Price Inflation: Real and Rhetorical

On the Mises Blog there is an article claiming that cars would cost $600 and hamburgers only $0.12 if only the government would hold the money supply fixed - or, more precisely, if only the government had held the money supply fixed from 1959 to the present.

I don't want to dispute the wisdom of fixed money supply. On that subject, I'm what you might call an agnostic who wants to believe. Not quite Fox Mulder, but definitely not Dana Scully. And if I'm not Mulder, it's only because I haven't been "out there" looking for the "truth." Lots of ink has been spilled on this subject, and I've read very little of it, so I'll hold judgment until I know more.

Certainly the naive common sense view is that a fixed money supply is a good thing. This is because it prevents arbitrary distortion. Ultimately, an economy is just a collection of "useful stuff," or "utility," as some prefer to call it. There are things and services out there that people want or need, they are willing to work or produce to get them, and so the engine goes on turning. If money is anything at all, then it's the grease that keeps this engine running smoothly. Ultimately what people are trading back and forth are goods and services - the aforementioned "useful stuff." All money does is facilitate this process. So in some sense it shouldn't matter how many paper dollars there are floating around out there. What changes are the prices, and if there are always the same number of dollars "out there," then we expect prices to go down as more stuff gets made. It's another way of saying that stuff gets more affordable. Fine, maybe your salary doesn't rise, but the amount of "useful stuff" that you can buy with it goes up, and that's what really matters. So we can do this one of two ways: we can have ever more paper dollars with ever-higher salaries and prices, or we can have the same amount of paper dollars with ever-lower prices and more-or-less fixed salaries. The only reason to prefer one system over the other that I can see is that the fixed-supply system is less dangerous. Since the money supply never changes, there is no opportunity for the government to get its numbers wrong (and, really, when doesn't the government get its numbers wrong?) and print way more money than we actually have, causing distortions in prices, etc. etc. It's better to just know that there is only so much in cash floating around and let prices (which are, after all, determined by the people on the ground actually moving the economy, not the people in their ivory tower in Washington running numbers that may or may not have much to do with how much "useful stuff" is actually changing hands) do the work of telling us how well the economy is doing. However, as I said above, I don't want to commit to saying too much here because I don't know nearly as much about it as I should. The naive view seems to paint a fixed-supply system in a nice light, but it's certainly happened to me before that my naive intuitions failed to appreciate subtleties that became apparent on closer examination.

The overall point, though, would seem to be that what matters to people on the ground, ultimately, is not how arbitrarily low or high prices happen to be, but what their individual actual purchasing power is. Whatever creative accounting we do to make the system look one way or another (I guess people respond better to seeing their salary go up than they do to seeing prices go down when all is said and done - though it can amount to the same thing in the end), the economy ultimately boils down to "how much useful stuff do I have and what do I have to do to get more?" And that's got more to do with earnings-to-price ratios than it does with raw prices and the raw money supply.

This is the point that I think Mark Brandly is glossing over (he wouldn't be missing it - he's a trained economist!) in his article. Brandly uses a simplistic formula to show that prices are as much as 34 times higher than they were in 1959 - numbers which are really shocking. This is how he does it. He reasons that the ratio of the 1959 money supply to the money supply in a given year should also be the same as the ratio of 1959 price to price in a given year. Fair enough - that makes a certain amount of sense. Of course, more of product x is probably being produced now than was being produced in 1959 (unless maybe it's hair curlers or pointy glasses), but this should be reflected in the price. (Remember, in theory a price is expressable as a percentage of the total wealth available.) Brandly admits that this model is simplistic - it's merely meant to give a rough idea:

For example, if the money supply increased from $100 in period one to $200 in period two, then the price level in the second period would be twice as high as it would have been in the absence of the expansionary monetary policy. Admittedly, the increased money supply may not have this proportional effect on the price level. However, all price indices are arbitrary and imprecise calculations that are often presented to the public as precise numbers. The following calculations are simply estimates of the price level effects of government policies.

