One Mike “Mish” Shedlock posted a pretty shattering take-down of Ben Bernanke’s latest blubbering about the housing market and the credit crunch. It’s hard to believe that a central banker in the US so completely fails to grasp basic economics. I’ve written before about the issue of central banking and inflationary monetary policy, and its culpability for the economic woes in the US and the world. That inflation is a deliberate policy of increasing the money supply, via low central-bank interest rates, and that a rising price level is merely an effect of inflation, which is to be expected when you increase the amount of currency in circulation, competing for the same amount of goods and services. (See here and here, for example, or spend an evening to read the Ludwig von Mises lecture notes I linked to here). But unlike Alan Greenspan, who simply worms his way out of accusations over his interest rate policy, Bernanke doesn’t even understand what inflation is, or how interest rates cause it. If he doesn’t grasp such elementary principles of central banking, why does he have the job?

The best quip is this:

This would be funny if it wasn’t pitiful. “A rough stabilization of commodity prices, even at high levels, would result in a relatively rapid moderation of inflation.” Translation: Inflation will stop once prices stop going up. Was that supposed to be a revelation? That was pathetic even for someone who thinks inflation is about prices.

That must be pretty embarrassing, if you’re the chairman of the US Federal Reserve. I entirely agree with Mish’s conclusion, too:

I have a simple solution for this madness: Want To Fix The Fed? Get Rid Of It.

That’s exactly the solution. If government price controls are a problem, causing either shortages (in the case of price caps) or surpluses (in the case of price floors), whoever thought it would be a good idea for the government to control the price of money and credit? That causes surpluses and shortages too, popularly known as “booms and busts”, or “the business cycle”. Except that business doesn’t cause it, but merely suffers the effects.

When the depth of the country’s electricity crisis became apparent in January this year, I noted with some amazement that Alec “The Bolt” Erwin, the minister in charge of public “enterprises”, told us it wouldn’t harm our economic growth. He seems to believe in the notion that if the collective decrees it, so it shall be. Why he didn’t just exclaim “fiat lux” we’ll never know. Surely, this would solve the perception problems South Africans seem to have in the dark?

I, on the other hand, called him an idiot who learnt nothing in economics lectures. I thought those who don’t believe Africans can run a competent government would claim vindication. I predicted severe inflation, and said that we’d be lucky if GDP stayed in positive territory. We can forget about poverty alleviation and job creation, I wrote elsewhere. Privately, I said, “by this time next year [meaning January 2009] we’ll be in recession”, but I couldn’t find anyone who’d accept even an even-odds bet on it.

Some commenters accused me of being overly negative, and several called me an afro-pessimist. I am pessimistic, yes, but it has nothing to do with people or geography. On the contrary, I have good reason to have faith in the ingenuity and productivity of free people, even in — or especially in — adverse conditions. My pessimism has to do with economics and government.

Maybe I was negative, but lo, just a month later, the first signs of the massive impact on growth in the mining sector became apparent.

Now, four months on, South Africa has double-digit inflation for the first time since our liberation. The central bank has jacked up interest rates by a massive 4.5 percentage points already, and its governor, Tito Mboweni, has just threatened a staggering further hike of two percentage points, which would bring it to 13.5%.

Our economic growth has crashed to not much more than 2% — thanks in part to a staggering 22% decline in the mining sector. The proximate cause? Power cuts, of course.

So now we face that dread curse of inflation that doesn’t buy growth: stagflation. Even the unions now argue that we’re heading for recession.

In response, finance minister Trevor Manuel seems intent on jumping off the same rhetorical cliff as The Bolt. He told parliament not to worry, “The slowdown we are experiencing is of a short-term nature.” He describes the causes of this deepening economic crisis as “short-term turbulences”. There will be growth! Fiat auctus!

Is delusion of competence a contagious condition? Is this what Thabo Mbeki means when he said that cabinet takes “collective responsibility for the decisions taken over 14 years”?

My initial response to Mbeki’s apology was, “Well, off you go then, the lot of you! One takes responsibility by resigning.” I had not considered that all Mbeki meant was that cabinet would get its collective story straight, and collectively play God, because what they say is all that matters. The rest is just racism or neo-colonialism or afro-pessimism or negativity or sensationalism or media hyperbole. Reality is created on command. Truth is what the government declares it to be. Hence its attempts to censor the media and establish its own party-run newspaper.

