The Path Towards Rampant Inflation

It isn’t a four-letter word uttered by Prime Minister Kevin Rudd on TV at the weekend that continues to get everyone in a tizz. Instead it’s four-little-words that everyone is rushing to embrace. Words that define the resurgence of a failed and discredited economic theory.

Those four little words are… The Paradox of Thrift.

Even more of a paradox is that the man who first uttered the phrase, the 1st Baron Keynes (or John Maynard Keynes to you and me) would have gone to his grave in 1946 believing he had created an economic theory to outlive all other economic theories.

Therefore if technology and science would allow it, if we could bring him back to life sixty-three years later, he would not be surprised that economists, journalists and commentators are embracing his ideas.

But not only are they embracing the ideas, they are putting them into practice.

And unfortunately, each idea leads us down the same path. It is the path towards rampant inflation. Many times in recent months I have written to Money Morning subscribers about the threat of inflation (you can read some of those thoughts in the essay below). Each time we write about it we think “That’s all there is to write about, policy makers couldn’t possibly make things worse.”

Then we open the newspaper, switch on the TV or read news stories on the internet. Soon enough we realise our imagination is incapable of matching the ideas put forward by the mainstream press, mainstream finance professionals and policymakers.

A perfect example was a quote we read in yesterday’s Australian Financial Review (AFR). When you read the quote it is important to remember that this isn’t the thought process of one isolated member of the finance industry. It is the thought process of 98.6% of those in the industry, and the thought process of 100% of those that advise our politicians.

The quote was from Adam Carr, senior economist at ICAP Australia:

“I think when you print money, it becomes very attractive [for investors] to take advantage of the fact that money is just given away for nothing.”

Remember, Mr. Carr isn’t an ‘outlier’ he is the mainstream. It really does drive home the point that when you read in the Markets and Money the possibility of Weimar Republic or Zimbabwe style hyper-inflation it isn’t just to get your attention. It is because policy makers are actually pushing ahead with policies that are taking Australia a step closer to it becoming reality.

It is Keyne’s ‘Paradox of Thrift’ that commentators are now paying close attention to. Why? Because unlike inflation and money supply, the ‘Paradox of Thrift’ can be easily understood and explained by the mainstream. For them, it is a simple equation…

The economy isn’t growing because consumers aren’t spending. If consumers aren’t spending they must be saving. If consumers are saving that is why the economy isn’t growing… Therefore saving is bad, spending is good, the economy must grow and the ‘Paradox of Thrift’ must be correct.

How can you argue with logic like that? Fortunately we can, and we do.

[Ed note: That’s why you need to do your part and let as many of your friends, acquaintances and colleagues know about Markets and Money (and Money Morning) so they too can read why government spending and the RBA giving away money “for nothing” is such a bad idea for Australia.]

But that’s only part of it. Because inducing the consumer to spend by cutting interest rates to artificially low levels still isn’t working. So how can government cut out the middle man? They can do exactly as Mr. Carr suggests, they can print money and give it away for free.

Obviously there’s no point in giving it away to the newly frugal ex-consumer. Nosiree, because the ex-consumer had morphed into a saver. And printing money to buy government or corporate debt isn’t likely to work either, because those are mainly held by fund managers. They’ll just take advantage of the high prices being paid by the central bank by selling to them and then just buying the same or similar bonds again in the market when prices have softened.

Nope, there’s only one solution to make sure the ‘free money’ goes to those who truly know what to do with it. And that’s to give it to federal, state and local governments. You must have seen how quick they were to reveal all of their “shovel-ready” projects. “Just pay us the cash and we can start these projects straightaway” was the universal cry.

As we mention below in today’s essay, the ultimate losers will be those that the government claims it is trying to help – individuals (families) and business.

The individuals will lose out, because as consumers they will be burdened by the combination of the devaluation of their earnings and savings, and the increase in prices. And small businesses in particular will be denied the chance to take market share from companies that would have otherwise failed.

As with many things, there is a bright spot. That is, government is notoriously bad at doing things. Therefore, the paradox they may not have bargained for is one based on their inflationary policies failing. The possibility is that what exists of a free market in Australia will be strong enough to ensure that individuals and small companies are agile enough to see through the recession and emerge stronger on the other side.

As for government, its failed policies should result in it becoming weaker and the free market gaining the ascendency.

Kris Sayce
for Markets and Money

Kris Sayce
Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Markets and Money e-newsletter in 2005. He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.

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Thanks for the occasional dose of sanity in a sea of irrationality. To paraphrase the late Milton Friedman ‘inflation is first, last and always a monetary phenomenon’. And while we are quoting ‘those who forget history are condemned to repeat it’ – George Santayana.

Sean Carmody
You say “It is because policy makers are actually pushing ahead with policies that are taking Australia a step closer to [hyperinflation] becoming reality”, but as far as I can tell you have not explained why this should be the case. Can you give any historical examples of a economy with non-convertible, fiat money where Government debt is denominated in local currency which has experienced hyperinflation for any reason, let alone as a result of the sorts of policies currently adopted? The Weimar republic doesn’t count (foreign debt and war reparations in foreign currencies), Argentina doesn’t count (currency convertible to… Read more »
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