Squeeze the Money
by Thomas Brewton

Experience has proved that a rising level of business activity does not create inflation, nor does a rising level of interest rates control inflation. Both are discredited liberal economic doctrines that survive in public misperception only because too many college economics professors continue to preach scientistic socialism. Yet this is the doctrine publicly espoused by the Federal Reserve Board.

Unprecedented levels of inflation here during the 1970s left only the willfully blind unable to see negative consequences wrought by Keynesian interest-rate fine-tuning of the economy. William Poole, President of the St. Louis Federal Reserve Bank, described it this way:

"How bad was the period of the Great Inflation? The inflation rate, a mere 1 percent in 1965, hit 14 percent by 1980. Unemployment trended up from a low of 3.5 percent (annual average) in 1969 to 9.7 percent in 1982. The stock market was in the dumps; oil prices jumped off the charts. Presidents Richard Nixon and Jimmy Carter became desperate enough to tinker with price controls, the results being disastrous."

The popular misconception is that, after President Reagan took office, Fed Chairman Paul Volcker stopped inflation by raising interest rates. Mr. Volcker himself states the opposite:

"By the time I became chairman and there was more of a feeling of urgency, there was a willingness to accept more forceful measures to try to deal with the inflation. And we adopted an approach of doing it perhaps more directly, by saying, "We'll take the emphasis off of interest rates and put the emphasis on the growth in the money supply, which is at the root cause of inflation" - too much money chasing too few goods .- "so we'll attack the too-much-money part of the equation and we will stop the money supply from increasing as rapidly as it was."

"And that led to a squeeze on the money markets and a squeeze on interest rates, and interest rates went up a lot. But we didn't do it by saying, "We think the appropriate level of interest rates is X." We said, "We think the appropriate level of the money supply or the appropriate rate of the money supply is X, and we'll take whatever consequences that means for the interest rate because that will enable us to get inflation under control, and at that point interest rates will come down," which, of course, eventually is what happened."

In other words, Chairman Volcker stopped inflation by squeezing the growth of the money supply. As a by-product, interest rates rose and business activity declined temporarily. But inflation came to a screeching halt. Thereafter, interest rates dropped and business activity surged in one of our longest-lasting and strongest periods of economic growth.

Numerous price indexes again are signaling a resumption of inflationary pressures. This makes very worrisome the public pronouncements of the new Fed Chairman Ben Bernancke, who talks about a guessing game to find an equilibrium level of interest rates that will control inflation while facilitating business growth, rather than controlling growth of the money supply.

Why not go to the root of inflation and squeeze money supply growth?

The answer is politics over practicality. The Fed is not the olympian, independent agency that it's cracked up to be.

Politicians are keenly aware that inflating the money supply produces a short-term illusion of real economic growth; people have more money to buy things. That's why Democrats traditionally, and Republicans of late, love pork-barrel and welfare-program spending. The political problem is how to fund the increased spending without spoiling the party by raising taxes.

In the 1960s, Fed Chairman William McChesney Martin set the great inflation in motion by yielding to President Lyndon Johnson's pressure to flood the economy with money to finance simultaneous expansion of the Vietnam War and the Great Society's socialistic entitlements. In 1972, Fed Chairman Arthur Burns pumped excess money into the system to help President Nixon's re-election bid.

The United States is today in a position not unlike that of the Vietnam War period. We have to spend large amounts of money for military purposes at the same time as our Social Security, Medicare, and Medicaid expenses are poised to skyrocket when Baby Boomers begin retiring.

Instead of fiddling around with interest-rate window dressing, Fed Chairman Bernanke ought to be squeezing the money supply if we are to avoid a repetition of the 1970s inflationary debacle.

Thomas E. Brewton is a staff writer for the New Media Alliance, Inc. The New Media Alliance is a non-profit (501c3) national coalition of writers, journalists and grass-roots media outlets. His weblog is THE VIEW FROM 1776.