The CON Game: Confidence, Spending and Inflation Expectations

The U.S. Federal Reserve consistently emphasizes consumer confidence, consumer spending and inflation expectations. The Federal Reserve’s basic theory, which is based on Keynesian economics, implies that as long as consumers remain confident in the economy, they will continue to borrow and spend, thus the economy will continue to grow.  In other words, both the money supply and debt levels continue rising, thus generating nominal, but not sustainable, growth of the gross domestic product (GDP).  GDP is approximately based on the number of dollars that change hands without regard to increasing debt.  In reality, if production is less than consumption in the economy, debt levels rise faster than GDP, which damages the economy.  The related Keynesian idea that government deficit spending causes the economy to grow faster than government debt, thanks to the mythical Keynesian multiplier, is equally false.  The actual result of the U.S. emphasis on spending is debt saturation en route to insolvency, debt deflation and a crisis of the financial system, i.e., bank failures.  Obviously, capital is generated by excess production, i.e., a surplus, rather than by spending or debt.  The Federal Reserve’s emphasis on spending and consumption, rather than production, reflects a fundamentally flawed approach.

Nobel laureate and “new-Keynesian” economist Joseph E. Stiglitz, Ph.D., wrote in his 2009 article, Death Cometh for the Greenback, that “The strength of the dollar is determined by the laws of supply and demand, just like the value of any asset.  The demand for a currency is based on the return to holding the asset relative to other assets, e.g., the interest rate received from a dollar asset, like a Treasury bill, plus the expected capital gain or loss.  Demand today (and thus the value today) depends critically on expectations about the value tomorrow, but the value tomorrow will, in turn, depend on expectations of the day after.  Prices are inexorably linked to expectations of the future, both near and far.  If investors, or even people as a whole, believe that sometime in the future there is going to be high inflation, then those who hold dollars will be able to buy less with those dollars.  The demand for dollars then—and now—will decrease, and hence (holding everything else constant) so will the value of the dollar at the present moment.”

Interestingly, Dr. Stiglitz does not mention confidence.  Since national currencies are ultimately backed by governments, i.e., by the government’s power to tax its citizens, confidence in a country’s economy and government affects demand for the currency.  Generally, if a country’s economy or government finances are weak, demand for its currency, and for its debt, will fall, thus the value of the currency will fall relative to other currencies.  To maintain the value of a currency, a nation’s economy must be strong, its government’s finances must be sound and its inflation rate must be low (which requires interest rates and bank reserve ratios to be kept relatively high).

Inflation expectations are another component of the Federal Reserve’s decision making process with respect to monetary policy.  Confidence cannot be maintained if business decision makers and consumers believe that prices will rise significantly in the future, i.e., that money is losing value.  The Federal Reserve’s theory is that as long as business decision makers and consumers do not expect prices to rise, they will not bid prices up even if the money supply increases relative to the supply of goods and services in the economy.  The theory is that price increases can be minimized, or indefinitely contained, by systematically misinforming business decision makers and consumers regarding inflation.  In reality, the insistence by the Federal Reserve that there is no inflation because a certain subset of prices (“core inflation”), after various adjustments, has not risen significantly is disingenuous.  Inflation is an increase in the money supply, which eventually and inevitably results in higher prices.  It is both equivocation and hypocrisy for the Federal Reserve to inflate the money supply while at the same time claiming that there is no “inflation”, meaning rising prices.  Among other things, there is a time lag between an increase in the money supply and higher prices.

Using what is, in effect, disinformation to prevent business decision makers and consumers from perceiving inflation until it is self evident does not suspend the quantity theory of money, which states that the average price level of goods (P) times the quantity of goods (Q) is equal to the total supply of money (M) times the velocity of money (V), where the velocity of money is approximately the rate at which money changes hands:

P * Q = M * V

The Federal Reserve’s constant focus on inflation expectations is prestidigitation.  The Federal Reserve may as well be trying to suspend the law of gravity.  If masking the fact that prices are rising is the key to maintaining confidence in the economy and financial system, something is rotten in the state of Denmark.  The statements of Federal Reserve officials and heavily adjusted official statistics, such as the consumer price index (CPI), cannot trump the everyday experiences of business decision makers and consumers.  At the end of the day, the Federal Reserve’s focus on inflation expectations destroys its credibility.

If the supply of a commodity is increasing and there are indications that the supply will continue to increase relative to demand, the expectation of a rational human being will be that its price will fall.  Conversely, if the supply of a commodity is decreasing relative to demand, the expectation of a rational human being will be that its price will rise.  Therefore, it is redundant and irrelevant to consider the psychological states of business decision makers and consumers as significant factors in determining prices, other than perhaps on a short term basis.  Further, any economic theory that relies on something as fickle and ephemeral as the psychological state of “confidence”, which exists only in the minds of human beings, rather than in objective reality, cannot pretend to be a scientific theory, or even a rational one.

Evidently, neither Federal Reserve officials, nor Dr. Stiglitz have ever heard of 14th-century English logician William of Ockham.  Occam’s razor, also known as the lex parsimoniae (law of parsimony), states entia non sunt multiplicanda praeter necessitatem (“entities must not be multiplied beyond necessity”) suggesting that expectations of the future are ultimately irrelevant to price levels.  Further, only academics can be so detached as to believe that inflation expectations can be reliably manipulated, e.g., through public relations, press releases, official statistics, press conferences and so forth, over and against the actual results of businesses and the everyday experiences of business decision makers and consumers.  In fact, only the mathematical reality of the quantity theory of money and the objective reality of rising prices are necessary.

The Keynesian theories underlying Federal Reserve’s monetary policies and propaganda have been consistently and decisively contradicted by real-world results.  Making consumption and spending a top priority leads to excessive levels of debt and inflation, which damage the economy.  Confidence cannot be reliably manufactured without regard to objective reality and attempting to do so destroys the credibility of the Federal Reserve.  The manipulation of inflation expectations through propaganda has no meaningful effect on prices in the long run (Q.E.D.).  Clearly, the theories underlying the Federal Reserve’s monetary policies are precisely an ideology, which is why psychological beliefs, i.e., confidence and expectations, are vitally important to it.  Thus, the Federal Reserve can be seen as a dangerously irrational Keynesian cult where initiates accept basic beliefs as articles of faith, evangelize others and staunchly defend their credo against reason and evidence.


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