By Dean Kalahar
Did you know you are about to be robbed of your hard earned property by the most diabolical criminal you have never met?
You will know it is happening but will be powerless to stop it.
Well, the suspect has been identified.
Her name - “Inflation.”
People don’t know much about her because she is usually tame. But don’t be fooled, she can be one nasty woman. It would be prudent if you understand her nature because Inflation is about to commit the biggest crime never reported.
Inflations basic temperament is a rise in prices. She also has a duel personality, so to truly understand her we need to ask which persona acted to make prices rise. Once that is answered, we can determine if we are faced with normal healthy Inflation or if we are facing her alter ego also known as “Miss-allocation.”
On her good side, natural Inflation is a market phenomenon in terms of productivity and/or price that increases sharing and economic efficiency in moving scarce resources to their most efficient use. Natural Inflation does not hide from the public and we can identify her in several ways.
· A rise in prices and corresponding loss of purchasing power due to an increase in the money supply with a corresponding increase in output of goods and services.
· A rise in prices due to the multiplier effect of economic expansion via real credit wherein people are saving money so others can borrow money.
· A rise in prices due to an increase in demand for goods, services or the currency.
· A rise in prices due to a lack of supply or a rise in raw material costs.
· A rise in prices as the result of demand pull and cost push inflation forcing wages higher.
On her bad side, “synthetic” Inflation caused by government intervention into markets decreases sharing efficiency. This evil Inflation is shady because she hides herself from the public while acting as a seductress to the government. And when the government indulges her, and believe me policymakers can’t resist her, she robs us of vast amounts of our wealth. We can identify her by this specific action.
A rise in prices due to the expansion of the money supply by government deficit spending of artificial credit; or Federal Reserve policy that tries to stimulate lending by lowering interest rates, reserve requirements, or when the Federal Reserve Bank purchases government bonds in return for Federal Reserve Notes, a.k.a. money via open market operations.
Inflations dark side increases the number of dollars in circulation, which reduces the purchasing power of each dollar without a corresponding increase in output of goods and services or a decrease in demand for the currency.
To make matters worse, some people do not trust or want inflated and devalued money. This can make the value of the money decline even further; sometimes ending in economic collapse.
The irony here is that expansionist monetary policy intended to help the economy will actually create a boom bust cycle. Synthetic Inflation forces people to suffer needlessly at the hands of those who believe they can manipulate the economy better than the invisible hand Adam Smith so eloquently explained.
Why do governments get in bed with Inflation and employ such insidious policies?
As Milton Friedman has explained, Government borrows in dollars and pays back in dollars. But thanks to inflation, or the simple act of printing money, it can pay off its debts without raising taxes because the government does not care if the dollars it pays back have less worth than the dollars it borrowed.
The problem is the dollars you have earned and saved are also now worth less in terms of purchasing power. In short, the government pays off its debts on the unknowing backs of the saver who has their currency’s purchasing power stolen.
Friedman points out that legislator’s have resorted to financing spending through “inflation, a hidden tax that can be imposed without having been voted, taxation without representation.”
Some of Inflations worse offenses and the destruction she can create can be seen in historical terms. Thomas Sowell reminds us of post WWI German history.
“In July 1920, 40 marks were worth one dollar; but it took more than 4 trillion marks to be worth one dollar by November 1923. People discovered that their life savings were not enough to buy a pack of cigarettes… During the worst of the inflation, in October 1923, prices rose 41% per day! ... The German government had, in effect, stolen virtually everything they owned by the simple process of keeping more than 1,700 printing presses running day and night, printing money.”
When Inflation strikes dollars are worth less than before. Worse yet, the entire currency can become worthless. In Zimbabwe, their 100 trillion dollar bill is not worth enough to buy a loaf of bread. The current exchange rate is 300 trillion Zimbabwe dollars for 1 US dollar.
How does Inflation create economic chaos?
Ludwig von Mises and F. A. Hayek both pointed to artificial credit expansion, normally at the hands of a government established central bank like the FED, as the non-market culprit that fuels synthetic inflation.
