For the last year, I've been convinced that inflation is back and getting worse. I can feel it in my everyday life. My favorite pizza guy raised his price for a slice by 20% last month. My kids' tuitions climbed 8% this year. Heating oil and electricity are more expensive. Breakfast cereal. Books. You name it, it costs more.
Yet for the last year, Alan Greenspan and the other members of the
interest-setting body, the Federal Open Market Committee, have been telling me not just that there isn't any inflation, but that there really isn't any danger of inflation.
Well, I've finally figured out why they're wrong. It's not because government statisticians have cooked the books to keep inflation numbers low (although they have), or that the Fed governors are part of a conspiracy to cut the inflation-indexed payments going to retirees (although they may be), or that these folks are so out of touch with the real economy that they can't see what the rest of us feel in our everyday lives (although that's quite probably true).
No, the real problem is that the Fed is worried about the wrong kind of inflation.
You see, the kind of inflation that the Fed cares about -- and tries to fight -- is the short-term, cyclical kind. Prices jumped by 13% in 1979, for example, after a 9% increase in 1978, as members of the Organization of the Petroleum Exporting Countries (OPEC) ratcheted up the price of oil. So the Fed, under then-chairman Paul Volcker, drove U.S. interest rates up to 14.7% on three-month Treasury bills in 1981, throwing the country into a recession that did indeed put an end to double-digit inflation. By 1982, inflation was down to 3.87%.
The Long View of Inflation
But the kind of inflation that you and I feel right now isn't cyclical but what is called secular. My belief is that prices tend to move up in long, long waves that last anywhere from 80 to 180 years and contain many short-term cycles -- like the one that peaked in 1979. It's the duration of these waves of rising prices, rather than the magnitude of year-to-year increases in inflation, that's important.
Past price waves have been characterized by annual increases of as little as 0.6%. But applied over long periods, even that rate is enough to set economic expectations, to produce a strong sense that something has gone wrong, to create intolerable stress in the economy and to lead finally to a political and economic crisis.
If the history of prices is an accurate guide, we're now about 100 years into a wave that hasn't yet peaked.
David Hackett Fischer, Pulitzer Prize-winning history professor at Brandeis University, lays out the case for long periods of steadily increasing prices interrupted by briefer periods of price equilibrium in his 1996 book,
The Great Wave
What's fascinating to me about Fischer's price waves, which are very different from and much more convincing in my opinion than some long-cycle theories, is how much they explain about our current economy.
Price Waves Boiled Down
Hard to spot:
In the early stages of a price wave, no one recognizes that a period of price equilibrium has ended and that a long wave of rising prices has begun. Partly, that's because the long-term upward trend in prices is obscured by short-term movements in prices such as those that the Fed manages. For example, Fischer finds that a great price wave began about 1729, with rising wheat prices in Paris, and by the early 1740s it had spread to most of Europe. At the time, people thought this was simply cyclical fluctuation in prices. But prices would rise by nearly 2% on average for the next 100 years. It wasn't until the 1760s that writers began to comment on rising prices and scarcity.
Food and fuel:
All of the price waves back to the first one that Fischer examines -- the medieval wave of inflation that started in 1180 -- began with increases in the price of food and fuel. Prices of manufactured goods actually fall during the initial phases of each price wave. The explanation seems straightforward: Through history, it has been relatively difficult to increase supplies of food and fuel to meet rising demand. Expanding food production often meant farming new, less productive land. Fuel for much of human history has meant wood, and it's hard to get trees to grow faster.
In contrast, productivity improvements in the machines that make goods are relatively easy. The Middle Ages, for instance, had its own "Industrial Revolution" when water power was applied to jobs like washing and preparing cloth that had previously been done by hand. Makes you think twice about our current insistence on taking energy and food costs out of our most-watched measures of inflation.
Price waves begin as demand inflation increases the prices for food, fuel, land and shelter. In all price waves until the 20th century, population growth led to that increase in demand. In the 20th century, rising consumer incomes and expectations produce the same effect.
Cost-push forces add to inflation, especially in food production, as higher prices encourage farmers to bring marginal, less-productive land into use. That produces more food, true, but at a higher cost, which leads to higher prices as the costs are pushed along to consumers.
