Prevailing practitioners of economics tell us that inflation stimulates exports. They get this inverted. Otherwise, pray tell, why wouldn’t Zimbabwe be the world’s leading exporter? Inflation inflicts injury upon the manufacturing base, engendering capital outflow and the destruction of jobs.

Contrary to prevailing economic orthodoxy, inflation is not export-friendly. Inflation nurtures dependence upon cheaper foreign markets to supply us with production (i.e. begets capital outflow). Capital outflow can be reversed by compelling the Fed to tighten. If the Fed tightens, interest rates rise, prices caollapse to reflect wages, the market clears (only then does the economic recovery begin), dollars that have accumulated in foreign reserves will coming flowing back into the domestic loan market, thus lowering the natural rate of interest.

“The dollar rose against most major currencies on Thursday as a latest report showed U.S. trade deficit plunged in February,” pursuant to one news source. (1)

“The contraction in the deficit came with a big recession-driven fall in imports and an unexpected rebound in exports, the Commerce Department said overnight in the US,” pursuant to another news source. (2)

In July of 2008, the dollar went through a rally – albeit, a pseudo-rally – marked by falling nominal prices. Although falling nominal prices is not deflation (i.e. the contraction of the money supply, which would be a healthy thing), that’s the definition of deflation pursuant to prevailing orthodoxy. When the dollar rally began, the trade deficit declined, due to both falling imports and increasing exports. In other words: the fall in the trade deficit had been accompanied by a dollar rally. What prevailing economic orthodoxy teaches regarding the international cycle of trade betrays this possibility.

In November of 2007, Ben Bernanke put on an exhibition of his confusion when he said that inflation is inconsequential for everything but imports. (3) He literally said that dollar devaluation raises prices of everything not denominated in….dollars! Apparently, Bernanke has been blinded by prevailing orthodoxy, which tells us that inflation mitigates a negative balance of trade – another Keynesian apologia for inflation that needs to be buried.

On a peripheral note, Bernanke’s argument runs slightly afoul of prevailing orthodoxy. Prevailing orthodoxy tells us that inflation does raise prices for Americans, and that this magically lowers real prices for foreigners. If Bernanke can’t figure out that increasing the supply of dollars raises dollar denominated prices, then the average person is hopeless for understanding the international cycle of trade and how capital flows.

The decline in imports and rise in exports in juxtaposition with the short-lived dollar rally were not a fluke, nor is this inexplicable. The trade “deficit” is but a symptom of monetary policy. A trade “deficit” isn’t bad per se. A trade “deficit” between two countries is no worse than a trade “deficit” between two towns. The consequential part is if the trade “deficit” is due to something other than comparative advantage (e.g. inflation).

“Again, suppose, that all the money of GREAT BRITAIN were multiplied fivefold in a night, must not the contrary effect follow? Must not all labour and commodities rise to such an exorbitant height, that no neighbouring nations could afford to buy from us; while their commodities, on the other hand, became comparatively so cheap, that, in spite of all the laws which could be formed, they would be run in upon us, and our money flow out; till we fall to a level with foreigners, and lose that great superiority of riches, which had laid us under such disadvantages?” –David Hume, Essays, Moral, Political, and Literary, 1752

What mainstream economists teach runs contrary to what David Hume taught us in 1752. Prevailing economic orthodoxy inverts the international cycle of trade. We are told that inflation mitigates the trade “deficit”. By inflating the money supply, dollars will become less attractive to foreigners. Thus, runs the argument, foreigners will follow by curtailing exports to the U.S. Somehow, domestic productivity will magically be increased, stimulating exports.

The genesis of this error is begotten by the underlying macroeconomic assumptions. Rather than using microeconomic principles to understand macroeconomic phenomenon, mainstream economics fragments microeconomics and macroeconomics into separate compartments. Macroeconomics then becomes myopic, by lopping individuals out of its paradigm. Myopic macroeconomics doesn’t consider individuals; it only considers aggregates.

Translated, the macroeconomic analysis is this: the country has dollars. If the country, or nation – or whatever aggregate you wish to use – decides to print more dollars, the country, or nation, isn’t going to refuse to use its own dollars. However, the country, or nation, of, say, France, being a different country, won’t like very much the devalued American dollar.