Don’t get me wrong. I’m not writing this to say I told you so (though I did). I’m not gloating that I know more about elementary economics than our minister of public enterprises (though I do). I’m the most modest person I know, after all (though besides that I have few failings).

I’m just wondering who dared disobey the honourable Alec Erwin’s command that growth would not be affected. I want to find the faithless exploiters of our collectivist misery, and expose them to public denunciation. Put them in the pillory and throw stuff at them, counter-revolutionary traitors that they are.

Last night, I found a neatly printed-out and stapled copy of Beware the Alchemists, by Ludwig von Mises. Detritus of good intentions some time past.

Transcribed by Bettina Bien Greaves from notes taken during a lecture tour in the 1960, the style is somewhat clunky, somewhat simplistic, somewhat imprecise, and somewhat repetitive. But though she says Mises didn’t like being quoted for that reason, I found his informal style a strength, not a weakness. Mises was the 20th century intellectual giant of the Austrian School of economics. He wrote his first major work as early as 1912, and died in 1973. Reading this, however, brings the old man alive again. You can picture speaking in somewhat clumsy English, patiently explaining the blindingly obvious, throwing up his hands with an exasperated sigh or sardonic grin as he points out the economic blunders of one government after another.

Beware the Alchemists is surprisingly accessible. It takes what appears to be a complex topic, encrusted with 100 years of Keynesian pollution and toxic government waste, and turns it into something simple and intuitive. I wish I had learned what I understand today about interest rates, monetary policy and inflation from this text. I wish I had been around in the 1960s to attend these New York lectures, so that I could have spent the four decades since going, “See? He told ya so.”

Today’s food price crisis? The oil price? The credit crisis? The weak dollar? St Alan “this was an accident waiting to happen” Greenspan? Mises explained all of these many years ago. And Greenspan, for all his claims to understand why Keynes was wrong (as a proponent of Hayek and Friedman’s Chicago School), not only waited for it to happen, but drove the bus to the scene of the accident.

Some quotations to pique your interest, perhaps:

The market is precisely the freedom of people to produce, to consume, to determine what has to be produced, in whatever quantity, in whatever quality, and to whomever these products are to go. Such a free system without a market is impossible; such a free system is the market.

We have the idea that the institutions of men are either (1) the market, exchange between individuals, or (2) the government, an institution which, in the minds of the many people, is something superior to the market and could exist in the absence of the market. The truth is that the government — that is the recourse to violence, necessarily the recourse to violence — cannot produce anything. Everything that is produced is produced by the activities of individuals and is used on the market in order to receive something in exchange for it.

It is important to remember that everything that is done, everything that man has done, everything that society does, is the result of such voluntary cooperation and agreements. Social cooperation among men — and this means the market — is what brings about civilization and it is what has brought about all the improvements in human conditions we are enjoying today.

Money is a market phenomenon. What does that mean? It means that money developed on the market, and that its development and its functioning have nothing to do with the government, the state, or with the violence exercised by governments.

The problem [that human action seeks to solve] is not to increase the quantity of money. The problem is to increase the quantity of those things which can be bought with money. And if you are increasing the quantity of money, and you are not increasing the quantity of things which can be bought with money, you are only increasing the prices which are paid for them. And in time, if the increase in money continues, the whole system becomes a system without any meaning… Prices are going up because there is an additional quantity of money, asking, searching for a not-increased quantity of commodities. And the newspapers or the theorists call the higher prices, “inflation.” But the inflation is not the higher prices; the inflation is the new money pumped into the market. It is this new money that then inflates the prices. And the government asks, “What happened? How should one man know? …” The government is very innocent. … And the governments try to find somebody who is responsible — but not the government. They consider the man who asks for higher prices responsible. But he must ask for higher prices because there are now more people wanting to buy his produce, you know. … Now we have the inflation.

Everything that is done by a government against the purchasing power of the monetary unit is, under present conditions, done against the middle classes and the working classes of the population. Only these people don’t know it. And this is the tragedy. The tragedy is that the unions and all these people are supporting a policy that makes all their savings valueless. And this is the great danger of the whole situation.

The book isn’t long. It’s an evening’s read. It’s an excellent way to spend the May Day holiday weekend, and is a lot easier than reading Mises’s magnum opus, Human Action (though the latter also comes highly recommended, for the philosophical grounding it gives economics).

