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THE ROAD TO HYPERINFLATION, Part 2
A failure of central banking
By Henry C K Liu
(See also PART 1: Fed helpless in its own crisis)
It has been forgotten by many that before 1913, there was no central bank in the United States to bail out troubled commercial and associated financial institutions or to keep inflation in check by trading employment for price stability. Few want inflation but fewer still would trade their jobs for price stability.
For the first 137 years of its history, the US did not have a central bank. The nation then was plagued with recurring business cycles of boom and bust. For the past 94 years the Federal Reserve, the US central bank, has assumed the role of monetary guardian for the nation, yet recurring business cycles of boom and bust have continued, often with the accommodating participation of the Fed. Central banking has failed in its fundamental functions of stabilizing financial markets with monetary policy, succeeding neither in preventing inflation nor sustaining growth nor achieving full employment.
Since the Fed was founded in 1913, US inflation has registered 1,923%, meaning prices have gone up 20 times on average despite a sharp rise in productivity.
For the 18 years (August 11, 1987 to January 31, 2006) of his tenure as chairman of the Fed, Alan Greenspan repeatedly bought off the collapse of one debt bubble with a bigger debt bubble. During that time, inflation was under 2% in only two years, 1998 and 2002, both times not caused by Fed policy. Paul Volcker, who served as Fed chairman from August 1979 to August 1987, had to raise both the fed funds rate and the discount to 20% to fight hyperinflation of 18% in 1980 back down to 3.66% in 1987, the year Greenspan took over the Fed just before the October 1987 crash, when inflation rose to 4.53%.
Under Greenspan's market accommodating monetary policy, US inflation reached 4.42% in 1988, 5.36% in 1989 and 6.29% in 1990. The inflation rate was moderated to 1.55% by the 1997 Asian financial crisis, when Asian exporting economies devalued their currencies to lower their export prices, but Greenspan allowed US inflation rate to rise back to 3.76% by 2000. The fed funds rate hit a low of 1.75% in 2001 when inflation hit 3.76%; it hit 1% when inflation was 3.52% in 2004; and it hit 2.5% when inflation rose to 4.69% in 2005.
For those years, US real interest rate was mostly negative after inflation. Factoring in the falling exchange value of the dollar, the Fed was in effect paying US transnational corporate borrowers to invest in non-dollar markets, and paying US financial institution to profit from dollar carry trade, ie borrowing dollars at negative rates to speculate in assets denominated in other currencies with high yields.
In recent years, the US has been allowing the dollar to fall in exchange value to moderate the adverse effect of high indebtedness and using depressed wages, both domestic and foreign, to moderate US inflationary pressure. This trend is not sustainable because other governments will intervene in the foreign exchange market to keep their own currencies from appreciating against the dollar to remain competitive in global trade. The net result will be a moderating of drastic changes in the exchange rate regime but not a halt of dollar depreciation.
What has happened is a global devaluation of all currencies with the dollar as the lead sinking anchor in terms of purchasing power. The sharp rise of prices for assets and commodities around the world has been caused by the sinking of the purchasing power of all currencies. This is a trend that will end in hyperinflation while the exchange rate regime remains operational, particularly if central banks continue to follow a coordinated policy of holding up inflated asset and commodities prices globally with loose monetary policies, ie releasing more liquidity every time markets face imminent corrections...>
http://www.atimes.com/atimes/Global_Economy/JA30Dj02.html
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