The tipping point

A recent article by David Jensen (Jensen Strategic) digs below the surface and analyses perceptively the reality of economic and financial developments over quite a long period. In particular, he looks more closely at the causes of those developments.

The essence of his analysis accords with what I put forward as long ago as 1971 in The Indigent Rich: A Theory of General Equilibrium in a Keynesian System, as well as in Inflation: A Study in Stability in 1974.

Much more recently, I have expressed similar views in America's Suicidal Statecraft: The Self-destruction of a Superpower (November 2006).

Jensen is one of very few analysts to remind us of Keynes’ reference to what he called "Gibson's Paradox" on the relationship between the price of gold and interest rates. The latter translates more widely into the relationship between interest rates and the rate of inflation, whether consumer-price or asset-price inflation.

In The Indigent Rich (1971), I pointed out that the restrictive policies of 1969 to 1971, including interest-rate hikes by the Fed, would increase, not reduce inflation; and, indeed, that was precisely what happened. We experienced what we then began to call stagflation. I reiterated my views in Inflation: A Study in Stability (1974) but the view of central banks and major governments persisted that the way to "fight inflation" was to raise interest rates.

Indeed, that view still prevails. The Fed and other central banks are seen to be "responsible" and to be "carrying out their fundamental mandate" when they raise interest rates in the face of inflation or the threat of inflation. That inflation is usually tacitly defined as consumer-price inflation.

Since 1969, Gibson's Paradox has proved to be correct. The purchasing-power value of the major currencies has declined precipitously - by many calculations, to about 5 per cent or less of their real value in 1971.

The value of gold has risen from about $30 an ounce to (in January 2008) about $900 an ounce. In other words, it now takes about 30 times the number of US dollars to buy an ounce of gold as it did in 1971.

As Jensen shows, the price of gold has been subject to intense financial-authority - central bank and other - manipulation. Its price was held down for long periods and, even now, its free-market value is almost certainly significantly suppressed.

That Consumer-Price Inflation (CPI) has seemed to be contained derives from this handling of gold, together with other deceits and manipulations. One device was the Greenspan-Boskin substitution and "hedonic" manipulation of the CPI. Meantime, however, the high nominal and/or real costs of production which the restrictive - "fight inflation with interest-rate hikes" - policies produced transferred real production from the United States and like economies to low-cost producers especially in Asia.

Over time, this led not only to a reduction - or lesser increase - in "inflation" in the United States but also to an enormous transfer of real fixed-capital investment, real production of goods and services and, with it, large increases in productivity, to the Asian Tigers and, most conspicuously in recent years, to China and India.

In the United States and like countries, manufacturing was gutted, jobs in the production of real goods and services was "off-shored" and "ownership" - especially speculative - investment took the place of real fixed-capital investment - both public and private.