December 6, 2023

Today’s Economist: Inflationphobia, Part III


Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of the forthcoming book “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

Today’s Economist

Perspectives from expert contributors.

When the most recent recession began in December 2007, there was no reason at first to believe that it was any different from those that have taken place about every six years in the postwar era. But it soon became apparent that this economic downturn was having an unusually negative effect on the financial sector that threatened to implode in a wave of bankruptcies. The Federal Reserve reacted by doing exactly what it was created to do — be a lender of last resort and prevent systemic bank failures of the sort that caused the Great Depression and made it so long and severe.

As the Fed lent freely to banks and other financial institutions, its balance sheet grew very rapidly. The reserves of the banking system grew concomitantly; reserves are funds that banks have available for immediate lending that theoretically should lead to credit expansion and new investment by businesses, durable goods purchases by households and so on.

Federal Reserve Bank of St. Louis

During the inflation of the 1970s, most economists became convinced that if the Fed adds too much money and credit to the financial system it will inevitably cause prices to rise. Since the increase in the money supply in 2008 and 2009 was unprecedented, many economists reacted fearfully to the Fed’s actions.

Given the order of magnitude of the increase in bank reserves, from virtually nothing to more than $1 trillion almost overnight and now to more than $2 trillion, it was not unreasonable to be concerned about the potential for Zimbabwe-style hyperinflation.

But inflation fell rather than rising. In the five and a half years since the start of the recession, the consumer price index has risen a total of 10.2 percent. In the five and a half years previously, it rose 17.7 percent. That is, the rate of inflation fell by almost half.

Now, I don’t expect all the people who filled The Wall Street Journal’s editorial page in 2008 and 2009 predicting an imminent rise in inflation to offer a mea culpa, but at some point I think the inflationphobes should at least stop saying that hyperinflation is right around the corner.

By 2010, the annual inflation rate was down to 1.5 percent, and the yield on the Treasury’s 10-year bond had fallen to 3.2 percent from 4.3 percent in 2007 – historically, long-term interest rates rise when inflationary expectations rise. In short, there was no evidence that Fed policy was causing inflation to rise.

Yet in November 2010, both Sarah Palin and Paul Ryan warned that inflation was imminent. As they are Republicans, one can assume they were just playing politics, pandering to their constituency. But a week later, a group of professional economists signed an open letter to the Fed chairman, Ben Bernanke, warning that continuation of an easy money policy risked “currency debasement and inflation.”

In 2011, there were still no signs of actual inflation, but the economist Allan Meltzer nevertheless asserted, “Inflation is coming.” He wisely chose not to say when. Writing in The New York Times, the former Fed chairman Paul Volcker made the time-honored slippery-slope argument: a little inflation always leads to higher inflation.

The inflationphobe Niall Ferguson at least acknowledged that official data showed no evidence of inflation but asserted that the data were wrong, that the consumer price index is “a bogus index.” He cited the authority of a Web site called ShadowStats, which, like the Unskewed Polls site that said all polls showing Mitt Romney losing were simply wrong, just arbitrarily adjusts the data to make it conform to its belief that inflation is high, not low.

In 2012, the consumer price index rose just 1.7 percent, but the inflationphobe Amity Shlaes feared that inflation could suddenly appear out of nowhere, apparently because there was hyperinflation in Germany in the 1920s. Representative Ron Paul, Republican of Texas, was so alarmed by the danger of inflation that he suspended his presidential campaign to lead a Congressional hearing on the subject in June.

In October 2012, Rick Santelli of CNBC said “printing money” caused the German hyperinflation and the same thing was happening in the United States. He, like other inflationphobes, saw the rising price of gold as an ominous sign of a takeoff of consumer prices.

Since Mr. Santelli made his prediction, the seasonally adjusted monthly inflation rate has been negative 0.2 percent in November 2012, zero in December and January 2013, 0.7 percent in February, negative 0.2 percent in March, negative 0.4 percent in April, 0.1 percent in May and 0.5 percent in June. Without seasonal adjustments, the annual inflation rate was 1.4 percent over that time.

Many conservatives, including the publisher Steve Forbes and Larry Kudlow of CNBC, always say that gold is the perfect forward indicator of inflationary expectations. I’ve often heard Mr. Forbes say that the price of gold is like a thermometer that continually gives us inflation’s temperature in real time.

Most economists think that’s ridiculous, but insofar as the gold price reflects inflationary expectations, its falling price is impossible to reconcile with Fed policy. The Fed has not decreased the money supply and continues its policy of “quantitative easing,” which means further increases in the money supply.

To inflationphobes, all increases in the money supply are inflationary; indeed, many define the word “inflation” to mean a money supply increase rather than a rise in the price level.

