Can the Fed Save Us?

Watching global market turbulence this last week, looking for clues. This bit from John Hussman, Why the Fed is Irrelevant, rings even truer today that when he wrote it in 2001…

…if you look at the statistical evidence, the relationship between monetary growth and inflation is very weak. Instead, our research indicates that inflation is primarily the result of growth in unproductive forms of government spending (basically defense spending, entitlements and other expenditures that fail to stimulate the supply of goods). The evidence both from the U.S. and other countries clearly demonstrates this relationship.

As Milton Friedman has noted, the burden of government is not measured by how much it taxes, but by how much it spends . The impact is particularly severe when growth in entitlements is high and growth in productivity is low. This is why inflation exploded after the late 60’s, and why it came down after the early 1980’s. This is why the Germans suffered hyperinflation after World War I when its government decided to keep paying workers who had gone on strike.

Always and everywhere, rapid inflation is produced by excessive creation of government liabilities without a corresponding increase in the amount of goods produced by the economy. The Fed doesn’t control this. It doesn’t even matter much what form the liabilities take. If the Germans had decided to issue bonds to striking workers instead of money, bond prices would have been driven to ridiculously low levels, driving interest rates to extremely high levels, creating an unwillingness to hold non-interest bearing money, resulting in a rapid deterioration in the value of money, and hyperinflation just the same.