An accessible introduction to elementary economics, as Mises offers in Beware the Alchemists, should be required reading for anyone hoping to serve in, vote for, or write about government. Sadly, those are the three occupations for which no qualification or experience is required at all.

Every economist, expert and commentator I’ve seen seems to be flummoxed (and mildly panicked) about food inflation. The question on everyone’s lips is, “What can be done about high food prices?” The answer to that is fairly simple. I asked Thomas Carlyle’s parrot to explain.

Price is a wonderful number. It contains a lot of information, and alerts both producers and consumers to a variety of facts. Examine each of these signals, and you’ll have a fairly good idea whether a perceived problem really is a problem, and if so, what public policy prescription might help.

The first point to make is that the solution to high prices is high prices.

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Joseph Stiglitz says the Iraq war is a central cause of the sub-prime mortgage crisis. From which we can conclude that the Iraq war is not a central cause of the sub-prime mortgage crisis.

The press never tires of describing Stiglitz as a Nobel Prize winner. This is true. He shared a prize in economics in 2001 with George Akerlof and Michael Spence, for work on the asymmetric availability of information in markets. One application, on which Stiglitz in particular focused, involved credit markets, in which lenders know less about the likely repayment of a loan than borrowers.

So one would think he knows something about the credit crunch. And perhaps he does. But if so, he’s not telling. He’s got a war to fight, and a book to flog to the economically illiterate antiwar left. The former economic adviser to US president Bill Clinton teamed up with Linda Bilmes, another Clinton-era economist (not that I’d for a moment suggest partisan bias, you understand), to publish The Three Trillion Dollar War.

Stiglitz’s explanation for the credit crunch? When in doubt, blame Bush. According to him, the Iraq war is a primary cause:

The spending on Iraq was a hidden cause of the current credit crunch because the US central bank responded to the massive financial drain of the war by flooding the American economy with cheap credit.

“The regulators were looking the other way and money was being lent to anybody this side of a life-support system,” he said.

That led to a housing bubble and a consumption boom, and the fallout was plunging the US economy into recession and saddling the next US president with the biggest budget deficit in history, he said.

He’s partly right: inflationary monetary policy was a central cause of the housing bubble. Low interest rates made money cheaper, which not only boosted investment in fixed assets such as houses, but also led to great offers on home loans at rates that could never last, squeezing those who bought houses they couldn’t really afford.

He’s also right to note that expanding the money supply by keeping interest rates low is a favourite technique of governments to “inflate away” debt. In essence, monetary inflation debases a currency, imposing an invisible tax on income earners that has the effect of reducing public debt: your dollar becomes worth less, and you can buy less with it, but the government’s dollar-denominated debt is also worth less as a result.

But here’s the rub: the US debt has not been inflated away. It may be lower as a percentage of GDP than it was during the height of the Clinton years, but despite the economic growth of the Bush years, it isn’t exactly heading down.

That’s not Stiglitz’s biggest error, however. He attributes this inflation in money supply to the Iraq war. So I got some data from the Federal Reserve, and drew a chart of the monthly federal funds rate since 2000, with the Iraq war period highlighted.

You’ll notice that for most of the duration of the war, the fed rate has risen sharply. It hasn’t been kept low, or been lowered, as Stiglitz’s theory would have it. The cause of the credit crunch predates the Iraq war, and contrary to Stiglitz’s claim, the fed’s policy during the war was to make credit more expensive.

I cannot imagine that a Nobel Prize-winning economist didn’t spot this, so I can only conclude that Stiglitz is simply lying when he attributes the Federal Reserve’s low interest rates to the Iraq war. Must be something he learnt from Bill Clinton.

A year ago, when presenting his paper, “The True Costs of the Iraq War,” he estimated that the war would cost between $1 trillion and $2 trillion, depending on how much longer troops stay.

Just a year later, he says the war will cost $3 trillion, and that’s a conservative estimate. Then his margin of error, at a conservative estimate, is between 100% and 200%. This seems rather higher than an economist should be comfortable with. Granted, such an estimate does indeed depend on how long the troops stay. Just like the price of an acid trip depends on how much acid you take.

Another way he arrives at this staggering figure is that Stiglitz uses a terrifically broad definition of war costs, including, for example, welfare costs for veterans. This leads to rather interesting conclusions.

One of the greatest discrepancies is that the official figures do not include the long-term healthcare and social benefits for injured servicemen, who are surviving previously fatal attacks because of improved body armour.

