The 1920s - the previous NICE decade

John Prescott has just repeated, on Newsnight, the Labour party's favourite myth, barely challenged by the opposition, media or academia. According to the myth, the Labour government ran the economy successfully for the decade preceding the onset of depression, as evidenced by low inflation, low unemployment and uninterrupted growth.

We all know the fiddle on unemployment statistics, incentivizing people to move on to Incapacity Benefit, and then trapping them there. If we take the number of people of working age not in employment as the measure, rather than the number of people collecting Jobseekers Allowance, then it is not true that we had low unemployment.

That illusion attracts a fair amount of criticism. What is rarely challenged is the claim that the Labour government must have been managing the economy well because they achieved continuous growth with low inflation. That depends how you define inflation. If you define it as increases in an arbitrary price-index, then it is true. But if you define it as increases in the broad money supply, it is not true.

M4 money supply vs CPI


The price-index school dominates the economics profession. Although I believe it is a mistaken focus, I don't intend to get into a sterile debate about the semantics. What is interesting is (whatever terms and definitions your use), how useful the concepts they describe are as indicators and predictors of stability, risk, prosperity, etc.

To most economists and commentators, the low CPI and relatively-low RPI figures prove that all was well with the economy, and that what we are suffering now is a blip unrelated to previous events. Interestingly, this is a close reflection of the debate over the lead-up to the 1929 crash and the Great Depression. Central banks, then as now, were focused on maintaining a stable price level. The US Bureau of Labor Statistics Index of Wholesale Prices was 93.4 in June 1921, rose to 104.5 in November 1925, and fell back to 95.2 in June 1929 (Murray N. Rothbard, America's Great Depression, Ch.6). Consumer prices were similarly stable. On the other hand, capital goods prices (particularly stocks and real estate, but also food and farm products) rose significantly. And, as Rothbard details, the total (broad) money supply increased from $45.3bn to $73.26bn.

Monetarists would say that everything was fine in the 1920s expansion and that it was only the wrong policies implemented from 1929 onwards that caused the ensuing crash and depression. Austrians would say that the monetary expansion caused imbalances in the economy that would inevitably have to be corrected at some point, and that the crash was inherent in the previous development. They would agree with the monetarists that the correction was unnecessarily prolonged and exacerbated by policy, but they would not agree on the nature of some of the policy mistakes.

The monetarists' main criticism is the failure to counteract the monetary contraction from 1929 with an expansive/inflationary monetary policy. We are in the process of testing this theory. A couple of articles, one at DollarDaze and one at ZealLLC demonstrate the extraordinary extent to which Bernanke is trying to reflate. And, in broad money terms, the UK is expanding more dramatically than the US or any other major economy, at 16.3% p.a.

We will find out in due course whether it is a good thing for central banks and politicians to intervene to steer the economy like this. They may or may not succeed in the short-term, and if they fail, we may say that they fell at the first hurdle. But even if they draw us out of recession quicker and with a less severe contraction than expected (say bottoming before the end of the year and with house prices, stock markets and GDP down by less than 20%, 40% and 2% respectively from their peaks), we will then find out if their medicine is more deadly than the disease. We will have to see if they can prevent a stronger surge of inflation when the upturn comes (or worse still, before that, in the form of stagflation), due to the huge expansion/devaluation of money. And just as the monetary inflations of the 1920s and 2000s manifested themselves in capital not consumer prices, we should keep an eye out during the period after the retrenchment is halted, not just for the consumer price indices, but for wherever the extra money may create a bubble.

If the expansionist policies that currently unite the Keynesians and monetarists either fail to have the desired effect or have painful after-effects, perhaps the majority of the economics profession will acknowledge that there is a problem with their paradigm, and that they ought to give more consideration to the Austrian approach. (Probably not, on past performance, but one clings to hope of the resurgence of reason.) After all, it was the Austrians who succesfully predicted the Great Crash and the Credit Crunch (and other crises). The interventionists repeatedly claim that no one could have seen it coming (ignoring the fact that some did) and without any embarrassment then proceed to tell us what we ought to do about the problems that their models failed to predict. And if they try to cling on regardless, perhaps natural selection (i.e. their paymasters' shortage of real cash) will do what their consciences fail to do.

A huge contraction in the number of interventionist economics "experts" - now there's a deflation to look forward to.



One illustration of the dominance of the price-index attitude to inflation, which I meant to point out in the original post but forgot, is the Bank of England's Inflation Report of November 2008. There is no mention in there of money supply, M0, M4 etc. Not a peep! How can you have an Inflation Report, at a time when money supply is expanding at an accelerating rate, and not even mention it?

Not so long ago, the Bank of England at least acknowledged the relevance of money supply. In fact, they provided a graph to demonstrate how significant a factor it is in inflation. See Chart 3 on p.2 of their 2004 publication on Low Inflation and Business. Amazing what the political desire to spend more than we can afford will make people forget.