I guess we aren’t supposed to ask why both inflation and the trade “deficit” have risen in juxtaposition with one another. Sound economics gives us that answer. If inflation did mitigate a trade “deficit”, then one is boxed into the position of currency devaluation wars. Inflation vs. counter-inflation vs. hyperinflation.

The economy is made up of individuals making choices in exchanges. When the government devalues the currency, this doesn’t only make dollars less attractive to individuals abroad, but also to individuals right here at home. This is reflected with higher prices. It isn’t about aggregates printing more money for use by aggregates.

Consequently, inflationary stimulus interferes with the price mechanism preventing prices from falling to reflect wages. The market fails to clear, thus derailing an economic recovery. With mass unemployment, the last thing that will rise will be wages. The domestic cost of production goes up. Thus, to reduce costs, capital flight takes place. Inflation actually increases the dependence upon cheaper foreign markets to supply us with production.

As David Hume saliently articulated in 1752, inflation makes not only the currency less attractive abroad, but also the higher-priced goods. It also makes the higher-priced goods less attractive right here at home. Using inflation to remedy a trade “deficit” is akin to breaking a leg to make yourself more competitive.

The short-lived dollar rally in 2008 – thanks to central bank policy – was not the consequence of the declining trade deficit; it was the cause of the declining trade deficit. Everything denominated in dollars becomes cheaper. It shouldn’t take a genius to figure out that one doesn’t become more competitive by raising prices.

If inflation actually mitigated a trade deficit, Zimbabwe would be one of the world’s leading exporters. Inflation doesn’t lower real prices for anybody. But even if inflation did mitigate a trade deficit by lowering real prices for foreigners, while making things more expensive for Americans, why would that be a good thing? Why should American economic policy be calculated to make things cheaper for foreigners and more expensive for Americans? Economic growth – which is not measured by the GDP – engenders falling prices, which is a good thing.

Pro-inflationary stimulus has served one purpose: preventing prices from falling to reflect wages. The market then fails to clear. The real issue isn’t even the direction of nominal prices, but what prices would otherwise be absent central bank manipulation. Even if prices fall in nominal terms while wages fall much faster, then we’re still suffering from the consequences of inflation. We can be suffering from lost price deflation. Falling nominal prices engenders rising real wages.

Inflationary policy by the FOMC suppresses nominal interest rates by increasing the supply of loanable funds, but without a genuine expansion of savings to fund investment. Investment can only come out of savings since producers must be able to consume in order to sustain the process of production. Deploying printing press money (i.e. unearned income) transfers money away from producers and the process of production to consumers. Inflationary stimulus disconnects consumption from production, turning Say’s Law upside down. Thus inflation not only drives capital overseas, but begets capital consumption. Inflation is injurious to the process of production.

Increasing the money supply tricks the loan market into consummating unjustifiable loans to non-credit worthy projects. That’s why malinvestment occurs and projects are halted midstream with the revelation of malinvestment. By allowing debtors to pay back creditors with devalued dollars, real interest rates are suppressed. There’s no right way for the loan market to extend credit at negative real rates, which is a negative ROR in real terms. That’s a calculus for the loan market to go bust as it did in 2008. See: http://www.federalreserve.gov/releases/h3/hist/h3hist1.htm Check out the early months of 2008. That’s not psychological and that’s not a matter of consumer confidence.

The long end of the curve is most sensitive to market forces while the short end of the curve is most sensitive to FOMC policy. If the Fed stays loose to prop up the bond market, this will undermine the very bond market the Fed is trying to prop up. Investors/lenders will account for the inflation risk by tacking an inflation agio onto the curve. Eventually, the Fed will lose control over the short end, too. Under the scenario where the Fed stays loose, there will be no floor underneath the dollar nor any roof on interest rates. If the Fed tightens, the short end will collapse instantaneously, bringing the long end down, too.

Under the scenario where the Fed props up the bond market indefinitely, both the bond market and the dollar collapse. Dollars will hit par value with the par value of bonds. The Fed will be left with $15 trillion plus – in nominal terms – worth of bonds on its balance sheet, and we will be left with both junk bonds and junk dollars. The dollar itself will go bankrupt. What’s the par value of bonds? We don’t know, because the Fed has been propping up the bond market.

