In a free market, prices do more than tell us what we have to pay for things. They are messages emitted by an intricate communications system that inform us of the relative scarcity of resources, labor and consumer goods, and the relative intensity of consumer demand. Thanks to prices, we can tell producers how we rank our preferences, and they in turn can arrange production according to our priorities. Without prices, economic coordination is impossible, which is why attempts at state planning produce, in Ludwig von Mises's words, "planned chaos".
We associate inflation with a rising price level, but equally important, relative prices change when new money is created. That garbles the messages. As Mises writes, "The additional quantity of money does not find its way at first into the pockets of all individuals; ... [P]rice changes which are the result of inflation start with some commodities and services only. ... [T]here is a shift of wealth and income between different social groups."
The Fed gives money to AIG or Citicorp, but not to Lehman Brothers, or you and me. The new bank reserves also push interest rates below what the market would have set, further distorting production by encouraging investment plans to be made on the basis of artificially low rates.How can the economy straighten itself out if it is being systematically skewed by government inference with prices?
Stossel makes two very intuitive points. First, all of this stimulus is inflationary. Second of all, it is skewed inflationary toward one group at the expense of other groups.
These two points should be viewed in the context of the last time the government provided so much stimulus, 2002-2003. At that time, I believe that the Fed provided far too much artificial stimulus when it lowered the Fed Funds Rate below 1%. This artificial stimulus caused banks to borrow far more money than a natural market would have wanted, and this created, in my opinion, the speculative market that lead to the mortgage crisis. Sometimes, we don't recognize just how inflationary a stimulus is exactly because the inflation becomes isolated in or a few sectors. That's exactly what happened with the Federal Reserve's stimulus. From 2003-2006, we saw an explosion in real estate prices. Things varied but on average prices went up about 50% in that time period. Most folks didn't see this as inflation though in fact that's exactly what it was and the inflation was mostly isolated in the value of real estate.
This massive inflation in real estate was part and parcel wrapped up in the speculative nature of the market for real estate. All of this was created by the artificial stimulus of the interest rate cuts. In that event, those that happened to buy into real estate were the winners of this inflation but everyone else that didn't take advantage lost out. During that four year period, many people became priced out of real estate.
Of course, currently we are looking at even more inflationary stimulus and once again the stimulus is isolated. Stossel very intuitively points out that folks like AIG, Citigroup, and the autos will be the beneficiaries of the bailout. So, where all of these folks that are the recipients of the stimulus put that money that will be the market that will see inflation. Furthermore, and much more importantly, because this stimulus is so massive it is likely to cause whatever market is the beneficiary to invariably become speculative. Too much stimulus almost invariably leads to a speculative market wherever that is applied.
What all of this stimulus will eventually do is create disequilibrium in some niche or market. That market will show signs significant potential income and every quick buck artist will begin putting their money there, and we are on a path for another catastrophe created by another speculative market.
Make no mistake the sort of stimulus the government has and will create is unprecedented. We are about to drop about $700 billion into one sector. The kind of stimulus that financial services is about to receive is unprecedented. Furthermore, the Fed Funds Rate currently is 1% and most expect it to go lower and possibly all the way to zero. As such, not only will financial services be flushed with all sorts of cash but they will have access to very loose credit. This is in fact exactly what stimulated the speculative market that caused this mess only the last stimulation was minuscule compared to what we are about to see. By every indication, we are now creating another speculative market to blow up in the next five years.
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