Myths about inflation.

ITEM: The New York Times for November 4, 2005, reported: "While the Fed chief sounded optimistic about the economy's prospects, Greenspan, who leaves early next year after 18 years, made clear that the Fed is keeping a close eye on high energy prices to make sure they don't spark broader inflation."

ITEM: The Times of London reported on October 28: "More interest rate increases will probably be needed from the Federal Reserve to head off inflationary pressures in America, the OECD [Organization for Economic Cooperation and Development] said yesterday in a report.... With little slack left in the US economy, inflation could 'continue to pick up,' particularly if energy prices keep rising."

ITEM: On ABC's Good Morning, America on October 16, reporter Geoff Morrell remarked that "soaring gas prices drove inflation to its highest monthly rate in 25 years."

CORRECTION: There are two major underlying errors at play here: first, the Fed doesn't cure inflation, it creates it; and, second, the commonly used definition of inflation is incorrect--confusing cause with effect. Higher prices are not inflation, but they may well be a result of inflation--which, properly defined, is an increase in the supply of money and credit.

The confusion, though widespread, is happily propagated by the government and those who benefit from cheapened money. The late Ludwig von Mises, the renowned scholar identified with the Austrian School of economics, often observed that the government is content to blame inflation on business, as has been the case most recently when prices rose in the energy sector. This is like a pickpocket yelling "catch the thief!" to disguise the fact that he actually lifted your wallet. "The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices."

Economist Henry Hazlitt was on the money with his straightforward explanation: "Inflation is an increase in the quantity of money and credit. Its chief consequence is soaring prices. Therefore, inflation--if we misuse the term to mean the rising prices themselves--is caused solely by printing more money. For this the government's monetary policies are entirely responsible."

Just because the game is an old one doesn't make it less effective. Every single day the mass media misuse the proper meaning of inflation until the general public now believes a rise in prices (a result of inflation) is inflation itself. Mises saw it happening in 1951, saying:

   Inflation, as this term was always
   used everywhere and especially in
   this country, means increasing the
   quantity of money and bank notes in
   circulation and the quantity of bank
   deposits subject to check. But people
   today use the term "inflation" to refer
   to the phenomenon that is an inevitable
   consequence of inflation, that is
   the tendency of all prices and wage
   rates to rise. The result of this deplorable
   confusion is that there is no term
   left to signify the cause of this rise in
   prices and wages. There is no longer
   any word available to signify the phenomenon
   that has been, up to now,
   called inflation.... As you cannot talk
   about something that has no name,
   you cannot fight it. Those who pretend
   to fight inflation are in fact only
   fighting what is the inevitable consequence
   of inflation, rising prices.
   Their ventures are doomed to failure
   because they do not attack the root of
   the evil. They try to keep prices low
   while firmly committed to a policy of
   increasing the quantity of money that
   must necessarily make them soar. As
   long as this terminological confusion
   is not entirely wiped out, there
   cannot be any question of stopping
   inflation.

Said inflation continually reduces the value of money. In this country, for example, the dollar lost about three-fourths of its value between 1965 to 1985; between 1985 and 2005, it lost a bit over one-third of its value. This was not a mistake. It was policy.

As Richard Rahn, director general of the Center for Global Economic Growth, has pointed out, the government normally produces "too much money, which causes inflation, because the government--as opposed to the people--has a vested interest in inflation. Under a progressive tax rate system, inflation results in unlegislated tax increases, by pushing people into higher tax brackets without any rise in real earnings and also erodes the government debt at the expense of the bond holders."

Rahn also recalls that before the Fed's creation in 1913, there was no persistent inflation (other than during the Civil War), noting that the "overall price level in those 124 years did not change much."

So when one hears that Alan Greenspan or his successor is fighting inflation by changing the federal funds rate, keep in mind that what is really happening is the creation of more inflation.

Dr. Frank Shostak, an adjunct scholar at the Mises Institute, reports that between January of 2001 and June of 2004, the Federal Reserve pursued "an aggressive lowering of the federal funds rate target. The target was lowered from 6.5% to 1% by June 2003. To attain a given federal funds rate target, the Fed must constantly manage the flow of money to financial markets. Changes in the Federal Reserve's balance sheet, also known as Federal Credit, depict the variability in the monetary pumping to sustain a given federal funds rate target. Thus, to support a lower fed-funds rate target the yearly rate of growth of Fed Credit jumped from 0.7% in January 2001 to 12% by September 2001."

Continues Shostak: "By responding to the symptoms of inflation that the Fed has itself created, the U.S. central bank gives the impression that it fights inflation. Once it is realized that inflation is increases in the money supply, it becomes obvious that the source of inflation is the Fed and fractional reserve banking. It also becomes obvious that rather than fighting inflation, it is the Fed itself that generates the inflationary process."

In short, the Fed ignites inflation by increasing the supply of money and credit, stoking the flames by manipulating bank reserves, then shows up with sirens blaring and saying it has arrived to put out the blaze. The media meanwhile pass out figurative gasoline to toss on the fire by cheering for the arsonists to do more of the same.