Price Stability versus Free Markets

As every economic historian knows, the pendulum swings between free markets and central control as the global economy passes through long economic cycles. These economic waves have been observed since the dawn of civilization. In Leviticus 25:10-26, there is mention of a 50-year economic cycle called the Jubilee that ends in a crash so severe that for one year there is no economic activity – “ you shall not sow, nor reap its aftergrowth, nor gather in from its untrimmed vines”. Like all long cycles, the Jubilee culminates in the destruction of society’s accumulated capital and the reset of consumption to levels that are sustainable. A Russian economist, Nikolai Dmyitriyevich Kondratieff, postulated the existence of 50 – 60 year economic waves divided into four phase: inflationary expansion, stagflation, positive deflation and destructive deflation. Nikolai was executed by Stalin for his work in 1938. For more on Kondratieff waves see http://www.kwaves.com/kond_overview.htm    According to wave theorists, the global economy is in the destructive deflationary phase of the wave that started after WWII. If they are right, we are in for a very bad stretch as the world economy resets the balance between consumption and resources. 

If you follow the wave theorists’ advice, you will sell all your assets and hoard cash, not gold, until the new economic wave begins in 2020, probably after the resolution of the Silk Road War between Russia and China or the occupation of Saudi Arabia by Iran.

 When the new long-term wave starts, it will bring with it a new set of economic micro- and macro-economic theories. I think that the most important lesson of the current crisis is that economies cannot function without price stability. Investment decisions cannot be made by governments, businesses or individuals when prices are fluctuating the way they have been in the last 18 months. Prices of houses and energy and metals and stocks and currencies and food stuffs cannot fluctuate by high double or low triple digital levels and still allow the economy to function. The net result of this price instability is the destruction of accumulated capital precisely as predicted by long-term wave theorists. The destruction of capital will lead to poverty and conflict.

I blame the Federal Reserve [and the central banks of the world, except the powerless Bundesbank, of course]. Its job is to maintain price stability. Some people characterize its mission as fighting inflation, but its real job is price stability so that people can make rational economic decisions. The Federal has fallen down at its job by continuing to create price bubbles through easy, politically-motivated money and through gross negligence of the regulatory regime. Mr. Greenspan and now Mr. Bernanke sit at the epicenter of these misjudgments. Sometimes I think that they just didn’t understand what was or is going on around them because they are blinded by their ideological blinkers – Milton Friedman and the conservative orthodoxy. After all, they were selected because they worn those winkers better than the rest of their cohort.

When Greenspan commented on the ‘irrational exuberance’ of dot.com bubble but maintained that it was not the Fed’s job to contain ‘asset bubbles’ or he sat by and watched Long-Term Capital nearly destroy the international financial system using leverage and derivatives or stoked the ‘now shocking’ fires of the housing bubble with 1% interest rates, he was not doing his job, but serving his political handlers. Mr. Bernanke has now presided over his first two assets bubbles with the calamitous rise and fall of commodity prices and the fall and rise of the dollar. [I was told by a Fed Governor at a party in September 2007 that the Fed didn’t care about the dollar]. 

The energy price bubble will wipe out renewable and nuclear energy investments for a decade as evidence by the collapse of wind and solar technology financings this month. It has severely delayed new fossil fuel exploration as evidenced by the collapse of capital budgets and stock prices at natural gas companies like Chesapeake Energy.   

The Fed’s rationale for all of this is that they are monitoring ‘core inflation’; a weirdly constructed economic measure that excludes most of the price movements that impact the real and perceived economy.

So going forward, Fed’s mandate needs to be re-crafted to focus on price stability in the broadest sense – consumption prices, production inputs, labor rates, asset values, foreign exchange ratios and risk adjusted rates of return. Unfortunately, no economist has been allowed to think such unorthodox regulatory thoughts for 30 years or a whole generation, so there is no conceptual framework on which to start this work.

At the risk of belaboring the obvious, I think the place to launch the new world order is energy policy and pricing. America can’t consume 25% of the world’s oil production while only producing 3%. The current regime results in the US shipping its wealth overseas to countries that do not share our national interests or core values. To solve this issue, I am going to break with a family tradition of internationalism/free trade and espouse an isolationist solution. The United States government should set tariffs on non-NAFTA crude oil and refined fuels. This import tariff would be designed to create a price level that will allow investments in renewal energy, domestic exploration and nuclear plants to offer a reasonable return without government subsidies, so that we can bring our energy consumption and domestic production back into balance. Oil prices need to be regulated if general price stability is to be achieved like in the old days of the Texas Railway Commission.   Oil prices have been a major driver of the last few recessions. The import tariff could be set quarterly or monthly as the difference  between the world price for crude and $100 per barrel. 

Consumers would initially be upset because $100 per barrel equates to $4.55 per gallon of regular gasoline.   But high oil prices would drive conservation which is one of the five major sources of energy: fossil, nuclear, biomass, renewable and conservation. 

So the question remains the same. How do we get these ideas to our elected officials and transformed them into policy? Nita Lowey, Robert Engel, Hillary Clinton, Charles Schumer, Barack Obama, John McCain, Sarah Palin, Joe Biden,  is anyone out there listening?

 

Postscript: I am proud to say that Alan Greenspan in his testimony to Congress this morning espoused the idea that resetting housing prices IS the key to fixing the current financial crisis, the theme of my recent article: Bail-Out Blues – Open Letter to Nita Lowey.