Monday, January 16, 2006

So Close, Yet So Far...

John Tamny of National Review Online almost gets it. Almost.

In his piece "Always a Monetary Phenomenon", he claims that inflation is, in fact, a monetary phenomenon. That is, that inflation only refers to price increases caused by the creation of excess money. Price increases or decreases due to other factors are not inflation. So low-cost foreign goods should not be seen as an indication of the strongness of the dollar.

There is a little problem. Inflation does not "result from" excess money creation. It is excess money creation.

The semantic revolution which is one of the characteristic features of our day has also changed the traditional connotation of the terms inflation and deflation. What many people today call inflation or deflation is no longer the great increase or decrease in the supply of money, but its inexorable consequences, the general tendency toward a rise or a fall in commodity prices and wage rates. This innovation is by no means harmless. It plays an important role in fomenting the popular tendencies toward inflationism.

-Ludwig von Mises,
Human Action


But this is a mere semantic argument.

His larger error lies in this statement:

...[Low inflation] arises when the central bank matches currency supply with currency demand...one sure way to warp this process would be to let exogenous factors get in the way of a supply/demand concept.

For someone who proclaims the free market (as Mr. Tamny does in the rest of his piece), to argue that the Fed's goal is to match money supply with money demand seens to me to be a fundamental understadning of what the free market is. The Fed is a government-sponsored business with a government-mandated monopoly on creating and maintaining the money supply. It can't operate on normal supply and demand principles because it is a socialist, centrally-planned institution. To ask it to match supply with demand is like asking the Soviet Union's commissars to match supply and demand.

The only way to have a true free-market in money is for the supply of money to be determined by the market, not the government. And the only way to do this is to letthe market determine what will be accepted as money. In practice, this usually leads to commodity money (e.g. the gold standard).

That is all.

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