Inflation now best friend of financial gnomes

January 05, 2003|By JAY HANCOCK

THE PRICE of tin, whose marriage to copper brought humans out of the Stone Age and which is a component of toothpaste and garbage cans, has risen 15 percent since August to $2.09 a pound.

Tin is one of those raw, brandless products, fixed in the commercial bedrock, that sometimes emit crucial economic information. Lately tin, soybeans, cocoa and other commodities might be signaling at least a pause in the trend of lower and lower inflation that began in the early 1980s.

It is far too early to say for sure. But if the new course is confirmed by time and a rise in prices for finished goods, the world's monetary authorities will have won a famous victory.

Inflation used to be bad. Since the 1960s, we have worried about rising prices and the high interest rates and economic friction they caused. Now, at least for the developed world, inflation is seen as good, a thing greatly desired by government and business alike.

After trying to kill inflation for four decades, and succeeding, the world's financial gnomes are trying to resuscitate it. Central banks have always stoked inflation in tough economic times by increasing the money supply, but the resulting higher prices were seen as a harmful side effect that would eventually have to be snuffed.

Now Alan Greenspan and other monetary authorities are seeking inflation for its own sake. They do not acknowledge it in public. Doing so might violate their charters and cause bond investors to drive up interest rates and hurt whatever fighting chance inflation and the economy may have. But the signs are unmistakable.

Worldwide short-term interest rates are lower than they have been in 40 years. Only three years ago the Federal Reserve worried that short-term rates of 5 percent were too low to keep inflation under control. Now short-term rates are 1.25 percent, and Greenspan said a couple of weeks ago that "deflation is more of a threat to economic growth than is inflation."

Deflation, defined as prolonged and widespread falling prices, results from excessive capital investment, as happened in the 1990s. When too much productive capacity meets too little consumption, companies cut prices to win business.

When the reductions come amid a general slowdown, they can feed on themselves, descending into a destructive spiral. Lower prices mean lower corporate profits. Lower profits lead to debt defaults and layoffs, which reduce consumer demand even further and put new pressure on firms. This was basically the mechanism of the 1930s Depression, as has been noted by many concerned bystanders.

Discussing ways to counter the "threat" of deflation, as Greenspan did last month, is monetary code for talking about promoting inflation. You can't do one without the other. Any contest of light vs. darkness involves potential overkill, and the anti-deflation campaign does not look like a surgical strike.

In November, for the first time all year, the word "deflation" was mentioned in the minutes of the Federal Open Market Committee, the U.S. central bank's monetary-control panel. Al Broaddus, president of the Federal Reserve Bank of Richmond, Va., and a friend to inflation the way Ronald Reagan was a friend to the Soviet Union, warned recently that "we need to be alert to this risk" of deflation.

The last piece of the anti-deflation alliance was added last month as the European Central Bank cut short-term interest rates by half a percentage point to 2.75 percent. With the Federal Reserve and the Bank of Japan, whose rates are close to zero, the ECB is flooding the world with paper money, which is what central bankers do when they lower rates.

The hope is that all the extra cash will bid up the price of Toyotas, toys and tin and head off the deflationary threat. Prices have popped for numerous commodities recently, from oil to cotton, and, because commodities are at the bottom of the economic food chain, some analysts look for higher retail prices this year.

But deflationary suction is strong, and inflation is not a lock. Worldwide demand is subdued. Capacity is still too high. China, newly arrived at the World Trade Organization, is a bottomless well of cheap labor and low prices.

Higher prices would be more welcome now than at any time since 1950 or so. They would help companies, which could raise what they charge and improve profits. They could help workers, who could get bigger raises. Debtors could pay off obligations with cheaper dollars. Inflation would raise tax collections and help legislatures reduce budget deficits.

The enemy of the past 40 years is now the ally. Well, Poland is in NATO, too.

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