On this we surely cannot fault him. It's clear that these numbers are not meant to be taken as scientific writ (and really, what in Economics ever is?).

So the way this works is that you simply cross multiply. If the money supply in 1959 is to the money supply in 2006 as prices in 1959 are to prices in 2006, then you can multiply prices in 2006 by the money supply in 1959 and divide by the money supply in 2006 to get an estimate of what the price of a given item would be today had the money supply remained fixed since 1959. Makes sense, right?

But here's where I think the magic comes in. The point is, people's earnings are not expressed in 1959 dollars, they are expressed in 2006 dollars. So while Brandly is in some sense correct, according to his formula, that a hamburger "should" cost $0.12 and a car "should" cost $600, it's also true that people like him "shouldn't" be making anywhere near as much money as he is actually depositing into his bank account every month. Simply saying that a hamburger should cost only $0.12 means nothing to me if I don't know what that is as a percentage of my income. And here's where Brandley's sleight-of-hand really comes into play:

Currently, price inflation is thought of as an increase in the price level above some previous level. However, if we think of price inflation as the increase in the price level over and above what the price level would have been in the absence of the expansionary monetary policies, then this gives us a more accurate picture of the effects of government policies. The estimations provided here show that the price level effects due to government manipulation of the money supply are much larger than indicated by standard price indices.

So that's right in absolute terms, yes, but in meaningful terms (i.e. in terms of whether my purchasing power has gone up since 1959) not so much. In meaningful terms, the government estimates of how much better off people are today than they were in 1959 are probably not as far off the mark as Brandly claims.

Now, Brandly would no doubt say that he never claimed they weren't - but I beg to differ. It's true that nowhere in this post does it specifically say that that if the money supply had remained fixed since 1959 that I would be able to buy 34 Big Macs for the price of one today, but Brandley doesn't seem to mind people getting that impression. Indeed, that last line in the quote above says to me that he's actively promoting the misinterpretation, as does the title.

So this is yet another disappointing post from the Mises Blog. The error in persuasion here is different from the one in the Rockwell post that I complained about earlier, though. My complaint about Lew Rockwell was that he was sabotaging support by arguing only in stark and simplistic terms of principle; he would have done better to take the obvious concerns of his readers about drunk driving into account and address them. In the case of this Brandly article, I think the sabotage is more insidious. Superficially, this article is very convincing indeed. It has the numbers to back up its claim, and it promises the reader something that he presumably wants to hear: namely that if we adopt Libertarian economic policies he will be rich in a short amount of time. But the numbers do not actually work out in the way promised, and any intelligent reader will eventually see through this, if maybe not on his first read. So Brandly is just setting himself up to fall. The Democrats and the Republicans can get away with this because nobody honestly expects them to deliver on their elections promises. We're used to hearing sunny predictions from them while bracing for business as usual. I don't believe third parties have this luxury. When you propose a radical change in a system and people go along with you, they bank on what you say, and they get petulant when things don't work out as you promised.

Now, as I said, I haven't read as much about this as I probably should have, so it's entirely possible that I'm overlooking something; maybe Brandly's right that I should be able to buy a fleet of 34 cars for the price of the one I have now. But that just seems wrong. Even if it's true that Libertarian economic policies in general would have netted us this level of wealth over the last 50 years, surely money supply policies alone would not have! Not that it even seems likely that 50 years of Libertarianism would have turned us all into owners of fleets of vehicles either...though I'm pretty damn certain that we'd all be a lot richer and more comfortable today if instead of embracing the so-called "Great Society" we had turned to the free market to help us spread the wealth around. So I guess I wish that people like Brandly would keep their claims realistic. After all, bottom-line better is bottom-line better - and that we can definitely deliver. When we promise people the moon, we just end up sounding like Lenin in the 20s. It's not only the government inflating prices here, in other words.