The Fed's Circular Firing-Squad... Got Gold?

Authored by Tom Luongo via Gold, Goats, 'n Guns blog,

The Fed Redefines Inflation... Again

The original definition of inflation was an expansion of the supply of money. If you create more money while keeping everything the same, ceteris paribus, then prices should rise accordingly.

This is a simplistic understanding of the role of the money supply as it leaves out the manner in which the new money makes its way into the economy.

If we digitally airdrop 10% more money into everyone’s accounts, as the latest proposals from economists attached to the Federal Reserve suggest, then the general price level will, in fact, rise 10% if that money is spent on necessities.

This is the scenario we are in now, as I talked about in a recent article.

In an environment where most people’s time preference is short because they are literally fighting for their economic lives, this new stimulus money will go right into the things people needs right now — food, clothing, shelter.

Things are so bad for so many Americans now that they saved their first stimulus checks and only spent them on the bare necessities, forgoing any thought of paying down debt.

They used what’s left of their credit rating to feed themselves now on someone else’s dime and let the bank choke on their mortgage when the credit card is maxed.

This next round of stimulus money will circulate. The Fed will finally do what Bernanke tried desperately to avoid, print helicopter money.

This showed up in consumer spending numbers outpacing expectations while debt delinquencies rise.

That definition of inflation, while simplistic, is still instructive under certain market conditions. It ignores the Cantillion effect of who gets the new money and how it travels. That was the old monetary policy mechanism, through credit expansion via the banks.

Jay Powell’s speech yesterday all but told us that that mechanism is broken and that we’ll be embarking on a new monetary experiment into the future.

That said, at a minimum, the simplistic view of inflation defines for us that moment when all the other considerations about the value of the money have been stripped away — the debt issued in that currency, the confidence in it, etc. — and just focuses on what happens when you pump money in.

Bids for goods rise. Not all goods, equally, but goods.

All About Prices…

To obfuscate this underlying truth, inflation was later redefined to reflect the change in the general price level, since this was one of the pillars of the Keynsian economic worldview which elevated concepts such as aggregate supply and demand to having near religious significance.

These concepts, steeped in the religion of social engineering and technocracy, form the basis for all central banking and monetary policy.

… and all of their basic, methodological errors.

It had to be done in order to support the Phillips Curve, the thoroughly-debunked relationship between unemployment and inflation, which has shaped monetary policy for two generations, to everyone’s detriment.

With this definition of inflation it allowed for the unmoored-from-gold financial system to engage in experiments based on flawed theories, like the Quantity Theory of Money (QTM), to justify monetary policy.

And every time the Fed (and every other central bank) was wrong in their forecasts, they redefined both inflation and unemployment to keep satisfying the Phillips Curve as the basis for their commnications.

But never for a second believe that the central banks didn’t know exactly what they were doing with this stuff. That was all for the big show — to project institutional confidence in their ability to manage the economy through monetary policy.

From that confidence flowed our faith in government’s ability to tinker with human nature, alter our incentives and prep humanity for their latest project, The Great Reset, as advocated by the World Economic Forum.

The Davos Crowd.

The operation was simple. Keep things anchored in arcane, economic guildspeak to bamboozle the muppets. Ultimately, it allowed them to print money for domestic political advantage during down periods of the economic cycle and pull back on the money supply to gain international political advantage during the ends of boom periods.

Buy votes at home and bankrupt/colonize people abroad. Lather. Rinse. Repeat.

All the while keep redefining unemployment, inflation and the money supply itself to constantly shape the narrative of their competence.

The Austrian Call

Austrian economists, as gadflies, sharpened their pens, pointed out these failings, advocated for gold and told everyone there is a limit to how far the expansion of credit over the base economy could go in propping up asset prices.

The economy always reaches a point where interest rates are irrelevant to creating confidence to take on new debt. I like to use the term ‘debt saturation’ to describe where we are.

Now with Jay Powell’s speech from virtual Jackson Hole, we have him openly admitting this, validating the Austrian criticism. And so, we have the new definition of inflation, freed from the shackles of the Phillips Curve.

It’s still all about prices today but now the Fed is admitting that the economy runs on the time preference of individuals rather than arbitrary definitions of full employment.

Powell uses the term ‘inflation expectations’ but time preference is still better.

Inflation is now a measure of the confidence of the people in their future, what they expect to happen. In that respect Keynes was right about ‘animal spirits’ affecting markets.

All the Fed can do now is print money, hand it out and try to create rising prices to fill the vortex of debt and stimulate growth. But that still misses the point. It still doesn’t address the real problem.

Actions Before Consequences

Confidence is a consequence of human action. Not all human action is not a consequence of confidence. People have to act first. The actions they take are informed by the confidence they have in their state at the time of that action.

People without confidence still act. They still eat. They still huddle in the corner and despair. Any economic theory that puts confidence in front of action as the primary driver is engaging in a fundamental methodological error.

It’s like saying that velocity determines position. Or that the first derivative of a function determines the function. The two are linked, certainly, but there is an unknown factor which determines the final outcome. You don’t know the starting point.

For example, the first derivative of a function (velocity) is f'(x) = 2x. This is the speed at which your position is changing.

Integrating that yields the function f(x) = x^2 + C, where C is an unknown constant. This function determines where you are at any given value of x. The final value of the function is only determined by knowing where you started, i.e. C, and adding that to the value of x^2.

So if x = 2, x^2=4. Not tough. But, that tells us nothing about where we actually are other than that we’re 4 units from where we started. Is four good? Bad? Hell if I know?

And neither does the Fed.

Now I’m sympathetic, for argument’s sake, to define inflation expectations as the first derivative of action. If you expect things to get better than you may make choices which lead to lower time preference behavior which, in turn, boosts investment in larger projects and an expansion of the division of labor.

Economic growth.

But, not necessarily. It all depends on C. If C is profoundly negative, a small increase in inflation expectations won’t do squat to push your decision tree with your extra money out in time. It will improve your economic thinking slightly but I in this example that means going from buying food to buying slightly more food, not investing in a new roof.

You Were Expecting Confidence?

Powell finally admitted that confidence in the future is what determines the actions people take economically. If they are facing an uncertain future no amount of new credit can stimulate demand.

It represents a sea change in monetary policy thinking. And I won’t argue that it’s slowly getting us closer to reality. But the question now is how will this new definition be used?

We already know the answer. They change the definition of inflation to suit themselves, not the people whose lives they affect. Because they are committed to 2% inflation, as defined by the terminally-flawed, constantly moving definition of the Consumer Price Index, as the policy goal.

And that means money printing to the extreme bringing us right back to what I outlined at the beginning. The Fed will airdrop money into people’s accounts to raise the general price level through the real definition of inflation, an increase in the money supply absent concomitant real capital formation, to support the value of asset prices inflated by previous poor definitions of inflation.

Sound circular? It is. Of the firing squad variety.

Because this sets the next stage in motion for the real collapse in confidence, central banks and the currencies they manage.

Got gold?

*  *  *

Join my Patreon if you have low inflation expectations. Install the Brave Browser to lower Google’s price inflation of valuable information.