When the central bank expands the money supply by lowering interest rates, lowering reserve requirements or when it buys government securities, it creates the money to do so out of thin air. Meaning the FED expands the money supply not with real tangible dollars but with “reserve balances” or “bank money” that is nothing more than an electronic transfer of numbers into a ledger.
The added currency the banks hold and will lend is not the result of people saving and putting more of their money in the bank; it is from an intervention into the market. Without the equal counterbalance of savings and the slowing of other spending, the new money is just looking for trouble with Miss-allocation.
These additional “synthetic” dollars force lower interest rates and stimulate investment into speculative projects, or other non market driven investments. We have seen this happen historically with inefficient spending on internet start-ups (dot coms) houses, gold, oil, and other speculative ventures that disrupt and distort the natural mechanisms of the free market.
With all this liquidity, the players in the market are enticed to find places to invest the money they would normally not be interested in. But herein we see a paradox. Why would self interested individuals working with sound free market mechanisms become afflicted by incentives that are inefficient, create inflationary boom bust cycles, and cause financial pain? Why do we see so many entrepreneurs making the same errors in misjudgment every time they are seduced into a relationship with synthetic Inflation?
Something outside the principles of the free market must be at play to create such delusional actions. Economist and historian, Thomas E. Woods Jr. explains that the inflated supply of money interferes with the market’s freely established structure of interest rates and disrupts the usual incentive system that coordinates the market and keeps inefficient decisions from being made.
In Human Action, Ludwig von Mises offers a great analogy regarding artificial credit expansion showing how “entrepreneurs, misled by the artificially low interest rate, behave as a master builder who lays too large a foundation for a house, because his subordinates incorrectly tell him how many bricks and other materials he has.”
Woods explains, “The sooner he discovers his error the better. The longer he persists in this unsustainable project, the more resources and labor time he will irretrievably squander. Monetary stimulus merely encourages entrepreneurs to continue along their unsustainable production trajectories; it is as if, instead of alerting the master builder to his error, we merely intoxicated him in order to delay his discovery of the truth. But such measures make the eventual bust no less inevitable – merely more painful.”
As the economy busts and is saddled with imbalances due to fiscal stimulus, it will suffer until the imbalances are corrected. The people will also have to suffer the cost of being held accountable for their decisions; even though the incentives came from a government and FED seduced by the political expedience of synthetic Inflation.
If a Laissez faire approach is taken and the market is left alone, freedom, choices and costs will allow the allocation of scarce resource to move back to an efficient equilibrium in the shortest period of time. A look at any number of recessions including the depression of 1920 legitimizes the market’s ability to recover and heal with a speed and ease unknown to those who believe they can micro-manage the economy.
Unfortunately, this simple solution to the bust cycle is often ignored as we have seen with the FED and Feds propping up Miss-allocation after the internet bubble,911, today’s housing bust, and predictably tomorrows gold bust. It is just too easy to employ another round of fiscal stimulus to avoid the pain of readjustment and admit of their torrid relationship with Inflation.
What’s more shocking are the policy actions we most often see after the bust. As the economy goes into a nosedive as a response to the artificial and unsustainable boom, policy makers step in and suggest a solution that created the problem in the first place, more fiscal stimulus! Can you say: $787 billion bailout, QE1, QE2, and Operation Twist?
The idea of government stepping in to solve an economic problem they created by instituting the same policies they used to create the problem in the first place is madness. Why should we believe the government now when the government did not know where to allocate the simulative money the first time around, or the second, or third.
Remember governments are not incentivized by any profit or loss system and their decisions are far more arbitrary than the decisions made by free individuals. Government obsession of synthetic Inflation is like a stalker addicted to a love gone bad. Unfortunately the government won’t place a restraining order on itself.
As far as bailouts, Woods again helps us understand that “Emergency lending to troubled firms perpetuates the misallocation of resources and extends favoritism to firms engaged in unsustainable activities at the expense of sound firms prepared to put those resources to more appropriate use. . . Bailouts merely freeze entrepreneurial error in place, instead of allowing the redistribution of resources into the hands of parties better able to provide for consumer demands in light of entrepreneurs’ new understanding of real conditions.”
All of this just postpones the inevitable. Because like a drunk, you can avoid the hangover costs of drinking if you just keep drinking, but you can’t keep drinking forever.
