CNN: Chasing Mythic Inflation

Central banking historian Allan Meltzer's latest piece on the CNN Money website raises the specter of inflation, arguing that the Fed must act now lest it become too late to save us. Please.

Dr. Meltzer writes:

The Fed has to remove most of the remaining $700 billion increase in bank reserves that it supplied in the past year before the banks use them to increase money growth.

Postulating money creation here totally ignores the overall wealth destruction we have seen. Given securitization and financial engineering, are other forms of wealth not near money these days?

The professor continues:

Once the economy recovers, banks will start to lend to their customers and attract new ones. The Fed must be willing to let lending and bond rates rise as banks reduce their reserves.

Postulating massive new loan growth once this supposed recovery happens ignores the giant debt overhang we already face. It also ignores the extremely weak balance sheets at the banks -- most are in no position to make large-scale loans -- and the lack of credit-worthy borrowers -- again, debt overhang plus massive overcapacity in everything except petroleum, high-quality medical care, and certain minerals.

Finally:

This problem repeats the experience of 1966-67, 1969-70, 1973-75, and other times. Outside pressures on the Fed increased when the unemployment rate reached about 6.5% or 7%, well below its current or prospective level. That ended the anti-inflation commitment.

There is only one exception: the Volcker disinflation of 1979-82. Paul Volcker was the most independent chairman in the Fed's modern history.

Using the Volcker example without comparing the inflation level at that time compared with other recessions. There was a veritable tsunami of built-in inflationary expectations after the debacle of the 1970s. Right now you have the reverse: no one has pricing power and everyone knows it. Plus, many of the big players are East Asians who go for market share regardless of lack of profit.