When Keynesian economists were unable to predict, or even explain, the stagflation of the 1970s, they lost their place of privilege in U.S. economic policy. When supply siders were able to predict, explain and even (under President Reagan and Fed Chairman Paul Volcker) solve the problem, they cemented their role as the Keynesians’ replacements. It became impossible for anyone who takes the data seriously to argue that economic growth was the cause of inflation, or that recessions could be cured by printing money.
But supply siders have been disagreeing with one another lately over precisely how to define “sound money.” Steve Forbes, Brian Wesbury, and various followers of the late Jude Wanniski have looked at rapidly rising gold prices and forecast serious levels of inflation. Larry Kudlow, Arthur Laffer, Allan Reynolds, James Glassman and the Bush Administration have been much less concerned about inflation, arguing that it has yet to appear in consumer goods. Some also point to the fact that increases in other inflation-sensitive market-indicators, such as interest rates, have been much less than gold.
This chart may explain what’s going on. Using numerous inflation measures, it shows that although commodity prices, as measured by the Commodity Research Bureau (CRB) spot index, have been rising rapidly, the price increases are smaller the deeper you go into the production process. At each stage, as raw materials are turned into intermediate goods and then consumer goods, inflation is wrung out of the system. Only time will tell, but so far U.S. ingenuity appears to be driving down the cost of production in the face of rising commodities prices and saving us from steep inflation in the cost of final products.