In short, as economist Roger Garrison states, “Savings gets us genuine growth; credit expansion gets us boom and bust.” Easy money leads to boom which is unsustainable which leads to bust which brings in even more easy money which leads to a bigger boom and thus a bigger bust until eventually the boom will lead to a complete breakup of the economy. And that is where we are heading after mismanaging the internet, 9/11, and housing boom and busts.
What is the current problem?
Today, the housing bust and the following gold boom have created the next wave of disaster. As International economist David Malpass explains, the FEDs near-zero interest rates penalize savers and channel artificially cheap capital to government, big corporations and foreign countries. As previously noted, low rates encourage excessive risk taking which fuels bubbles. This stimulus, however, has not shown up in the marketplace with Inflation, yet. At some point, as we have seen with all artificial economic growth, an increase in interest rates will fuel the bust.
Our current boom bust cycle has been covered up right under our noses by arrogant and dangerous actions taken by the Central Bank and Executive branch.
The Fed has been fully sterilizing its asset purchases, meaning all the cash it has used to buy bonds to fund the government’s deficit spending and stimulus is still contained at the Fed, not multiplied in the private sector. The Fed has accomplished this through bank regulation and by borrowing from banks at above-market interest rates—$1.5 trillion as of Jan. 18, 2012.
The FED buys US government bonds and then they -as well as the government, via Dodd-Frank and other statutes- regulate member banks so as to keep the money that was used to buy the bonds from being lent to consumers. The FED then borrows money from these same Federal Reserve banks and pays them interest greater than the rate set by the FED which is zero. Thus the FED soaks up the potential liquidity and the reserve banks make “no risk” money. Dollars are thus not put into circulation but the banks become very profitable on their balance sheet which creates a multiplier effect in expanding the number of dollars without printing more dollars and without having to lend dollars to consumers or cause Inflation to strike – yet!
The result is a vacuum of tremendous subdued Inflation. As economist John Taylor of Stanford has noted; “ before 2008 reserve balances were 10 billion, at the end of 2011 when QE1 and QE2 ended they were 1600 billion. This money will “eventually pour into the economy causing inflation.” “The FED is distorting incentives and interfering with price discovery with unintended consequences throughout the economy.” The lack of transparency keeps the scheme all but hidden from the general public while in the meantime, investors flock to gold and other resources as they know their currency is being devalued by the Treasury Department and the FED.
Even though we don’t fully see her yet statistically, common sense screams that a massive outburst from Inflation is coming. At some point, as all schemes do, the vacuum seal will be broken, the Inflation bomb will be unleashed, and the people will have to pick up the bill for the government prostituting Inflation.
In short the government is monetizing their debt under the cover of the FED who is creating a monetary bubble to prop up and profit their banks that upon its “pop” will make the housing bubble seem like a snap.
What do we do?
As you can see, Keynesian stimulus strategies do not work while Austrian models define why they are failures. The solution then is for the FED and policy officials to understand, as Taylor states, “that rules based monetary policy works and unpredictable discretionary policies do not.” The goal then should be long run price stability, also known as a sound dollar. This means it is the job of the FED to maintain the stability and purchasing power of the dollar and thus keep Inflation’s evil side in check by minimizing her seductive lure.
The FED should get rid of its current dual role of maximum employment and price stability as it is working at cross purposes. What good is the expansion of the money supply to foster employment when it destroys the currency stability which acts as a break on hiring?
One idea offered by Taylor is to design a gold standard that requires no physical gold to operate, and that is not subject to speculative attack. The idea is to develop a policy that would automatically adjust the size of the money supply either up or down mirroring the price of gold. Another important step is for the government to get its fiscal house in order and stop borrowing money.
As you can see natural Inflation is not a worry, but when money is effortlessly stolen by Inflations dark side the crime is immoral by definition. This is made even more maddening when the theft is the result of a government and central bank that have, as their very reason for existence, the job of protecting you and your property.
Of course their betrayal at the hands of a seductress should not surprise anyone. Thomas Jefferson said: “To preserve our independence, we must not let our rulers load us with perpetual debt… And I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale … (Where) private fortunes are destroyed by public as well as by private extravagance.”