Fed Finally Being Blamed for Inflation

Editor’s Note: Even though this article tried to make a mockery of the issue, it is a somewhat tacit admission of what thinking people have known for a long time: inflation is a monetary event and central banks are in fact responsible for the concomitant loss in purchasing power.

Food riots, deposed Middle Eastern despots and now this? Last week, a Texas man brandishing an assault rifle was involved in a three-hour shoot-out with police and had to be subdued with tear gas after ordering seven Beefy Crunch Burritos at a Taco Bell drive-through and being informed that their price had risen from 99 cents to $1.49.

Late night comedians and serious pundits alike had a field day with the story, opining on issues like fast-food culture, obesity (the seven burritos contain 3,600 calories, double the recommended daily intake) and gun control.

With his petty gripe, the gunman, Ricardo Jones, is no Muhammad al Bouazizi, the self-immolating Tunisian fruit seller who inspired millions across the region to throw off the yoke of tyranny, but 50 per cent is 50 per cent in San’a or San Antonio. Food inflation is a global phenomenon.

Taco Bell may well not be the villain here. It was recently alleged in a class-action lawsuit that only 35 per cent of what the fast-food chain describes as “beef” meets the strict technical definition (meat from a cow). The remaining 65 per cent is claimed to be made from fillers such as potassium lactate, modified corn starch, malto-dextrin and autolyzed yeast extract. Taco Bell has said it vigorously disputes the allegations made about its food – but if the class action claims were proved to be true, it could be seen as an ingenious attempt to hold the line on meat price rises. However, it is not only the price of meat that is rising alas, but also fuel, flour, vegetables and even autolyzed yeast extract.

The finger of blame is increasingly pointing toward central banks and the US Federal Reserve in particular. By printing money through quantitative easing, there are supposedly more dollars, yen and pounds chasing the same number of Beefy Crunch Burritos. Fed chairman Ben Bernanke actually was asked during a speaking engagement last month whether the central bank was culpable for the revolution in Egypt.

“I think it’s entirely unfair to attribute excess demand pressures in emerging markets to US monetary policy because emerging markets have all the tools they need to address excess demand in those countries,” said the clearly annoyed banker.

But an increasingly common view is that, with the very best intentions, he is at fault. Critics regularly cite the words of Milton Friedman, who said that “inflation is always and everywhere a monetary phenomenon”.

The great economist’s words and work are being misinterpreted though. The monetary base has indeed mushroomed but, in the quantity theory of money, it is not a simple increase in the base that causes inflation. It is an excess supply of money, which is not the case – not yet anyway. At the moment, the money shows up as excess reserves on bank balance sheets, for which they receive interest.

If the Fed were to reduce or eliminate what it pays banks to park those reserves at the Fed, or if banks decided to expand balance sheets rapidly, then things would change. A little of this might be welcome but, if the Fed were too slow to put the brakes on a surge in lending out of fear of harming the recovery, serious inflation could result.

QE is not entirely off the hook though. Even if there is actually not more money in the economy chasing assets, the market’s anticipation of future recklessness and the opportunity cost for investors of holding low-yielding cash has increased the appeal of real assets. The Fed is happy to see this when it comes to shares or homes as this creates a benign wealth effect. Commodities are a different matter.

Even so, the price of oil, or of burritos for that matter, corresponds much more closely to supply and demand than, say, a share of Apple, which is not consumed and whose value is in the eye of the beholder. Rising affluence of developing market consumers – the so-called “march of the Chinese meat-eaters” – is the chief culprit. This is exacerbated by distorted currency regimes such as China’s, as Mr Bernanke hinted.

Just don’t shoot the messenger. Or the drive-through employee for that matter.

Read more at Andy Sutton’s Extemporania