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The Fed vs. Employment

The Fed vs. Employment
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Federal Reserve Bank of Chicago president Charles Evans gave a speech a couple weeks ago at the 2013 Wisconsin Real Estate and Economic Outlook Conference where he said when the Fed took interest rates to zero, expanded its balance sheet and started quantitative easing, “a couple of nice folks mailed me worthless $100 trillion Zimbabwe notes to warn me of the inflationary consequences of our policies.”

Evans went on to worry about how low the inflation rate is. His employer wants two percent inflation and is going to extraordinary measures to create it. Evans, believing Bureau of Labor Statistics (BLS) numbers, told the Wisconsin crowd inflation has averaged much less than the Fed’s two percent target.

“Inflationary expectations have not risen at all,” said Evans. “And there are simply no signs of cost pressures building. Most importantly, wage growth has been quite modest, and there is no evidence of labor cost pressures. Without rising labor costs, a 1970s-style cycle of price increases cannot be sustained.”

He went on. “Let me just remind everyone that inflation falling below our target of 2 percent is costly. If inflation is lower than expected, then debt financing is more burdensome than borrowers expected. Problems of debt overhang become that much worse for the economy.”

When Evans talks about “worse for the economy” he’s talking about high unemployment. However, low inflation, or deflation, for that matter, does not create unemployment. “People are not just unemployed,” writes professor Jörg Guido Hülsmann. “They choose not to work for an employer under the (pecuniary and non-pecuniary) conditions offered to them.”

As long as people can survive on what they make, they will work at a particular job. In a deflation wages fall but so do all other prices. Involuntary unemployment only occurs if minimum wage laws prevent workers for offering their services at market rates below the government mandate.

Keynesians such as Evans often contend deflation will slow the economy. What deflation does is reward the best entrepreneurs using resources in the most efficient ways. Inefficient, wasteful businesses cannot hide under a cloud of phony profits as they do in an inflation.

Yes, “deflation in the worst of all circumstance induces businessmen and factor owners to hold back with their assets to avoid wasting them in any fancy venture,” explains Hülsmann. “Deflation is therefore inherently sober, prudent, and financially conservative.” Nothing wrong with that.

So why would anyone start a new business in a deflation? Because prices are not what determine a viable business, profits do. It is the difference between revenues and expenses that determine a successful enterprise. Inflation masks unprofitability as inventory and tax costs are underestimated.

In his piece, “In Fed and Out, Many Now Think Inflation Helps,” Binyamin Appelbaum implies that inflation helps rank-and-file workers get jobs. The Keynesian thinking being businesses can raise prices, earn profits before their costs and wages go up, and thus they will hire labor because its cheaper.

This is a temporary phenomena at best because costs quickly rise. Workers, even when wages increase, never seem to catch up. Every inflation and investment bubble in history has left the average worker more impoverished.

If you wish to level the playing field, deflation actually harms lower income workers less than the rich. Low income people derive their wages from labor. If they lose one job they can find another even at a lower wage. The rich, professor Hülsmann points out, earn a larger share of their income from financial assets. These assets are tied to capital goods which often times have very specific purposes.  When these assets are no longer needed there will be a dramatic drop in their market price, often to scrap value.

Economists at the Fed still have it in their heads that people will postpone purchases indefinitely unless prices are rising. Of course this just doesn’t make sense. People’s prosperity depends upon trading for goods and services to satisfy their needs and wants. They don’t do that sitting on their money.

Frank Shostak pointed out in a piece on mises.org in 2010, “since January 1998 the price of personal computers has fallen by 93%. Did this fall in prices cause people to postpone buying personal computers? Not at all. Consumer outlays on personal computers have increased by over 2,700% since January 1998.”

Shostak’s piece points out deflation brought about by debt liquidation is not the cause of an economic slump but just the economy’s attempt to heal from the central bank’s loose monetary policies.

He writes, “it is not a fall in prices as such but instead the declining pool of real savings that raises the debt burden and intensifies price deflation. The declining pool weakens the process of real-wealth generation and in turn weakens borrowers’ ability to serve the debt.”

Mr. Evans and the other policymakers at the Fed are slowing the healing process with their money creation. Shostak tells us why. “The reason for this is that more money only weakens the wealth-generating process by stimulating nonproductive consumption (consumption that is not preceded by the production of real wealth).”

Evans laughs at people who sent him Zimbabwe notes. Indeed, there is no hyperinflation in sight. However, the Fed has nothing to brag about.  Its policy is keeping people unemployed. If Evans, Bernanke and Co. would just get out of the way, the economy would heal and people would go back to work.

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Douglas E. French is a Director of the Ludwig von Mises Institute of Canada. Additionally, he writes for Casey Research and is the author of three books; Early Speculative Bubbles and Increases in the Supply of Money, The Failure of Common Knowledge, and Walk Away: The Rise and Fall of the Home-Owenrship Myth. French is the former president of the Ludwig von Mises Institute in Auburn, Alabama.

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