THE LIBERTARIAN ENTERPRISE
Number 596, November 21, 2010
"Protecting our lives by depriving us of
any reason we might have for living them"

Previous

Contents

Next

Inflation is Not Your Friend!
by C. Jeffery Small
[email protected]

Special to The Libertarian Enterprise

Federal Reserve chairman Ben Bernanke thinks that we don't have enough inflation in this country, so he is now engaged in printing up $600 billion crisp new dollars with which he will purchase government securities such as treasury bills. Of course, the average person has a glimmer of understanding that just printing money out of thin air might not be such a good thing to do. (Don't we call that counterfitting when others do it?) So the Fed tries to distract us from those concerns by calling it Quantitative Easing, because who actually understands exactly what that means? Well, let's allow this short video explain it to us:

According to CNN Money, in addition to the $600 billion in "new" cash, the Fed also plans to "reinvest" up to an additional $300 billion from the original $1.8 trillion in the 2008-09 first round of Quantitative Easing. And we have already seen what a stupendous failure that has been.

In an op-ed piece in the Washington Post, Bernanke states:

The Federal Reserve's objectives—its dual mandate, set by Congress—are to promote a high level of employment and low, stable inflation.

What is so desirable about inflation, which is a decrease in the purchasing power of money? Inflation means that producers are forced to raise their prices, decreasing the size of their markets, and consumers can obtain fewer goods and services with their earnings. Why would anyone wish to promote or maintain inflation as a matter of economic policy? The answer becomes clear once you determine exactly who benefits from an ever inflating money supply.

As stated above, inflation is good for neither producers nor consumers. But what about borrowers and lenders? Lenders provide cash for today's purchases, with the promise to repay the principle plus interest at some specified time in the future. With a stable currency, it is easy to determine the rate of return on a given loan. However, if the money supply is inflated during the course of the loan, then the future dollars used to pay it back are worth less than those loaned out in the present. Inflation works to the disadvantage of the lender, but to the advantage of the borrower. Of course, borrowers and lenders attempt to predict the level of inflation that will occur over the duration of the loan and build this into the interest calculations, but guessing too high means that the borrower overpays for the loan, while underestimating the inflation means that the lender does not achieve the anticipated rate of return on their investment.

Now ask yourself, who is the biggest borrower of them all? The obvious answer is the federal government, which as of today has accumulated a national debt in excess of $13.7 trillion, and which continues to grow at an average of $4.14 billion each day. The 2011 interest payment alone on this debt will be just under $24.2 billion! If you could inflate the U.S. currency, just imagine how much you would save by making this interest payment with devalued dollars. Kick inflation up 3% and that makes your debt 3% less valuable, which happens to be roughly a $411 trillion savings without having to do anything except run some printing presses. And if you can inflate 3% for a full year, than that 2011 interest payment can be effectively reduced by the equivalent value of $726 million. Hey, not bad for a days work! In fact, why stop at 3 percent? How about 4, 5 or more? You can never get too much of a good thing!

Of course, there's no magic bullet here, because the government's debt holders are sitting on the other side of this equation, and directly lose a dollar for every one saved by Uncle Sam. And everyone else sitting around with dollars (hey, that's you and me!) find that their purchasing power is also reduced day by day. Inflation is really just a hidden tax that the Fed and Treasury impose upon each of us to cover their bills.

Now, if you listen to Bernanke, he will warn you of the dangers of deflation:

Today, inflation is at 2%, below the Fed's target rate. While low inflation is usually good thing, if inflation gets too low, it can morph into deflation and consequently economic stagnation

Here is what economist and market strategist Richard Salsman has to say about this in his article, The Deflation Myth:

The current anxiety over "deflation," that is, an increase in money's purchasing power, causing a declining price level, is ridiculous, for two reasons: (1) there's no actual deflation to speak of (nor is it likely to occur in the coming few years, given prevailing public policies), and (2) even if some deflation were to take hold, it wouldn't necessarily be bearish for equities, profits or economic growth.

Many economists presume, falsely, that deflation necessarily coincides with (or causes) a contraction in economic output. In fact, deflation by itself in no way curbs the motive to produce, because it doesn't preclude the maintenance of business profit margins. During the Industrial Revolution, deflation was common. It was also a bullish phenomenon in the second half of the 19th century, the period of the fastest economic growth in human history.

The only genuine danger from deflation is that faced by over-indebted, would-be deadbeats.

Possibly, Bernanke's real concern with deflation is that should it occur, the U.S. government would find itself sitting on the other side of the table, having to repay their immense debt with dollars of increasing rather than decreasing value. And that is something that should truly worry him! Maybe the Fed and Treasury are really nothing more than those "would-be deadbeats" that Salsman warns of, trying to insure that it is us and not them that take it in the shorts!

What do you think is the most likely explanation for a government that has set inflation as its self-acknowledge mandate?

First published at Mr. Small's blog at smallthoughts.com/blog/permalink/0143.html