individual is really worried about losing that to inflation, they can buy inflation protected bonds.  If the waters look calm, they may well choose just to bear it, since inflation insurance has to cost more than average inflation.

But as Steve Randy Waldman says, it is highly expensive and counterproductive to protect all money from inflation.  In effect it is a giant subsidy to savers, especially the most wealthy ones.

So what is the proper division between public and private?

The primary role of government should be protecting it's citizens.  And the most important way that can be done is by guaranteeing full employment.  If private industry won't do something, the government must.  Lincoln said that.

That's the minimum.  The best would be this: just what Lenin said, the government needs to control the commanding heights.  Especially now, and during the tumultous changes of the next 200 years.

The small stuff, the restaurants, theatres, and so on, private industry does that reasonably well if everything important is properly regulated (or horribly if they aren't).

Some of the most crucial commanding heights are: investment banking (i.e. Wall Street, all government backed now anyway), retirement, energy, healthcare, education, transportation systems, corporatized aspects of agriculture, and drugs.  All these areas work best not being left to the flim flam scammers of private industry.  In fact, most of them are essentially funded by government.  The private aspect, if any, only siphons off wealth.

But isn't the government just some kind of giant thief?

Wealth must originate in the private sector, I have heard many people say.  But there is little evidence this is actually true.

Governments have throughout history, right up to the present, created nearly every kind of good or service people need.  They often do so more efficiently, effectively, and useful to the common welfare than private actors.  The best example of this is the near worldwide adoption of national healthcare systems, dozens of which produce better outcomes at lower cost than the mosterous private-public conglomeration in the US before ACA.  The ACA might help a bit, but a better answer would have been true National Health Service as in UK...a system which consistently has proven to produce the best outcomes at the lowest cost.  Single Payer would be second best.  This is shown consistently in comparative studies.

Governments sometimes fail to produce things effectively.  This can happen for many reasons, many of which may not even be related to the actual production, but rather to class warfare being waged on behalf of international actors (that is one part of the failure of French Socialism, the other is these industries were not actually run socialistically, they were run like the flintiest of private businesses).

But so can private actors.  Private corporations can be odiously inefficient monopolies, implied contract breaker, fraudsters, and worse.  Sometimes it seems that the best private corporations die young, and the worst live forever, destroying the earth.

And however socially good or bad they are, most of the time, after a long enough time, they collapse.

The only real rub against public-owned industry (see analyses by Steve Keen and John Quiggin) is that if it is tied to an undemocratic state, poor performance could be perpetual.  You need to dump the business if it is a failure, and if it's the government, it may be impossible to dump.

But that has not generally been the history.  Both the Brits and the French abandoned many of their socialized industries.  Ironically, it was the government owned copper mine that kept Chile going through the pre-neoliberal dark age of Pinochet.  Examples of successful public producers is given in the book Kicking the Ladder.

Even the infamous Soviet Union--a state of publically owned enterprises--ultimately was let go by it's citizens.  The Soviet Union actually was, at various moments in it's history, an economic miracle--one barely reported in the west.  I'm not saying it was always good in all ways...but there have also been and still are capitalistic thugocracies that do all the same things.  The singular example of the Soviet Union is little evidence for the thesis that "Communism can't work."  In many ways it worked as well or better than capitalistic states given it's starting state and other factors, and it was subject to it's own internal history and contradictions that had little to do with Communism per se.

Prior to it's ultimate disappearance, people had guaranteed employment (which Gorby cancelled) and material affluence similar to (perhaps slightly lower on average than) the capitalist west--despite all the mistakes. I think the real downfall of the Soviet Union was not communism, per se, but an attempt to compete with the imperialistic US militarily, which was unachieveable.  The war in Afghanistan was the fatal mistake. The US simply enjoys important material advantages over many other countries.  Or at least it did, until we started fracking the place apart to get the last drop of gas.

And I can't say how much of the so-called collapse of the soviet union was a mostly unorganized conspiracy to destroy it, mostly on the part of outsiders or backed by them.  That started in the very first challenging counter-revolutionary White Russian war.  In the end, I also think Gorby's attempt to neoliberalize the Soviet Union by cancelling the job guarantee was politically and socially fatal.  IMO a socialist state that cannot employ everyone is a failure.  It no longer deserved to exist.  It was disasterous politically as well.

So why have private industry at all?

Well of course if you don't have private industry, you can't have much in the way of private wealth. People can work a bit harder, and make a bit more, but they can't exploit masses of workers. Sometimes it works better, maybe.  Perhaps if you tried enough times you could get state industries to actually do everything.

And right now, especially, I believe most countries on earth need far more socialized industries for the forseeable future than they have now.

Yes the government can actually create all the wealth we need.  Or better, we can--through our government acting as sponsor and agent.

Now in the USA as in most capitalist countries in the age of neoliberalism, public industry has largely been abondoned, and even unavoidably-public services have been contracted out.  The latter is almost always a bad idea.

So we have tied our government (mostly, or partly) to the rock that it must not create wealth.  The key reason is not that it can't, but if it did, it would compete with our wealthy class.  Ultimately the wealthy class would become less important, and even fade away, while a higher median wealth results.

That is precisely what should happen, in my radical view.

Instead, we have created what Jamie Galbraith calls the Predator State, which functions mainly to protect pools of private profit, including the socially functionless private wealth scalped by the private health insurance industry.  Our post-New Deal predator state does that even if the protection is harmful to the actual common good.  People may suffer, lives may be lost, but profit must not be harmed.

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