Why On Earth Would You Fight ‘Inflation’ With Higher Interest Rates?

“What we need is a period of slower growth so that the economy can cool off, so the labor market can cool off, so that wages can cool off. That’s how inflation comes down. That’s the only way we know to bring inflation down.” – Jerome Powell

Please read the above quote from Fed Chairman Powell over and over again. It’s essential as a way of understanding why the Fed is wrong about inflation twice.

Inflation is a decline in the measure that is the currency. It’s currency devaluation. Hyperinflation in Germany after World War I and II wasn’t born of hyper growth, but the exact opposite of it. People were desperately poor, only to have the money in their pockets devalued to worthlessness. Inflation is devaluation.

Please keep this in mind given the view inside the Fed that inflation is a consequence of economic growth. You see, the Fed thinks inflation is “higher prices,” which is like saying that coughing causes smoking. Causation is at best reversed. Worse for the Fed, there’s no causation.

Economic growth is just another word for productivity growth, and productivity growth is a consequence of investment. Of more equity and debt capital reaching the intrepid. When the intrepid seek capital, they’re doing so in order to produce exponentially more with less.

Which is a long or short way of saying that if we accept the Fed’s wholly flawed definition of inflation as “higher prices,” the greatest, most obvious way to fight higher prices is with more investment and more lending. Despite this, economists who mostly reside on the left and Paul Volcker devotees on the right claim that the answer to inflation is “tightening” so-called “easy money” from the Fed in order to put people out of work. This is what Powell believes as the above quote indicates, but it’s also what the Wall Street Journal editorial page’s lead economics writer (Joseph Sternberg) believes. The problem is that it makes little sense. For two reasons.

For one, if we ignore that the genius of compound interest means there’s no such thing as “easy money,” the surest way to once again push down prices is to direct precious capital to businesses and entrepreneurs. Put plainly, we need the opposite of “tight credit” to fight “higher prices.”

What’s important is that contra what Powell and Sternberg contend, the Fed can’t increase or shrink credit on their best day. Think about it. No one borrows “money” or seeks equity financing as much as they seek what money can be exchanged for. It’s a reminder that “easy,” mildly expensive, or “tight” credit is always and everywhere a market phenomenon simply because goods, services and labor that entrepreneurs and businesses seek in exchange for money are always and everywhere a creation of the private sector.

From there, Sternberg and the right err in their presumption that a stable dollar “is supposed to be the Fed’s job,” as a recent Wall Street Journal editorial asserted. In reality, Fed officials almost never comment on the dollar’s exchange value simply because the latter has never been part of the Fed’s policy portfolio. When FDR devalued in 1933, he did so in the face of virulent but toothless opposition from Fed Chair Eugene Meyer. An incensed Meyer resigned only to buy the Washington Post to fight an inflationary Roosevelt administration. In 1971, Arthur Burns begged Richard Nixon to not sever the dollar’s link to gold. The simple truth is that a stable currency is a policy choice that takes place away from the Fed.

Which means if the goal is a stable dollar, so be it. If so, dollars in circulation would soar to reflect global usage of what’s trusted by producers. Put another way, it doesn’t just boggle the mind that policy elites would call for higher interest rates to fight inflation. Even more puzzling is that they’d call for reduced circulation of that which is non-inflationary by virtue of its stability.