Under the scenario where the Fed tightens, the bond market will collapse, but the dollar will be saved. Dollars won’t hit par value with the par value of bonds. The only way to save the dollar is at the expense of the bond market.

Until the Fed is compelled to tighten, we won’t have an economic recovery. The loan market has to set interest rates pursuant to the true supply of savings. If interest rates were to hit, say, ten percent on the two-year with a $15 trillion national debt, do the math. The longer interest rates are artificially suppressed, the higher they will have to go in order to correct the imbalances in the economy.

By tightening sooner rather than later, this will not only allow the market to discover the natural rate of interest by letting interest rates rise, this will encourage capital inflow. Capital naturally gravitates towards cheaper, higher-yielding, more efficient economies. It’s called arbitrage. The Fed is waging an eternal struggle against…arbitrage. People naturally gravitate towards where capital gravitates. We should be talking about repatriating dollars to the domestic loan market rather than repatriating immigrants to their native land.

It makes no sense to close down the borders considering the fact that welfare states engender capital outflow and the natural flow of people is to follow capital. (4) Thus it’s hard for me to not imagine that closing down the borders could be used to trap people in rather keep keep people out. Interfering with the flow of capital will necessarily lodge capital where it ought not be. Interfering with the flow of people will necessarily lodge people where they ought not be.

If a person, firm, or institution is dependent upon inflationary credit expansion – as opposed to non-inflationary – for sustenance, that person, firm, or institution is – by definition – insolvent. Somebody or some institution (e.g. the government) is spending beyond their/its means. As a nation, we have spent beyond our means. Expenditures exceed earnings and we depend on foreign markets to supply us with production.

Inflation (i.e. the creation of money ex nihilo) is no substitute for income-generating investment, which inflicts further injury upon an already precarious economy. There’s no right way to invest in the U.S. economy. It’s error to conflate trading with investing. Buying real estate is not investment. I’ll draw the distinction between trading and investing. A trader buys and sells a particular asset class based on nominal price movements. An investor buys and holds a particular asset class based on returns from the underlying asset class itself. In the case of real estate, that would be rents.

The problem isn’t a lack of regulatory oversight. One can’t regulate away past mistakes. Insolvency can’t be regulated away. The only solution is to force up interest rates, prices fall, dollars that have accumulated in foreign reserves will flow back into the domestic loan market, which will then beget a lower natural rate of interest. Any other solution will lead to the destruction of the currency, in which case everybody’s savings get wiped out. Loose monetary policy to prop up a spending orgy engenders capital outflow (i.e. begets outsourcing).

Inflation is a tax. There’s no objective difference between the government taking the money you have in your pocket and duplicating the money you have in your pocket, thus devaluing the purchasing power of what you have in your pocket. Even if prices don’t rise in nominal terms, the real issue is what prices would otherwise be absent central bank manipulation.

Furthermore, if one is going to hold the position that inflation is synonymous with economic growth, then they’re boxed into advocating skyrocketing prices in order to have a fast economic recovery. The way to have a fast economic recovery under such a scenario would be to have prices rise fast. I believe there’s a term for that. It’s called hyperinflation. Who supports hyperinflation?

The only path to an economic recovery runs through monetary tightening by the Fed. Waiting until we have an economic recovery before tightening is a calculus to destroy the currency and the economy. Absent dealing with monetary policy, no candidate can pretend to offer economic solutions. The only candidate who offers real solutions is Ron Paul.

1) http://news.xinhuanet.com/english/2009-04/10/content_11160595.htm

2) http://www.theaustralian.com.au/business/us-trade-deficit-dive-may-ease-slide/story-e6frg8zx-1225697017588

3) http://www.youtube.com/watch?v=nj9KHJRRUbQ
The consequential portion of the video is around the 5:00 minute mark. Inflation is not rising prices. To say so implies that rising prices are caused by…rising prices. That contorts Irving Fisher’s own Quantity Theory of Money. Rising prices are the consequence of inflation, which is an expansion of the supply of money not redeemable in a fixed amount of specie. Prices could drop in nominal terms, yet prices could be too high in real terms. Falling nominal prices engenders rising real wages. We can still be suffering from inflation due to contortions in the price mechanism since prices remain higher than what they otherwise would be absent central bank policy.