Hard-core inflationphobes like Peter Schiff simply ignore the reality of today’s economy and assert without evidence that it is exactly like the inflationary 1970s. Inflation is due any day now and gold is “on the verge of its biggest rally ever,” he said. On June 18, Mr. Paul said gold could go to “infinity.”

To be sure, some inflationphobes never believed their own rhetoric; they were just trying to score political cheap shots or con unsophisticated investors into buying gold – from which the inflationphobe reaped a commission. But many others were sincere in their belief that higher inflation was inevitable.

Intellectually honest inflationphobes need to explain why they were wrong and stop crying wolf or else it will be reasonable to assume they are simply cranks and crackpots.

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Business Briefing | FINANCE: The F.D.I.C. Closes First National Bank of Florida

Regulators on Friday closed a small bank in Florida, raising to 71 the number of bank failures this year. The Federal Deposit Insurance Corporation seized First National Bank of Florida, based in Milton, Fla. The bank had $296.8 million in assets and $280.1 million in deposits. CharterBank, based in West Point, Ga., agreed to assume the assets and deposits of the failed bank.

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The Agenda: More Lending, but Not to Small Businesses

The Agenda

How small-business issues are shaping politics and policy.

The Federal Deposit Insurance Corporation reported a modest bit of good news from the banking world on Tuesday.

In the second quarter of the year, bank failures were down, troubled banks were fewer and bank profits were up. And the F.D.I.C. said that “loan portfolios grew for the first time in three years.” According to the agency’s release, the bulk of the lending growth came in commercial and industrial loans as well as loans between banks.

Ah, business lending, then, is back! Well, not so fast. Yes, top-line commercial lending is up, but a closer look shows one segment of loans that did not increase: those to small businesses. According to the F.D.I.C., while the nation’s total commercial and industrial loan portfolio grew by $34 billion, or almost 3 percent, total outstanding loans to small businesses actually fell by $2.5 billion, or 0.4 percent.

Small-business loans are defined as those of $1 million or less, but exclude agricultural loans and loans secured by farmland. As of the end of June, the total commercial and industrial loan portfolio amounted to $1.2 trillion. Small-business loans made up almost exactly half of that, or $607 billion.

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Fewer Banks In the U.S. Considered To Be at Risk

The number of banks on the government’s list of institutions most at risk for failure fell in the second quarter, the first drop since before the financial crisis began.

Twenty-three lenders came off the list of so-called problem banks during the second quarter, bringing the total to 865, according to data released Tuesday by the Federal Deposit Insurance Corporation. Not all the troubled lenders will inevitably fail, but the F.D.I.C. considers them most at risk, making the quarterly update one of the clearest measures of the banking industry’s health.

It was the first decrease in the number of problem banks since the third quarter of 2006. 

The report also contained other signs of improvement. There were 48 bank failures in the first half of 2011, far fewer than the 86 failures in the first six months of 2010. Last year’s total of 157 collapsed banks was the highest since the last severe recession, in the early 1990s.

 And the F.D.I.C. insurance fund that protects the nation’s depositors showed a surplus for the first time in two years. It stood at $3.9 billion, compared with a negative $1 billion balance at the end of the first quarter.

Still, the magnitude of problem banks — roughly one of every nine lenders — remains relatively high. And the number could rise again if the economy suffered another downturn, a prospect that seems increasingly likely amid all the grim data that has surfaced in the weeks since the list was compiled at the end of the June.

Martin J. Gruenberg, the acting F.D.I.C. chairman, played down that risk in some of his first public remarks since being nominated to run the agency in June.

“Banks have continued to make gradual but steady progress from the financial turmoil and severe recession that unfolded from 2007 and 2009,” Mr. Gruenberg said in a statement.

Beyond the drop in problem lenders, there were other signs that the industry was getting back on its feet. The nation’s 7,513 banks and savings institutions reported a total profit of $28.8 billion in the second quarter, up nearly 38 percent from a year ago and the eighth consecutive quarter that earnings have increased. Bank losses continued to ease, while loan balances rose — albeit slightly — for the first time since the second quarter of 2008.

Much of the uptick in lending could be attributed to loans made to businesses and other financial institutions. Real estate lending continued to be very weak.

Total revenue fell for the second quarter in a row. Fee income declined as more stringent regulations curbed overdraft charges and other penalty fees, while interest income was lower because of an increase of money in low-yielding accounts at Federal Reserve banks.

The recent market turbulence from the debt crises in Europe and the United States continues to weigh on the industry. Deposits increased almost 3 percent during the second quarter, with the bulk of the cash going into the nation’s largest banks.

“Recent events have reminded us that the U.S. economy and U.S. banks still face serious challenges ahead,” Mr. Gruenberg said in the statement.

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