Tuesday, August 21, 2012

Silence! Mark Carney Speaks and Inflation is Low

Also available at mises.ca

Last Friday Statistics Canada reported that the Consumer Price Index had declined despite modest gains in consumer prices. Combined with other data, mainstream economists and financial journalists have interpreted this to mean that inflation is low. Bank of Canada Governor Mark Carney himself has called inflation low and admits that the "strong" Canadian loonie is to blame for the country's manufacturing woes.

There are many problems with this analysis due to a mix-up of definitions. Inflation, as defined by the establishment, is the Canadian Consumer Price Index. CPI Inflation is an increase of prices based on an index of goods and services. This collection of goods rests on the whims of central bankers. A built-in bias is inevitable.

If inflation is defined by its traditional meaning, an increase in the money supply, then inflation in 2011 (according to StatsCan M3 data) was a 7.5% increase from 2010. And from 2009 to 2010 inflation increased 5.1%, and from 2008 to 2009 inflation increased 3.3%, and from 2007 to 2008 inflation increased 11.9%.

Redefining a word for political ends is obviously Orwellian. Hopefully when Mark Carney speaks to auto workers tomorrow, he'll have an opportunity to answer some tough questions.

The last time the Canadian Auto Workers Union negotiated their contract with the big auto companies, the Canadian dollar was trading at 80 cents to the greenback. That is, one loonie bought you 80 American pennies. Since then, the situation has changed a bit. The loonie and greenback are now at par due to investors flooding into Canadian bonds. As Europe crashes and burns while the USA continues to behave as if $222 trillion is no problem, Canada has been setting records with over $25 billion in securities being bought by foreigners.

Canada as a safe haven has put upward pressure on the currency, putting it at par with the US dollar. Thus, auto workers feel as if they are getting the short-end of the stick. Once upon a time the Detroit Three would open up plants in Canada for its (relatively) cheap labour. Now that the two currencies are essentially identical, the auto companies are opting out for cheaper labour elsewhere.

Mark Carney has the power to change this. He can literally print more money to buy up US treasuries. This would drive up the value of the greenback at the expense of the Canadian dollar. Japan likes to do this, as well as the Swiss in relation to the Euro. But it would appear that Carney has no plans to do this. For starters, he would have to print a lot to counteract the commodities boom.

In addition, Canadian monetary policy doesn't operate in a vacuum. Right now the overnight rate is at 100 basis points; if Carney cut this rate to zero not only would he shock the market but it'd be unlikely to have the desired effect. Some estimate this move would only drop the Canadian dollar to $0.98 USD. Nowhere near the 80 cent level advocated by the CAW.

So what is one to make of all this?

Well first things first, central banks are detrimental to prosperity. Although Canadian bank panics existed before central banking, systematic nation-wide booms and busts were either a result of US central banking or non-existent.

Secondly, inflation is not low. It's high. Despite year-to-year fluctuations, the purchasing power of the Canadian dollar has lost more than half of its value since the Bank's inception in 1934. Even the Bank's own documents admit that,

"Even with a low annual inflation rate of 2 per cent (the midpoint of the Bank of Canada’s 1 to 3 per cent target range for inflation since 1995), a dollar will lose half of its purchasing power in approximately 35 years."

Thirdly, and finally, the manufacturing sector is burdened by thousands of economic regulations and policies that favour monopolies over competitiveness. Promoting manufacturing via a “weak” loonie means a continuing debasement of the Canadian dollar. This ensures that real values of rent and income decline; this hurts both workers and capitalists. By contrast, a “strong” loonie (or a loonie based on a commodity such as a gold) lowers raw material costs, capital costs and will naturally bring down interest rates.

Everybody, including the CAW, should be demanding a higher purchasing power of their money. Everybody should be demanding change from the Bank of Canada, but not in the way some "progressive" bloggers are proposing. The change needed is an ideological one. As Ludwig von Mises wrote,

"The gold standard alone makes the determination of moneys purchasing power independent of the ambitions and machinations of governments, of dictators, of political parties, and of pressure groups... The return to gold does not depend on the fulfillment of some material condition. It is an ideological problem. It presupposes only one thing: the abandonment of the illusion that increasing the quantity of money creates prosperity."

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