The funny thing about inflation and the stock market is … well, there is nothing funny about inflation. In fact, inflation is one of the most insidious of economic actors, not so much for its direct promulgation of rising prices, but also for the unintended consequences this poisonous beast brings about.
One need look no further than the political and social upheaval in Egypt to see the latest instantiation of the tumult inflation can help engender. In a recent column in National Review Online, economist Larry Kudlow essentially blamed the U.S. Federal Reserve and its inflationary QE2 policies for sparking the social unrest and rioting in the streets of Cairo that’s now morphed into regime change. According to Kudlow, “Decades of autocratic government and a lack of free elections are, of course, the main drivers of the political upheaval in Egypt. But did the sinking dollar and skyrocketing food prices trigger the massive unrest now occurring in Egypt — or the greater Arab world for that matter?”
Kudlow’s answer is “yes,” and he cites protests over higher food prices in Algeria, Jordan, Libya, Morocco, and Yemen, and even localized riots in rural China, where food prices recently surge over 10% in just one month to support his thesis. Now, we may all collectively be rejoicing in the ouster of an autocratic Middle East dictator. I’m certainly not sorry to see Mubarak out of the picture in Egypt. Yet a focus on what will likely be a positive outcome for that nation fails to consider the deeper cause, and that is that inflation essentially brought about social chaos in one of the world’s oldest civilizations.
When you consider this from a macro perspective, you get a real appreciation for the power of inflation. And while social unrest and regime change are extreme consequences of inflation, this fiscal disease also has the ability to destroy jobs, stimulate malinvestment and alter the way we live our lives.
In recent testimony before the House Financial Services Subcommittee on Domestic Monetary Policy and Technology, economist Thomas DiLorenzo explained what the Fed’s inflationary policies really do:
“When the Fed expands the money supply excessively it not only is prone to creating price inflation, but it also sows the seeds of recession or depression by artificially lowering interest rates, which can ignite a false or unsustainable ‘boom’ period. Lower interest rates induce people to consume more and save less. But increased savings and the subsequent business investment that it finances is what fuels economic growth and job creation.”
DiLorenzo went on to tell the Committee, “…lower interest rates are caused by the Fed’s expansion of the money supply and not an increase in savings by the public (i.e., by the free market), businesses that have invested in long-term capital projects eventually discover that there is not enough consumer demand to justify their investments. (The reduced savings in the past means consumer demand is weaker in the future). This is when the ‘bust’ occurs.”
These inflation-induced boom and bust cycles were seen recently in the housing market, and before that in internet stocks. Some say that the next big boom and bust cycle will be the stock market as a whole. Of course, this remains to be seen, but wise investors cannot ignore the possibility of a bust in equities following what is likely a Fed created, inflation-induced boom pushing money into equities.
Unfortunately, the only real way to truly mitigate the insidious consequences of inflation is for it not to occur in the first place.
One person trying to make this happen is Congressman Ron Paul. Rep. Paul (R-Texas), who doesn’t think the Federal Reserve should be in the business of setting interest rates, or regulating the money supply. He’s especially critical of the Fed’s printing of mass quantities of money to “stimulate” the economy. Paul wants to audit the Fed, and expose the Central Bank’s operations to harsh light for all to see.
I’m not sure if a mere audit of the Fed would eventually cage the beast of inflation, but I’m willing to give it a try.
Jim Woods is a financial journalist and a former stockbroker and money manager. He celebrates the virtue of making money from his ranch in rural California.