Inflation’s Real Cause

According to Pimco’s new Chief Economist, Paul McCulley, the Fed’s war against inflation has been won!  But, before we get out our party hats and plan the tickertape parade, we have to ask ourselves – for the past 27 years have we really been at war with inflation?  Yes, during the late 1970’s and early 80’s a different Paul (Paul Volcker, Chairman of the Federal Reserve) waged a real battle against inflation.  Mr. Volcker painfully took the Fed Funds rate to near 20 percent in June of 1981.  The economy suffered a deep recession, it was a treacherous battle plan, but the Fed stayed the course because Volcker was correctly convinced that limiting the growth rate of the money supply was the key to popping asset bubbles, vanquishing inflation and establishing a sound economy. 

Fast forward six years, exit Paul Volker, and enter Alan Greenspan. For the back drop, it was the crash of 1987….and after declaring “mission accomplished” on the inflation war, Greenspan sought to fight a new war against falling stock prices.  Acting as the veritable Navy Seal of financial market defense, Greenspan valiantly leapt to shield markets from corrections.  This “special operation”, was affectionately referred to as the “Greenspan put”.  Over the years the “put” has remained, we have merely substituted Greenspan with Bernanke and now Yellen.  And so for the past 27 years, the only “war” the Federal Reserve has been waging has been to inflate asset bubbles.  These bubbles bring the economy to the brink of financial destruction, leading the central bank to intensify its efforts to fight deflation with each iteration.

McCulley goes on to say “For the last 15 years inflation has been incredibly absent…We’ve had our cyclical ups and downs but when you look at it on a chart, I think we’ve achieved the promised land of price stability over many cycles.”