An increase in the money supply kicks in to drive inflation higher after the initial demand-based inflation has set prices in motion. Governments typically attempt to combat rising prices by increasing the amount of money in circulation. That, of course, just adds speed to price increases. This is true even in the 20th and 21st centuries, where central banks may try to fight cyclical inflation by raising interest rates or slowing growth in the money supply, but where the economy as a whole keeps creating new money in the form of looser credit requirements or no-down-payment mortgages.
The advantage of wealth:
In the first half of a price wave, the wealthy are able to stay ahead of inflation by demanding tax cuts as they did in the run-up to the French Revolution, increasing rents on their property, demanding subsidies from government and using the power of the government and the courts to force increasingly impoverished wage-earners to pay their debts.
Wage-earners, on the other hand, lose ground steadily to prices. And to taxes. Governments, facing their own debt crises as prices rise, attempt to raise taxes. But those taxes aren't distributed equally among the population, since the wealthy use their political clout to get themselves exempted from the tax increases.
The rising prices of a long price wave have a psychological effect on a society. As inequalities rise, optimism gives way to pessimism. Since price waves are accompanied by increases in violence, family breakups, alcoholism and poverty, there's a growing sense in a society that something is wrong. Could the sense that something has gone wrong in this country that shows up in current opinion polls -- shared by conservatives and liberals, by the devout and the secular -- even if we don't agree on what it is or how to fix it, be an instance of this shift in social psychology?
As prices rise, the economy and the society become increasingly stressed until a bit of bad luck that would have been shrugged off earlier leads to a crisis. So, for example, by 1789 a wage-earner in France was spending 88% of his income to feed his family. In the period from 1726 to 1791, it took only 50% of income. So when the harvests failed in 1788 and 1799 and prices soared, as they had done in earlier years of bad harvests, it was enough to tip the country into chaos. Make up your own list of tipping points for today's economy.
Where Fischer Left Off
Fischer's book ends with a discussion of the price wave that began in 1896 and continues today. But the book was published in 1996, so it doesn't discuss the rise of China and India, the U.S. debt bubble or Washington's fiscal crisis. Let me try to add those events to Fischer's framework.
First, adding the 2 billion consumers of China and India to the global economy is our century's equivalent of the population increases that Fischer posits as the cause of earlier price waves. This is a massive increase in global demand, and we're seeing the expected increases in the prices of food, fuel and other basic commodities. And we're seeing the stable of declining prices of manufactured goods that are typical of the first half of price waves.
Second, Fischer is a subtle-enough historian to realize that the changing nature of governments and societies changes the possible response to a price wave. He notes, for example, that social relief programs that date back to the 18th century have been critical in reducing the degree of suffering among the poor during more recent price waves. I'd add that the expansion of political power from a narrow elite as in pre-revolutionary France to the voting population of today's America has changed the way that the society responds to the initial stages of a price wave.
Real wages still fall in today's U.S. because of rising prices, but thanks to credit cards and home-equity lines of credit, you don't have to be the Duc de Deux Ponts to find a way to keep up with inflation. (In 1786, the Duc said about the peasants, "It is in our interest to feed them, but it would be dangerous to fatten them.")
Third, we don't know where we are in this price wave. If it started in 1896 and lasted 80 years -- the minimum for the waves Fischer studied -- it would be over by now. If it lasts 180 years -- the maximum for previous waves -- it will end in 2076.
I think this price wave still has years to run, and when it ends and how it ends depends not on some mechanical theory of history but on the decisions we make now. As Fischer points out, the collapse of the French monarchy, the bloodbath of the French revolution, and the world war unleashed by Napoleon were by no means preordained.
Fischer writes: "By 1787, Europe's most powerful government (France) was on the edge of bankruptcy. ... Ministers tried desperately to balance their books. Economies were enacted. The king himself, Louis XVI, set an example by reducing his household expenses from 22 million livres to 17 million, largely by consolidating the royal stables. ... The financial ministers of Louis XVI pleaded desperately for more revenue, and were refused. The possessing classes refused to accept new taxes. Many demanded more privileges and exemptions. This combination of public need and private greed was fatal."
So how will this wave end? It's our choice.
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