Since Barack Obama has decided to continue down the path George Bush started down, the path of Robert Mugabe and Friedrich Ebert, the United States economy will soon be facing all the problems associated with inflation.
Unfortunately, the effects of inflation are poorly popularized, meaning that most people have a very limited understanding of inflation. As a result when confronted with symptoms of inflation people all to often pin the blame on other “causes” such as Jews or greedy white landowners. These false accusations are heavily promoted by the ruling classes; after all it’s better that the mob chase some Jews or hedge fund managers with pitch-forks than coming after the rulers who inflated the currency.
What Inflation Isn’t
The primary misconception of inflation is that it merely is the rise in prices. The news media encourages people to believe this, reporting the inflation rate in the same way it reports on changes in the weather, as if it is some natural phenomenon over which people have no control.
Price increases are a result of inflation, yes. However, inflation has the same relationship with price increases that war has with the number of burials per month at Arlington Cemetery.
The Mechanics of Inflation
Inflation is the phenomenon where additional money is created. In the case of the Unites States, the Federal Reserve purchases some asset, such as a United States Treasury Bond, paying by check. The seller deposits the check in a bank, which then records the additional money as part of its demand deposits. This is the moment where the inflation occurs. The bank then loans out 80% of those deposits to borrowers. Those borrowers spend the loaned money. This spent money is deposited back into the banking system. The banks loan out another 80% of this latest round of deposits. This cycle of loaning out money which then spent and then deposited back into the banking systems continues until eventually an equilibrium is established where banks list $4.00 in outstanding loans for every dollar created when the Federal Reserve Bank wrote that first check.
The people spending this newly created money bid up prices; people selling stuff tend to sell stuff to the highest bidder, and the people holding the newly printed money are competing with other buyers to purchase the stuff they want.
The result is that this new money slowly disperses out through the economy, leaving higher prices in its wake. The people who spend it first get the benefit of being able to buy stuff at pre-inflation prices, the people who spend it last do not. The people who have access to the newly printed money are left better off, the people who don’t are left poorer. Inflation invisibly and without much fuss transfers purchasing power from those who are not closely connected economically with the central bank to those who are.
Follow the Money
The price increases generally show themselves in the sectors of the economy where the new money is spent. For example, let’s say that President Obama directs the Secretary of the Treasury to sell a bond to generate the money needed to build yet another bridge over some stream in West Virginia named after Robert Byrd. The bond is purchased by the Federal Reserve Bank with newly printed money. The money is spent by the Federal Government on tools and materials needed to build the bridge. The price for cranes, hourly employment of road-crews, concrete and steel increases.
The Rise of the Ersatz Product
The other users of these raw materials find themselves struggling to buy the supplies they need. For example, a manufacturer of prefabricated steel sheds might find that he has to pay more to get the metal he needs. He is caught in a squeeze; the price his customers are willing to pay has remained unchanged while his production costs have increased. The manufacturer can’t raise his prices, so naturally he decides to cut costs by attempting to reduce the amount of steel he uses by substitution or adulteration. The end result, the steel shed might cost the same, but the quality of the steel, the strength of the steel, or its toughness will be inferior, resulting in a shoddier product. Candy bars are packaged to look like their sizes are constant, while the volume of candy is reduced. Houses are built less sturdily. Automobiles are manufactured with lower quality steel, with engines that wear out more rapidly, etc.
The Rise in Prices
As the money percolates out through the economy, the people coming into possession of it bid up prices. In fits and starts, at different rates in different sectors of the economy, the price levels go up. People on a fixed income find themselves becoming poorer and poorer. The unpredictability of the price levels causes accounting to become more uncertain. Investments and projects that otherwise would be attempted are foregone. A majority of the population is left poorer as a result of the inflation.
Increased Political Repression
These people naturally lobby for relief. However the political classes that benefit from the inflation don’t want to stop, and the people are too ignorant of economics to recognize the fact that it was the printing presses which caused their problems. Instead the people attack profiteers or greedy manufacturers or the greedy bankers. They call for price and wage controls, which if instituted, further wreck the economy.
People also try to abandon the unreliable monetary system for alternatives. They try to do business in foreign currencies or even use commodities such as cigarettes or gold chains as money. Governments typically react savagely, criminalizing attempts to do business using alternatives to the rapidly devaluing currency.
Stop Me Before I Inflate Again!
Typically, when a government or central bank engages in inflation, they find it hard to stop – the political incentives are too great to resist. They cannot fund their operations if they stop the printing presses. The more the economy falters, the more the tax-base is disrupted, the lower the productivity of the industrial base, the more dependent the elites are on the printing press to fund their lifestyles and the operations of the state. In private, the central-bankers will admit that the currency debasement is wrecking the economy. But the central-bankers’ fear of the negative personal consequences if they should stop inflating the currency overrides any impulse to do the right thing.
America’s Peculiar Institution
Some economists argue that since the Federal Reserve is not part of the U.S. government such a doomsday scenario cannot play out here. They claim that the Federal Reserve, being independent, is immune to political pressure. Yet throughout its existence it has acted to support the U.S. government; periodically, the Congress threatens to update or revise the Federal Reserve Act to mandate greater congressional oversight of the Fed’s operations and the ‘independent’ organization suddenly becomes quite accommodating.
Historically, the Federal Reserve has purchased only a small fraction of the bonds issued by the U.S. Treasury; it didn’t have to – there were always sufficient buyers willing to buy Treasury Bonds to keep the U.S. government operating. That is changing. The U.S. government will have to borrow more than a trillion dollars a year to fund its operations. At the same time the U.S. Government is borrowing at such unprecedented levels, the willingness of voluntary investors to purchase the bonds is collapsing. If the Federal Reserve were passive, within a year or so we would see U.S. Treasury Bonds routinely going unsold at auctions. The Federal Reserve, inevitably, will begin purchasing those bonds to keep the U.S. government solvent.
In an inflationary economic regime, the formal economy is generally a suckers game. To avoid being taken to the cleaners, consider doing the following:
- Start or purchase a business making something in relatively widespread demand that is not likely to have price controls slapped on it.
- Go into a profession where your skills will be in wide demand.
- Learn how to fix broken things.
- Cultivate circle of associates with whom you can engage in gray-market or black-market business deals.
- Befriend a policeman or a judge! They can get you out of hot water should you get tagged for committing an economic ‘crime’.
- Get to know local gold-dealers, particularly ones who buy and sell gold chains.
- Learn how to defend yourself; police take time to respond, and are prone to prosecuting economic crimes when confronted by evidence of contraband.
- Buy an old “Whip Inflation Now” button. It will be about as helpful as it was in the 1970’s
You don’t have to be helpless as the Democratic and Republican Party Apparatchiks loot the economy. Prudent steps taken now can pay off in the coming dark years.