The Need for Deflation
In a follow-up on Tarran’s excellent Primer on Money, I’d like to take the opportunity to bring the lessons to bear on our current financial situation.
Tarran correctly points out what has happened with the US Government and its ability to control the money supply:
Today, the United States government has engaged in massive amounts of spending. They are not getting this money through taxation. Rather they are borrowing it, and a good portion of what is being borrowed is money created by the Federal Reserve.
As Milton Friedman pointed out, inflation is always a monetary phenomenon. Here’s my quick and dirty example of inflation:
Imagine if you were in a poker game with four other people. You each put $50 in. That means there’s $250 on the table. Now, you’re playing with chips instead of cash. The banker makes sure each of you get the equivalent of $50 in chips. So far, so good, right?
After a while, the guy sitting to your left starts losing chips on some bad bets. He’s not wiped out yet, but he’s not doing great either. You start watching him more carefully as he continues to lose money. Suddenly, through the buzz you’ve got going after four beers, you realize that he should have run out of money two hands ago. He’s been adding chips to the game! Worse, they look identical to the chips used by the banker.
You call the guy on it, and the rest of you decide it’s time to cash out. There’s a problem, though, because now there are more chips than there is real money. In other words, your chip supply has been inflated beyond whatever value was backing it. So, to cash out of the game, you would have to adjust the value of the chips so that all the chips added together equals $250, now making each chip worth less than it was before.
In this example, by introducing more chips into the game, our cheat was able to steal a little bit of money from each of the other players in the game to continue his play after the point he should’ve been bust. His deliberate inflation of the chip supply was theft.
Now, take this example and apply it to what happens when the US Government demands freshly-printed money from the Federal Reserve for spending. All the other dollars in circulation lose a little value upon the creation of that new money. In other words, the US Government has gotten the Federal Reserve to steal a little bit of buying power from your wallet, bank accounts, and investments by forcing them to print new money. That’s theft!
It’s theft in reality, but because of the party committing the theft, we have a special name for it: a tax. So, in the case of the US Government, inflation is taxation.
But, that’s not all that’s been going on. The Federal Reserve has been spurring on the appearance of economic activity by loosening lending standards and fueling a credit bubble. Consumers make decisions based on the total amount of money available to them, both earned and borrowed. So, when lenders are encouraged through regulation and a loose Federal Reserve money supply to lend more than they normally would, that also causes inflation. In this case, it’s a tax paid by all to make some appear more prosperous than they really are. Another example of the inflation as taxation.
Consider a common complaint from the left about the Bush presidency, voiced here by none other than Barack Obama:
“We have now lived through the first so-called economic ‘expansion’ on record where typical families saw their incomes fall, and working-age households lost more than $2,000 from their paychecks,” said Mr. Obama, referring to inflation-adjusted figures compiled by the Census Bureau.
Productivity expanded, but workers lost money from their paychecks. How could that happen? Workers had that money taxed away from them by the inflation caused by the borrowing to cover the Bush Administration’s profligate spending. How does Obama propose to address the impact of the inflation tax on ordinary workers? He wants to increase the inflation tax by spending even more:
Eager to jolt a worsening economy back to life, President-elect Barack Obama’s aides are assembling a two-year stimulus package that could cost $850 billion, dwarfing last spring’s tax rebates and rivaling drastic government actions to fight the Great Depression.
That, of course, is exactly the wrong thing to do. Sadly, Barack Obama and his comrades in the Democratic Party have no concept of an inflation tax and can therefore never realize the harm it is doing. (Then again, neither can most Republicans.)
The real solution is indicated in the positive economic signs pointed out by Tom Blumer:
The hopeful signs are these:
- As of December 19, oil is down over 70% from its summer peak. Many drivers are spending over $150 per month less on gas than they were just five months ago.
- The Fed has taken interest rate reduction as far as it can go, which has taken mortgage rates to historic lows. Refinancing activity has picked up, disproving the notions that credit isn’t available to worthy borrowers and that most of us are a bad hair day away from homelessness. This is an ideal opportunity for those who have good credit but poorly structured adjustable-rate or interest-only mortgages to get out of them, and for those carrying 6% or higher fixed-rate mortgages to lower their monthly payments or draw out equity. (Yes, Virginia, people in most states still have plenty of home equity.)
- A falling Consumer Price Index of -1.7% led to real earnings growth of 2.3% in November. A repeat performance but with smaller numbers looks likely in December.
- Christmas shopping season retail sales, while still far less than impressive, might not be as bad as originally predicted.
Look at the third sign, the falling Consumer Price Index (CPI) leading to an increase in real earnings growth. This means that, with falling prices, companies have had more buying power. No doubt the same is true of consumers, as the better than expected Christmas shopping numbers indicate. Personally, I’ve been able to stretch my paychecks much more in the last couple of months than I’ve been able to in a long time.
In other words, we’re experiencing a holiday from the inflation tax. Suddenly, the value of the dollars in our wallets and bank accounts isn’t eroding. In fact, it’s increasing. Workers are finally seeing an increase in the buying power of their paychecks. The trend the left has been whining about for almost a decade has come to a stop.
This is deflation at work. We need deflation to put economic power back in the hands of the little guy and the small business, neither of whom can curry favor with Washington D.C. the way the rich and big business can. We need deflation to allow the young who are making their way into the world to have a shot at an independent life.
While the holiday season is coming to a close, we need this holiday from the inflation tax to continue until the monetary bubble of the last two decades is but a memory. This means no bailouts, no stimulus packages, and no manipulation of the money supply to create sham prosperity. The left is fond of telling us that dissent is patriotic. In this case, it’s true. Opposing the Keynesian orgy of spending and inflation that is sure to arrive after January 20, 2009 is the most patriotic thing any American can do in the coming year.