So let me get this straight: It’s a bad thing when soldiers don’t die, because then you have to keep paying them? Nice sentiments, Mr Stiglitz. At least we know now why you didn’t win the Peace Prize.

This Wall Street Journal editorial is an interesting read, about a country few of us know much about, El Salvador.

The core angle of the article is the threat of a return to socialism because El Salvador, which converted to the dollar several years ago, is being hit hard by the Fed-induced decline of the dollar. There are many other observations that are topical, however, especially for other emerging markets, like South Africa:

Since 1992, El Salvador’s democratic leadership has opened markets, reduced the role of the state in the economy, and created the conditions for competition in most economic sectors. In telecom, the government boldly went against the advice of a Washington consensus, which insisted that a 10-year private monopoly was the only way to transition from a state-owned monopoly. (That model set Mexico and Argentina back decades in telecom competition.) Instead, policy makers insisted on full deregulation, and competition has driven down prices and delivered top-notch service.

An untenable public pension scheme has been replaced by a privately administered, defined-contribution system; this removes a massive liability from the government’s books and increases the security of future retirees. Import barriers have come down, international competition now exists in the financial sector, and the economy has diversified into services and low-tech manufacturing.

Though official statistics estimate growth from 1989-2004 at 4.1% per year, former Finance Minister Manuel Enrique Hinds told me in an interview here that he believes it is much higher. He has published extensive research arguing that traditional methods of measuring Salvadoran growth do not capture changes in the makeup of the real economy. When these are factored in, he says, the average annual growth rate is 6.2%. Mr. Hinds’s estimates are supported by World Bank findings and also jibe well with the fact that, from 1991 to 2006, Salvadoran poverty was halved and extreme poverty went from 28% of the population to less than 10%.

I’ll quote the entire piece below the fold, because despite the fact that the WSJ Editorial Page is now free, I still can’t figure out how to navigate to yesterday’s articles, and whenever I click on a link someone else sends, I get to a useless “resubscribe” notice I can’t seem to bypass. I found the link at the top by checking my cell-phone browser’s history and typing in the article code. Hint, hint, guys.

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Two well-written items on economics caught my attention recently. They’re worth reading to get some perspective on issues that are sure to be mangled, spun, highlighted or covered up by the political candidates running for president in the US.

One is an essay written by South African tech entrepreneur, Mark Shuttleworth, a couple of weeks ago, in response to the first of the Fed’s two panicky rate cuts. With admirable simplicity, it explains the impact of using interest rates to modulate the economy, and why the US Federal Reserve, both under Alan “Maestro” Greenspan and Ben Bernanke, must shoulder much of the blame for causing the credit crunch, and for eroding economic performance with inflationary monetary policy. Shuttleworth says people who take over at the bottom and lead upwards do so even if “their voodoo had no mojo”. Which, applied to central banking, is as good an explanation as any of where the real “voodoo economics” lies.

Another is an angry editorial in the Wall Street Journal yesterday that takes offence at the fact that the fiscal stimulus on which the Bush adminstration and Democratic leaders in congress agreed will prove to be nothing but an injection that merely postpones the pain, and increases the budget deficit for no discernable long-term benefit. Worse, the resultant deficit will be unjustly wielded as a blunt weapon in the election campaign, and could derail what should have been one of Bush’s most durable and important legacies: making his tax cuts permanent.

This is tragic, in a side-splitting sort of way:

Zimbabwe’s latest inflation figures had been delayed because there were not enough goods in the shops to measure price increases, the state statistical department said yesterday.

It’s instructive for various reasons. The most obvious is that price controls, which Zimbabwe imposed to curb consumer price inflation, cause shortages. Eventually, those shortages become critical, as they have done now. Pity it’s the Zimbabwean people who pay the price for their government’s failure to grasp Economics 101, but it’s hardly surprising.

The other point to make is that the consumer price index that is usually held up as a measure of inflation is, in fact, nothing of the sort. It measures a possible effect of inflation, perhaps, but it does not measure inflation itself. Inflation is not a general increase in price levels. Inflation is an increase in money supply.

