Friday, October 19, 2007

Inflation Theory

Along with its pains, inflation can help a person get out of debt. Think about it. You borrow $10,000. You're earning $10,000 a month. It will take you a month's gross earnings to pay off your debt. Now suppose you get wage inflation. Your income goes to $20,000 a month. Now it will take only a half-month's gross earnings to pay off your debt. The debts that the U.S. owes to the rest of the world tend to be priced in dollars. The dollar has been dropping for some time. My theory is that this is intentional. I don't really know how Dick Cheney thinks, or how much influence he has on White House economic policy. But my seat-of-the-pants guess is that he remembers that little inflation lesson from the 1970s. I wouldn't be surprised if he was among those who believed Japan was manipulating the exchange rate to keep the yen artificially low in the 1980s, when Japan was overtaking one U.S. industry after another. Once he got into power in 2000 -- or especially, I think, once China began rising in a really noticeable way early this decade -- there was some willingness if not outright determination to dial the dollar down. If the Chinese were going to cheat by manipulating their currency's value, which they have plainly done, the U.S. would play the same game. In this theory, the White House responded like anyone who thinks they are getting a free ride. Debt became less of a worry because, what the hell, we were eventually going to inflate our way out of debt anyway. Sure, we would owe the rest of the world trillions. But trillions of dollars would be less of a big deal as the dollar's value tanked. So while it was not possible to let everyone in on the secret, it was possible not to be too worried by debts that seem large enough to sink the republic. My reading on Fed chairman Bernanke, in this light, is that he's not a determined inflation-fighter. For him, growth comes first. They say he's a scholar of the Depression. I haven't read his works. But judging from his willingness to cut rates to fight recession despite some inflation uncertainties, I think he will take risks with inflation that a Paul Volcker would not have considered prudent. I don't want to say that Bernanke shares the hypothesized desire to inflate the dollar. But it is possible that his response to stagflation will surprise us.