For an illustration, consider this chart, which measures US money supply against the value of the US dollar:

As the value of a dollar decreases, consumer prices will, of course, tend to increase too, but that increase is not in itself inflation. An Austrian School monetarist, Frank Shostak, has this to say by way of defining inflation:

The subject matter of inflation is the debasement of money. For instance, historically inflation originated when a ruler would force the citizens to give him all the gold coins under the pretext that a new gold coin was going to replace the old one. In the process, the king would falsify the content of the gold coins by mixing it with some other metal and return to the citizens diluted gold coins. On account of the dilution of the gold coins, the ruler could now mint a greater amount of coins for his own use. (He could now divert real resources to himself). In short, what was now passing as a pure gold coin was in fact a diluted gold coin. The expansion in the diluted coins that masquerade as pure gold coins is what inflation is all about. As a result of inflation, the ruler could engage in an exchange of nothing for something.

Under the gold standard, the technique of abusing the medium of the exchange became much more advanced through the issuance of paper money unbacked by gold. Inflation therefore means here an increase in the amount of paper receipts that are not backed by gold yet masquerade as true representatives of money proper, gold. Again the holder of unbacked money can now engage in an exchange of nothing for something.

In the modern world the money proper is no longer gold but rather paper money hence inflation in this case is purely the increase in the stock of paper money. Please note we don’t say as monetarists are saying (sic) that the increase in the money supply causes inflation. What we are saying is that inflation is the increase in the money supply.

Note that inflationary monetary policy remains, today, a way for governments to “inflate away debt”. But more pertinently for Zimbabwe, this shows that inflation can be measured simply by checking the records of the central bank: how much money did it print last month, as an annualised percentage of money in circulation? That’s inflation.

Measuring inflation does not require shelves full of consumer goods of which prices can be determined. Why would such a measurement be meaningful if prices are capped by government anyway? More pertinently, why would such a measure be meaningful if the shelves are empty in the first place?

Sounds like every central banker. I whipped up a couple of simplified graphics that illustrate, quite dramatically, the impact of fiat money, government price controls on credit, and inflationary money supply policy. One might call it the curse of the central banker.

(Adapted from charts originally created by Michael W. Hodges, based on data from the Federal Reserve Bank of Minneapolis.)

Listening to CNN hail some recent economic pessimism as an “It’s the economy stupid” moment like the one which swept Bill Clinton to power in 1992, it not only sounded like a Democrat stump speech, but prompted me to give the US economy some thought. The proximate cause of the current low economic confidence is, no doubt, the mortgages problem. “Credit crunch”, “subprime crisis”, it’s all over the papers.

What I’m wondering is what this has to do with the current president, and how a different president with different policies would have done (or rather, would do) things differently.

To simplify somewhat (but not much): after the dot-com bubble burst two things happened. Both were designed to ease the pain and soften the landing. Alan Greenspan lowered interest rates, and kept them at record lows for a long time. George Bush proposed a raft of tax cuts. So Greenspan made debt look attractive, by making the real interest rate (nominal rate minus inflation) negative, prompting a rush of zero-rate deals offered by banks. Bush, by contrast, took less money from people’s incomes, leaving more in their pockets for spending or investment.

Lots of people took the debt deals, with or without the elementary understanding that zero interest rates couldn’t possibly last, whether or not they could now afford it. Since then, interest rates have risen, but taxes have not.

So who’s the villain in this piece? The Fed chairman, who independently determines interest rates, or the president, who doesn’t? Granted, it’s always nice to blame your bank when you’re in trouble, or your spouse, or your kids, or your government, but it’s not always accurate. St Alan, not the devil in the White House, was most responsible for today’s credit crisis. Unlike the president’s remedy, the Fed’s medicine was at best a temporary salve. Greenspan is already gone, but his successor, Ben Bernanke, has as much power in controlling the price of money. Price controls don’t work anywhere else, so why would it work in the credit market?

And if you think the problem is larger than bad credit, and point, say, to the ever-weakening dollar, one can again point to the Fed’s inflationary monetary policy. If you’re printing money to keep consumer spending up, your currency is going to devalue. Ask Bob Mugabe.

Since Bernanke isn’t up for re-election, and the Federal Reserve isn’t up for a renewal of its charter, why would these issues even feature in a presidential election campaign? They have little, or nothing, to do with the current president. (Just like Congress’s profligate spending has nothing to do with the president if he doesn’t even have a line-item veto.) If I were an American voter, I’d be thanking the president for doing what he could do — cut taxes — and considering any candidate who looks skeptical enough of the Fed’s inflationary monetary policy to try to do something about it.

Why would CNN be telling us they’re critical election issues for Campaign 2008? This is misdirection, and partisan misdirection at that.